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Faculty Research from the
Leavey School of Business

Research

Financing from Family and Friends

Abstract:

Most informal finance comes from family and friends. Existing informal finance theories cannot match two characteristics of family finance: family investors may accept below-market or even negative returns, yet borrowers often prefer formal finance. We argue that social preferences make family finance cheap but create shadow costs that nonetheless discourage its use: Committing family funds to risky investment displaces intrafamily insurance and undermines limited liability. The same characteristics that sustain familial insurance thus render family finance a poor source of risk capital. Even when overcoming capital constraints requires social ties, intermediation and semiformalization may therefore be crucial for promoting risk taking.

Received April 29, 2013; accepted December 4, 2015 by Editor Andrew Karolyi.


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LSB Research, Featured, FNCE