Financial Theories
What are the finance theories about entrepreneurship?
Financial theories in entrepreneurship attempt to explain how founders acquire resources, how they value their ventures, and how they navigate relationships with investors despite uncertainty.
Agency Theory
The Principal-Agent Problem.
Agency theory often starts with skeptical assumptions about entrepreneurs. It seeks to explain the potential conflict of interest between the "principals" (investors/shareholders) and the "agents" (entrepreneurs), focusing on how to use governance and contracts to align their interests.
Information Asymmetry
What you know that they don't.
In the early stages, entrepreneurs know much more about the venture's potential than investors do. This "asymmetry" creates a gap that explains bargaining power, valuation difficulties, and why investors demand higher equity stakes to offset the risk of the unknown.
Liquidity Constraint Theory
Capital as the barrier to entry.
This theory posits that access to liquid capital is the primary key to entrepreneurship. It suggests that individuals with personal wealth or easy access to credit are significantly more likely to start businesses than those without, highlighting the "wealth gap" in startup creation.
Pecking Order Theory
How entrepreneurs choose funding sources.
Pecking order theory suggests entrepreneurs do not choose financing randomly. They follow a hierarchy of preference to minimize loss of control and signaling costs: Internal Funds (Bootstrapping) first, Debt second, and Equity as a last resort.
Real Options Theory
Entrepreneurship as a strategic bet.
Real options theory views entrepreneurial investment decisions from a "gambler's" or strategic perspective. It treats the decision to invest in a startup not as a one-time event, but as a series of options (to expand, defer, or abandon) based on how the market unfolds.
Signaling Theory
Reducing uncertainty for stakeholders.
Because of information asymmetry, investors look for "signals" of quality. This theory explains how entrepreneurs communicate quality to stakeholders through credentials, patents, prestigious alliances, or personal financial commitment to bridge the trust gap.
