Chapter 5 concentrated on issues relating to debt finance of entrepreneurial ventures. This broadly reflects the emphasis in the literature. Yet many start-ups obtain external finance through informal sources, such as loans from family and friends and credit co-operatives. A smaller number utilise equity finance (venture capital). Part of the interest in studying alternative sources of finance is that they might be able to fill any gaps created by credit rationing.

The structure of the chapter is as follows. Section 6.1 explains the economics of informal sources of finance, and section 6.2 treats aspects of equity finance that relate to typical entrepreneurial ventures. We will cite only selectively and sparingly from the extensive corporate finance literature on risk capital, most of which pertains to large firms. Section 6.3 concludes.

Informal sources of finance

Family finance

In his analysis of the 1992 CBO database, Bates (1997) showed that families are the most frequently used source of business loans in the USA after financial institutions (mainly banks). Bates reported that 26.8 per cent of non-minority-owned businesses used family finance, compared with 65.9 per cent who used loans from banks. Among some minority groups, however, family finance was used more extensively than bank finance. For immigrant Korean and Chinese business owners, family finance was used by 41.2 per cent, whereas bank finance was used by 37.4 per cent (see also Yoon, 1991).