The king’s speech: How entrepreneurs’ family social capital and risk aversion shape new venture financing

Frame of the research. Traditionally, the entrepreneurial function has been conceptualized as closely related to the entrepreneur’s personal wealth. Despite the expanding supply of equity-based funding and the fact that venture capitalists (VCs) usually provide managerial and value-added contributions critical to new ventures success, VCs continue to account for only a modest share of overall entrepreneurial finance, especially when quantitatively compared to commercial banks. This phenomenon raises a fundamental question: what are the factors that systematically shape the propensity of entrepreneurs to choose between venture capital and bank financing? Purpose of the paper. The primary objective of the paper is to advance our understanding of when a rational entrepreneur would seek venture capital rather than bank financing by developing a more comprehensive framework that incorporates two practically salient factors: family social capital and risk aversion of the entrepreneur. Methodology. We propose a theoretical model of entrepreneurial financing in which preferences are characterized alternatively by a mean-variance framework and CARA utility, linking family social capital and risk aversion to show how their interaction shapes the financing choice. Results. Family social capital affects utility under bank financing through two channels: it improves borrowing conditions by lowering the cost of debt, but it also increases effective risk aversion. The net impact of social capital on utility therefore depends on the relative strength of these two forces. Under venture capital, equity-based financing exposes the entrepreneur to full payoff variability, so that risk aversion directly reduces the attractiveness of venture capital. As a result, there exists a threshold level of effective risk aversion such that venture capital is preferred to bank financing. Research limitations. The impact of family social capital on borrowing conditions and risk aversion is modeled in a linear form, but potentially nonlinear relationships may generate richer dynamics and alternative threshold effects. Managerial implications. Venture capital financing is likely to be most beneficial when the new venture lies squarely within the venture capitalists’ domain of expertise, enabling meaningful managerial value-added, when entrepreneurs pursue ambitious growth objectives, and exhibit lower risk aversion. Venture capitalists are more likely to achieve favorable outcomes when the entrepreneur’s family social capital is limited. Originality of the paper. While past research has focused almost exclusively on the central trade-off in venture capital financing – the profit motive versus the control motive – characterizing this trade-off as a “double moral hazard” problem, we advance the idea that entrepreneurial risk aversion and family social capital jointly shape the choice between bank debt and venture capital. Abstracting from these factors sharpens analytical tractability, yet it limits the understanding of a phenomenon that remains widely underexplored despite its practical relevance for new venture success.