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date: 05 December 2022

# Entrepreneurial Finance and Governance

• Pierluigi Martino, Pierluigi MartinoDipartimento di Economia e Management, Università di Pisa
• Greg Bell, Greg BellCollege of Business, University of Dallas
• Abdul A. RasheedAbdul A. RasheedDepartment of Management, University of Texas at Arlington
•  and Cristiano BellavitisCristiano BellavitisWhitman School of Management, Syracuse University

### Summary

Entrepreneurial finance includes a wide array of sources of capital, such as venture capital, angel investors, equity, and debt finance, along with new forms of financing through crowdfunding and initial coin offerings. Providers of funds to entrepreneurial ventures, whether they are venture capitalists, angel investors, debt holders, or participants in crowdfunding face similar agency problems, such as moral hazard and adverse selection. There are considerable differences across investors in terms of their objectives, risk-bearing capacity, and time horizons, as well as in their motivation and ability to monitor the firms in which they invest. These differences give rise to governance challenges associated with each source of entrepreneurial finance.

### Subjects

• Entrepreneurship

### Introduction

Entrepreneurial finance includes a wide array of sources of capital, such as venture capital (VC), angel investors, equity, and debt finance, along with new forms of financing through crowdfunding and initial coin offerings (ICOs). External investors can have considerable influence on entrepreneurial ventures. Formal VCs emerged in the 1940s, and by the mid-1980s their influence had spread internationally (Bruton et al., 2005). Business angels (individuals who invest their own money) are also referred to as informal VCs (Bonini et al., 2019). Business angels have created formal business angel networks (BANs) and groups to build a more structured and visible market for angel finance. Entrepreneurial finance continues to evolve, especially with the advent of digital technologies. Nontraditional forms of entrepreneurial finance have also emerged, with crowdfunding and ICOs the most prominent examples.

Over the last three decades, the market for entrepreneurial finance has grown significantly, and this is reflected in the growth in research on entrepreneurial finance as well (Li et al., 2020). Research on professional VCs took off in the mid-1980s and has grown exponentially ever since (Wallmeroth et al., 2018). There have been multiple attempts to survey the state of research in this area (Chemmanur & Fulghieri, 2014; Cumming & Groh, 2018; Fraser et al., 2015), and Bellavitis et al. (2017) have reviewed the emerging sources of entrepreneurial finance, such as crowdfunding. Similarly, Nguyen et al. (2021) reviewed the effect of business angels and VCs, and the interaction among different types of investors (e.g., crowdfunding, business angels, VCs, etc.). Other comprehensive reviews on entrepreneurial finance include Li et al. (2020) and Cumming et al. (2019a).

Entrepreneurial equity investments spark innovation and development for entrepreneurial ventures. However, providers of funds to entrepreneurial ventures, whether they are VCs, angel investors, debt holders, or participants in crowdfunding, face similar agency problems. First, there are substantial information asymmetries between the entrepreneur and the providers of funds. The entrepreneurs have incentives to misrepresent the prospects of the venture, either because they have an inflated belief in the venture idea or because they are less than honest. This can lead to problems of adverse selection. In addition, there is also potential for moral hazard in the relationship between providers of finance and the entrepreneur. Burchardt et al. (2016) identified several potential causes of moral hazard problems, such as entrepreneurs’ unwillingness to expend full effort once funds are committed, their ability to extract informational rents, their leverage of threatening to leave knowing fully well that their human capital would be difficult to replace, and their knowledge that fund providers have limited capacity to intervene.

A typical new venture avails itself of financing from multiple sources, and the investors differ in terms of their objectives, risk-bearing capacity, and time horizons, as well as in their motivation and ability to monitor the firms in which they invest. Given the differences across investors, the objective of this article is to provide an understanding of the governance challenges associated with each source of entrepreneurial finance and the mechanisms that are employed to mitigate these challenges. The following sections review the literature on entrepreneurial finance with a focus on the central issues in venture governance, namely the inherent agency issues associated with each source of finance and the mechanisms adopted by fund providers to mitigate agency risks.

#### Venture Capital

VC tends to be the most widely used form of equity financing for entrepreneurial ventures (Wallmeroth et al., 2018). VC firms raise funds from high-net-worth individuals, university endowments, and pension funds and invest in a portfolio of innovative companies (Gompers & Lerner, 2000). These investors are seeking higher returns than they can get by investing in the stock market and are willing to bear much higher risks than normal investors. VC firms are typically small, and they often work closely with the ventures in which they invest to provide guidance and value beyond just capital (Sørensen, 2007). VC firms provide patient capital and their time horizon is typically under ten years. Their goal is timely exit via either an acquisition or an initial public offering (IPO).

Given that investing in new ventures carries a high level of risk, VC firms pursue a number of strategies to mitigate their risk and to maximize their payoff. They begin by conducting comprehensive screening before they invest in a new venture (Gompers & Lerner, 2000), and they invest in only the ventures that they believe will be successful. VC firms also invest in several ventures at a time, thereby diversifying their risk. Also, most VC firms form investment syndicates with other investors. Syndication enables VC firms to jointly vet investment opportunities. It has been observed that the same VC firms frequently partner together in their investments. This can reduce partner-specific risks, such as free-riding, relational conflict, and self-serving behavior, and can facilitate relationship continuity, trust, and collaborative capabilities. Thus, a continuing pattern of co-investments can lead to better syndicate performance, although excessive co-investing has its downsides (Bellavitis et al., 2019). Instead of making a one-time big investment, most VCs split funding into multiple rounds. Thus, at each stage they evaluate whether additional funding is warranted or whether they should stop funding a venture.

Unlike for debt holders, whose primary goal is to limit risk exposure, for VC firms, limiting risk is not the primary motivation. Their goal is to maximize their payoffs while managing risks. VC investments are like holding options, in the sense that they have unlimited upside potential and limited downside losses. Therefore, VC firms place more emphasis on strategies that can maximize the value of the firms in which they invest. VCs are active investors who take part in the strategic development of the venture (Wallmeroth et al., 2018). Occasionally, they may participate in the operations of the firm as well. VCs help inexperienced firms develop strategies that strike the delicate balance between satisfying profit demands and simultaneously positioning the firm for sustained growth.

Research has demonstrated that VC firms act as effective monitors (Barry et al., 1990) and may even take steps to change the management of their portfolio firms if they find the performance of the current management inadequate (Hellmann & Puri, 2002). In addition, VC firms bring considerable expertise and network connections to help their invested firms. Most VCs have the ability to work effectively in highly uncertain environments and to reduce the cost of information asymmetries (Ang, 2006).

In any situation where funds are provided to a firm by one set of parties and the funds are used by another set of parties, there is potential for agency problems or goal conflicts. Cumming and Johan (2009) pointed out that VCs face significant adverse selection problems due to the presence of systematic, unsystematic, and informational risks associated with start-ups. Moral hazard problems are also present due to the malleable nature of the assets, which allows entrepreneurs greater opportunity for extracting private benefits of control. These problems are exacerbated in high-tech ventures due to the preponderance of intangible assets, a high degree of asset specificity that reduces the collateral value of the assets, and excessive reliance on the unique skill sets of the entrepreneurs (Burchardt et al., 2016). In response to these challenges, VCs engage in several strategies to enable better monitoring and control and to bring about incentive alignment. Monitoring mechanisms used by firms may be either contractual or mechanisms that enhance the ability for control. These include use of performance-sensitive compensation, such as stock options (Arcot, 2014), covenants (Bengtsson, 2011), liquidation rights, contingency-based control rights, and vesting rights. Other mechanisms include decision and veto rights, the right to appoint the CEO and other board members, board representation, and active monitoring of the management team post-investment (Drover et al., 2017). VC firms also make extensive use of convertible debt to enhance their ability to intervene if things do not work out as expected (Burchardt et al., 2016).

#### Corporate Venture Capital

Corporate venture capital (CVC) has become more common as corporations have increasingly invested in early-stage businesses and start-ups. According to Global Corporate Venturing (GCV) Analytics, in 2019, major companies worldwide participated in a record 3,237 CVC deals, which is more than four times the number of CVC-backed deals in 2011 (Irwin-Hunt, 2020).

CVC is equity investments in entrepreneurial ventures by larger, more established firms (Dushnitsky & Lenox, 2005). CVC is an attractive alternative to acquiring smaller firms because it requires fewer financial resources, and it enables new ventures to maintain their independence, thus allowing them to be more creative and innovative.

Organizations can use a variety of forms when conducting corporate venturing, as CVC investments, alliances, joint ventures, and acquisitions all fall under this definition (Anokhin et al., 2016). Galloway et al. (2017) pointed out that CVCs present many advantages to the investee firm as well as to corporate parents. The advantages include the resources that CVCs can provide, including managerial and technical expertise, R&D, product support, and marketing and distribution networks (Lantz et al., 2011). CVC investments help corporate parents monitor markets and technologies for new developments (Keil, 2004). CVC-backed firms tend to attract higher valuations in both IPO (Stuart et al., 1999) and acquisition markets (Ivanov & Xie, 2010) than the valuations given to independent VCs. Last, the investment horizons of CVCs are longer than those of VC firms. Table 1 highlights the key differences between VC and CVC.

#### Table 1. Differences between Venture Capital and Corporate Venture Capital

Corporate Venture Capital

Venture Capital

Definition

Independent investment group within an organization

A company (“fund”) whose primary objective is to invest in startups

Objectives

Value creation for the corporate parent and synergies with portfolio companies

Financial returns for limited partner investors

Investment horizons

Medium to very long term

Medium term (6–10 years)

Source of funds

The company’s balance sheet

Limited partners

Value proposition

Managerial experience, network, channels to customers

Partners’ experience and network

#### Angel Investors

An angel investor is a

high-net-worth individual, acting alone or in a formal or informal syndicate, who invests his or her own money directly in an unquoted business in which there is no family connection and who, after making the investment, generally takes an active involvement in the business, for example, as an advisor or member of the board of directors

The key role that business angels play is to fill the funding gap between the internal financing coming from the entrepreneurs and their friends and family, and the external financing raised from institutional VC firms. Angel financing can come in the form of equity, loans, or loans that convert to equity on maturity at favorable terms (Chemmanur & Chen, 2014).

Most of the research on angel investors is focused on the pre-investment stage, and there is only limited research on post-investment activities of angels. Most angels draw up contracts at the time of their initial investment (Kelly & Hay, 2003). These contracts typically deal with issues like right to participate in future financing and ways to prevent potential future dilution of their stock, rather than on measures to ensure control. As suppliers of funds, angels are very much involved in the monitoring of the firms in which they invest, but angel monitoring is often referred to as “soft monitoring” (Bonini et al., 2019) and is different from contractual-based monitoring mechanisms typically used by VCs. The monitoring mechanisms used by angel investors are nonaggressive and informal, based upon a close post-investment involvement through company visits, interactions with entrepreneurs, and other approaches based in trust (Bonini et al., 2019). Angels accomplish their governance role by offering advice based on their extensive prior experience, by allowing access to their personal networks, by providing informal consulting help, and occasionally by serving on the company’s board. Thus, angels primarily rely on relational approaches, rather than contractual or transactional approaches, to mitigate their agency risk (Collewaert et al., 2021).

Fili and Grunberg (2016) identified five governance processes through which business angels engage with new ventures. The boundary-spanning process involves interactions with external parties by facilitating access to resources through their networks and contacts, providing contact with business actors, helping recruit key personnel, providing market intelligence, and, finally, transferring some of their social capital to the venture to establish credibility and legitimacy.

Second, business angels engage in several structuring processes. They help the venture follow more formalized approaches to operational planning by introducing strict accounting procedures, regular reports on financial data and operational progress, and cash-flow planning. They also help develop the company’s long-term strategy (Fili & Grunberg, 2016).

Third, they contribute through leadership processes by acting as a sounding board and by participating in discussions with venture managers. A fourth governance process is referred to as “the doing process,” in that business angels often get directly involved in the operational aspects of the venture, ranging from shaping the business model, to helping solve operational issues, to evaluating capital expenditures. Finally, the monitoring process includes monitoring activities from a board position, monitoring strategic decision-making, and overseeing the financial performance of the venture (Fili & Grunberg, 2016).

#### Equity Markets and Governance

For most entrepreneurial ventures, a landmark event in their history is the IPO. Accessing equity markets is an important choice that the management makes, a choice that comes with both advantages and some disadvantages. It is important to note that some new ventures do not pursue the IPO path at all, with some firms opting to remain private and others preferring to be bought out by other, bigger firms. The motivations and drawbacks associated with an IPO and the factors that research has identified as contributing to IPO success are discussed next.

The IPO is the process by which a private company becomes a publicly listed company through the sale of a certain percentage of its stocks to the public. There are several motivations for an IPO. First, it provides the firm with external capital that is critical for firm growth, because most growing firms need capital for capital expenses and for funding R&D and product development. For the founders, an IPO represents a means to greatly enhance their wealth. For the VC firms, an IPO is often an exit strategy with significant gains on their initial investment. As a result of the IPO, the firm can reward its executives and employees with stock options. Moreover, the infusion of equity that results from the IPO also increases the firm’s borrowing capacity. In addition, an IPO brings the advantages of greater visibility, higher legitimacy, and significantly higher market valuation. Yet, some disadvantages also accompany an IPO. First, the firm becomes subject to greater scrutiny by analysts, the business press, and the shareholders. The pressure to meet the short-term expectations of financial markets can greatly increase the pressure on the top management team. As a public company, the firm is also subject to greater disclosure requirements and even potential lawsuits by unhappy investors. The passage of the Sarbanes-Oxley Act of 2002 also greatly increased compliance requirements and the cost of compliance for publicly listed firms.

##### Initial Listing Decisions

Two very important decisions that a firm has to make in the context of an IPO are where to list its stocks and how many classes of shares it should issue. Both decisions have significant governance implications. For instance, many developed countries today have more than one stock exchange, with different listing requirements and costs. In the United States, for example, there are the New York Stock Exchange (NYSE), the NASDAQ, the American Exchange (AMEX), the Better Alternative Trading System (BATS), and the OTC markets. Today, firms are not restricted to their home country’s exchanges for raising capital. A number of firms choose to list outside their country, forgoing their domestic markets altogether. The increasing competition among stock markets around the world to attract more firms and the establishment of stock exchanges that require lower levels of transparency have accelerated the trend toward foreign listing. In 1995, for example, the alternative trading market (AIM) was established in London to cater to the capital demands of small and medium-size firms. Similar trading platforms modeled after London’s AIM have been opened in other countries as well. Firms are motivated to list abroad for several reasons, including greater liquidity and access to capital, potential to make future acquisitions, increased reputation and valuation, and marketing and public relations benefits (Bell & Rasheed, 2016). Most importantly, foreign listing may also be motivated by a firm’s desire to signal that it is willing to adhere to higher standards of governance (Bell et al., 2012). For example, Coffee (2002) suggested that foreign firms originating from jurisdictions that feature potentially weaker investor protection can increase their valuation by bonding themselves to a host market’s securities regime and adhering to high governance standards. Scholars have argued that a greater fit with the institutional environment should lead to higher levels of legitimacy for firms desiring to list outside of their home capital market (Moore et al., 2012).

A second decision that has significant governance implications is the number of classes of shares issued. A company has the legal right to issue multiple classes of shares, each with differential voting rights. These are referred to as dual class structures or super-voting structures. Dual class structures deviate from the common principle of one share/one vote, tilting the balance of power in favor of owners of the higher class of shares because they have disproportionately higher voting rights despite their lower share of ownership. For example, Class A shareholders of Alphabet Inc. (holding company of Google) have one vote per share, while class B shareholders have 10 votes per share. Dual class structures are increasingly popular among technology companies and today account for about one fifth of the new issues in the U.S. exchanges. Such structures are characterized by a significant divergence between ownership stakes and control rights. They essentially disenfranchise the majority of providers of share capital and render corporate governance (CG) mechanisms powerless by disabling the market for corporate control. So, the obvious questions are, why do firms choose such structures and why do investors accept such structures? From the perspective of the founders of the firm, there are clearly several benefits. First, firms can focus on long-term goals without worrying about short-term results by compartmentalizing short-term capital and patient capital. Second, dual class structures enable the entrepreneurial founders to stay in leadership positions for an extended period and ensure continuity in leadership and strategies. Third, dual class structures constitute the ultimate antitakeover mechanism by preventing takeover attempts, especially of a hostile nature. To date, investors seem to be happy with dual class structures because many firms have rewarded the investors with above-average returns (Singh et al., 2021). One problem with dual class structures is managerial entrenchment. However, the problems of managerial entrenchment that accompany dual class structures can be mitigated by sunset provisions. Sunset provisions establish a fixed point in time at which the class of shares with superior voting rights will automatically convert to common stock with one vote per share.

##### Pre-IPO Governance Signals

One of the challenges that new ventures face in their attempts to garner investor support for a new issue is informing investors of the true value of the firm. One of the principal mechanisms through which a company can signal to the market the value of their new issue is with the prospectus. Considering the degree of information available about the history of the firm and its management, many of the signals associated with new issues can be gleaned from a firm’s prospectus.

Research has identified several theoretical and empirical signals contained in the prospectus that communicate the value of the firm to potential investors. Leland and Pyle (1977) suggested that retained ownership by an organization’s initial shareholders could provide outsiders with a credible signal of less principal–agent conflict and a positive signal of expected future cash flows. Downes and Heinkel (1982) confirmed that “firms in which entrepreneurs retain high fractional ownership do indeed have higher values” (p. 9). When key executives maintain significant ownership levels in their firms, investors are less inclined to foresee agency problems with upper management and therefore anticipate decision-making that is aligned with maximizing long-term shareholder value and ultimately better performance by the firm. It is believed that those firms with higher levels of insider ownership will perform better due to improved decision-making via the alignment of interests between managers and owners. A number of studies have supported the important role that retained ownership has in the performance of IPOs. Both block holders (those with greater than 5% ownership) and institutional owners have also been demonstrated to be viable signals of credibility that uninformed investors may refer to when evaluating their support of a new issue (Sanders & Boivie, 2004). Similarly, continuing ownership by VC firms even after the IPO sends a strong positive signal about their belief in the firm’s prospects.

Investors tend to view new issues whose CEO is also the organization’s founder positively simply because not only do these executives possess structural authority, but also they convey symbolic value by their continued commitment and personal tie to the organization (Nelson, 2003). When compared to nonfounder-CEO firms, founder-led firms amass a higher premium of stock price over book value at IPO (Nelson, 2003). At the time of the IPO, the presence of a founder CEO may be a powerful signal, because founder CEOs often make substantial personal investments in helping an organization grow from infancy (Nelson, 2003). Founders also possess a great deal of knowledge about the firm and its processes (Fischer & Pollock, 2004) and can be considered a source of competitive advantage (Baum et al., 2001) for the firm.

In their comprehensive review, González et al. (2020) pointed to several different CG characteristics used to mitigate the agency problems of adverse selection and moral hazard faced by a firm when going public. The governance characteristics function as signals to external investors to show a strong interest alignment during and after the IPO. The characteristics include managerial incentives, IPO lockups, and boards (composition, leadership structure, reputation, size). Independent boards that possess a diverse set of skills and experience are considered important to investors because they imply the firms will be better governed (Useem et al., 1993). Similarly, board size is also often interpreted as a positive signal. A larger board is likely to bring in diverse views and experience and, more importantly, a bigger network of connections that will be beneficial to the firm. Fischer and Pollock (2004) suggested that larger boards may lead to quicker decision-making and better performance. However, Jensen (2003) suggested that larger boards are less effective and may lead to communication and coordination challenges. Other factors, including the reputation of the auditing firm, have also been studied. For example, Beatty (1989) and Michaely and Shaw (1995) found that reputable auditing firms are associated with lower underpricing.

#### Debt Markets and Governance

One of the most fundamental decisions that a young entrepreneurial firm has to make is the choice between debt and equity. This choice involves many trade-offs, and in many cases it is not entirely a matter of choice, because a firm may be constrained in its choice by the specific circumstances that it is facing.

Other things being equal, most entrepreneurs may prefer debt to external equity (Berger & Udell, 1998), for two reasons. First, entrepreneurs have a strong incentive to retain high levels of equity because accessing external equity would involve ceding at least some level of control to external parties (Cumming & Groh, 2018). Second, for the founders and promoters of the firm, the upside gains are higher when the firm performs well if there are a smaller number of shares outstanding. External equity comes with unavoidable dilution of ownership, thus limiting the entrepreneur’s ability to appropriate subsequent gains in value.

But, in practice, it is found that entrepreneurial firms generally rely more on equity than traditional forms of debt, such as bank loans and bonds. This is attributed to three main reasons. First, most startups, especially in high-tech areas, have very little in terms of fixed assets that they can offer as collateral to a traditional bank. Second, the information asymmetry problem between the lender and the borrower is far more acute in the case of new ventures than in the case of established firms. Third, new ventures have very unpredictable cash flows, with cash flows expected to arise far into the future. Generally, commercial banks prefer short-term financing. Similarly, a new venture may find it difficult to raise debt capital through the issue of bonds because investors will be unlikely to buy long-term bonds from new ventures, which tend to have a high level of bankruptcy risk. This logic may suggest that new ventures have very limited access to debt, but it is important to note that this line of reasoning only applies to traditional commercial bank lending. There is growing evidence that entrepreneurial firms are increasingly availing themselves of less conventional forms of debt: personal debt and business debt.

An entrepreneur can borrow in his personal capacity rather than in the name of the business. In this case, the lending officer is not evaluating the future cash flows of the business, but only the credit worthiness of the entrepreneur. If it is an unsecured loan, obviously the interest rate will be higher. Alternately, the entrepreneur can obtain a loan by offering his personal assets, such as real estate, as collateral. Either way, the loan application is likely to be processed faster than in the case of business loans. But there are three negatives associated with personal loans. First, the amount that can be raised through personal loans is likely to be small, which can work only for relatively small startups. Second, in personal loans, the entire notion of limited liability that is so essential for business activity is absent. Third, the lender does not monitor the business, which makes personal loans ineffective from a governance perspective.

An entrepreneur can obtain business debt for the venture from multiple sources and in multiple forms. Typically, the providers of business loans to new ventures tend to be more informed lenders. They also tend to have greater capacity to monitor the entrepreneurs and to constrain them through loan covenants. The initial cost of obtaining the loan is higher because of the need to reduce information asymmetries by providing more information to lenders. But the interest costs may be lower than they are for most types of personal loans.

One common governance mechanism used by lenders is covenants. These are restrictions that lenders place on lending agreements to limit the actions of the borrower (debtor), and they serve to safeguard the interests of lenders. In his review, Denis (2004) summarized how covenants address problems of information asymmetry and moral hazard in entrepreneurial financing arrangements by structuring investments so that the financing party is able to maintain control, and that the entrepreneur has the appropriate incentives to maximize the value of the financial claims. Also, covenants enable the financing party to be actively involved in the management of the company, and the financing party can preserve the ability to liquidate their investment (Denis, 2004). Properly structured debt covenants can mitigate agency problems between stockholders and bondholders and reduce the firm’s borrowing costs. They are designed to discourage reliance on risky debt financing that can often lead to inefficient investments and other related agency costs that are associated with heavy reliance on debt (Smith & Smith, 2019). However, as Smith (1993) pointed out, covenants that are too restrictive can severely limit the operating and financial activities of the borrowing firm.

##### Venture Debt Lenders

A new form of business debt that has grown considerably in volume is venture debt, which is provided by specialized financial institutions called venture debt lenders (VDLs). VDLs mostly provide loans to high-tech firms. Even given the problems of information asymmetry, cash-flow uncertainty, and absence of tangible collateral, VDLs can increase the odds of repayment. First, intellectual property, though less tangible, is just as valuable as physical property. VDLs accept patents as collateral. Second, they prefer to lend to firms that offer them warrants. These warrants are subsequently convertible to equity at very attractive prices. This helps to overcome the agency problems associated with loans (Brennan & Kraus, 1987). But from the investor’s perspective, the warrants represent a cost in the sense that they carry the potential for equity dilution later. It has also been found that ventures backed by VCs are more likely to be able to access debt financing (De Rassenfosse & Fischer, 2016). Thus, debt is not a substitute for VC funding. Instead, VC funding facilitates access to debt capital. It appears that the certification benefits of VC backing substitute for positive cash flows.

##### Informal Debt

There is increasing recognition that not all the debt taken by new ventures is formal debt from lending institutions. Many new ventures in emerging economies primarily rely on informal debt (Bruton et al., 2011). This may be the result of institutional voids in many emerging countries, which do not have well-developed institutions like VCs or even credit ratings. Informal finance consists of supplier credit, customer prepayments, rotating credit associations, informal money lenders, personal savings, and gifts from family or friends. Thus, informal financing is a mix of debt and equity. Informal debt is attractive to entrepreneurs in emerging economies for a variety of reasons. It comes with no collateral requirements and no formal contracts, although it is common to have a written or oral agreement regarding interest rate and repayment schedule. Thus, transaction costs are minimal. Even more importantly, such loans are negotiated in a matter of days, rather than the weeks or months it would take for a formal loan to be approved and disbursed.

In many emerging economies, entrepreneurs facing extreme working capital problems go to informal money lenders to tide over short-term cash-flow issues. In countries like India, for example, there is a parallel banking system that is almost as sophisticated as the commercial banks. The money lenders provide a variety of financial services, such as bill discounting and money transfers, with minimal paperwork. Although the transactions are quick and convenient, they come with prohibitive interest costs and aggressive debt collection if the borrower defaults.

In summary, contrary to the notion that new ventures rely mostly on equity, many new ventures incur considerable amounts of debt from both formal and informal sources. In most cases, debt does not substitute for equity, but supplements equity. The presence of equity along with debt suggests that effective monitoring is ensured and that lenders maintain the option to exercise greater control through exercise of warrants or by converting debt to equity.

### New Forms of Entrepreneurial Finance

The landscape for entrepreneurial finance has changed significantly The fintech revolution, enabled by new digital technologies, has led to the development of new financial alternatives for seeding entrepreneurship (Bellavitis et al., 2017; Block et al., 2018; Bruton et al., 2015). The most prominent examples of such innovative forms of entrepreneurial finance are crowdfunding and initial coin offerings (ICOs; Block et al., 2021; Bruton et al., 2015).

Both crowdfunding and ICOs have their roots in the broader concept of crowdsourcing, through which individuals or companies use the “crowd” to obtain ideas, feedback, and solutions (Belleflamme et al., 2010). In the case of crowdfunding and ICOs, the objective is to raise money (Adhami et al., 2018; Belleflamme et al., 2014; Lambert & Schwienbacher, 2010) by leveraging the geographic and social reach of the Internet to connect fundraisers to millions of potential backers (Bruton et al., 2015; Moritz & Block, 2016). This allows entrepreneurs to obtain funds from a large audience, with each individual providing a very small amount, instead of raising large amounts of money from a small group of sophisticated investors (Fleming & Sorenson, 2016; Hornuf et al., 2018; Martino et al., 2020a), thereby democratizing entrepreneurial finance (Bellavitis et al., 2017; Martino et al., 2020b). Depending on how they are structured, both crowdfunding and ICOs may have different impacts on the ownership and governance of new ventures (Ahlstrom et al., 2018; Bruton et al., 2015; Momtaz, 2020a).

#### Crowdfunding: Definition and Main Characteristics

In a crowdfunding campaign, the process of fundraising takes place on crowdfunding platforms—i.e., Internet-based platforms that act as intermediaries between individuals, start-ups, or companies (i.e., the fundraiser) on the one hand, and potential backers (i.e., investors) on the other. In contrast to traditional financial intermediaries, crowdfunding platforms do not borrow, pool, and lend money on their own account; instead, they facilitate transactions by matching project fundraisers and backers and act as an information, communication, and execution portal (Belleflamme et al., 2014). Such platforms allow entrepreneurs to advertise and pitch their products and ideas to the community of online backers, for example by showing prototypes of their products or by presenting an investment opportunity. Moreover, crowdfunding platforms provide infrastructures for managing payments and for keeping track of, and communicating with, scores of donors or investors (Agrawal et al., 2011; Fleming & Sorenson, 2016). Platforms usually charge those receiving funds a fee, typically a percentage of the amount raised (Agrawal et al., 2014).

There are four main models of crowdfunding: reward, donation, lending, and equity crowdfunding (Belleflamme et al., 2014; Block et al., 2018; Hemer, 2011). In reward-based crowdfunding, promoters raise funds in exchange for a reward, which typically involves the delivery of a product or service of the company. As an example, in 2012, Formlabs—a 3D printing technology company—launched a campaign that raised nearly $3 million, and the reward was delivery of their printer to backers who pledged$2,299 or more. However, in other cases backers may also be offered other types of (“symbolic”) rewards, such as a name plaque, invitations to social events, or symbolic objects that show support for a project (Block et al., 2018). In donation-based crowdfunding, individuals or nongovernmental organizations raise money to support humanitarian and artistic projects. They promise no remuneration and therefore the process resembles philanthropy rather than entrepreneurship.

Contrary to the first two models, where funders do not receive monetary compensation, equity and lending-based crowdfunding can be considered alternative financial investment instruments (Belleflamme et al., 2015; Hornuf & Schwienbacher, 2018). In lending-based crowdfunding, the fundraiser seeks to borrow capital from the crowd in the form of loans, and lenders are compensated with interest. From an entrepreneurial perspective, the most important form of crowdfunding is equity-based crowdfunding,1 in which the fundraiser offers equity stakes (Ahlers et al., 2015; Colombo et al., 2015; Vulkan et al., 2016) and the subscribers become shareholders with voting rights and are entitled to the distribution of future profits (Ahlers et al., 2015). The Rushmore Group, a U.K.-based company that owns and manages a chain of private members’ clubs, hotels, and restaurants, for example, sold 10% of its equity for £1,000,000 to 143 small investors (Ahlers et al., 2015) through crowdfunding in December 2011.

Crowdfunding has been studied in the literature from the perspectives of both the fundraiser and the investors. From the fundraiser perspective, funding is the main reason for using crowdfunding, because it expands access to financial resources for those often excluded from traditional forms of entrepreneurial finance (Cumming et al., 2021b; Hemer, 2011). Crowdfunding dramatically lowers the costs of fundraising (Agrawal et al., 2015; Fleming & Sorenson, 2016) and overcomes the distance-related economic frictions usually associated with financing entrepreneurial ventures (Agrawal et al., 2011). However, fundraisers are interested in crowdfunding for reasons that go beyond the need for funding. Various studies have found that fundraisers take advantage of crowdfunding for marketing purposes (e.g., gaining public attention), receiving feedback on products or service, and allowing companies to exploit their market potential (Agrawal et al., 2014; Belleflamme et al., 2010; Hu et al., 2015; Mollick, 2014).

Entrepreneurs can use crowdfunding to demonstrate demand for a proposed product, which can then lead to funding from more traditional sources. Moreover, fundraisers may receive input on their product or business plan from investors, thereby facilitating the early development of an ecosystem around the product. As an example, Scanadu—a Silicon Valley-based company developing next-generation medical tests, devices, and services, used crowdfunding not only to raise money ($1,664,574 raised in under 60 days), but also to acquire individuals willing to participate in its clinical trials. For investors, the main motivations are community participation; support for a product, service, or idea; early access to new products; and access to investment opportunities (Agrawal et al., 2014; Cholakova & Clarysse, 2015; Hemer, 2011; Schwienbacher & Larralde, 2010). Agrawal et al. (2011) showed that investors support projects based on an emotional relationship or a personal identification with the project’s subject and its goals. Other studies (Agrawal et al., 2014; Hemer, 2011; Schwienbacher & Larralde, 2010) showed that backers participate in crowdfunding with the aim of contributing to a societally important mission or being a member of a specific community. The interest in using the product or service offered by the venture also plays a significant role in the investor’s decision to bid in crowdfunding offerings (Mollick, 2014). Finally, financial returns are the main motivation for most investors in equity crowdfunding (Bretschneider et al., 2014; Cholakova & Clarysse, 2015; Vismara, 2016). The information asymmetry problem is particularly acute in crowdfunding (Moritz & Block, 2016), given the diversity in the nature and quality of ventures seeking funding, as well as the lack of established intermediaries and negotiable contracts (Agrawal et al., 2014; Ahlstrom et al., 2018; Kim & Viswanathan, 2014; Vismara, 2016). Thus, several primary factors contribute to a successful crowdfunding campaign. For example, a founder’s social capital and geographical proximity to the venture play an important role in overcoming information asymmetries and contribute to crowdfunding success (Agrawal et al., 2011; Colombo et al., 2015; Mollick, 2014; Vismara, 2016). Other factors that contribute to success include investments by experts (Kim & Viswanathan, 2014) or investors with a public profile (Vismara, 2018b), because they send powerful positive signals. Additional positive signals include equity retained by founders and the internal governance structure of the venture, such as a proper board structure and the qualifications of the board members (Ahlers et al., 2015; Piva & Rossi-Lamastra, 2018; Vismara, 2016). #### ICOs ICOs represent a new funding model based on blockchain technology that enables new ventures to raise money from the public via peer-to-peer financing (Chen, 2018; Tapscott & Tapscott, 2017). In an ICO, a start-up sells its new cryptocurrency for the first time to the public in order to raise capital (Adhami et al., 2018; Chen, 2018; Fisch, 2019). It typically begins when the organization issuing the cryptocurrency publishes a “white paper” that describes the details of the project, including information on IT protocols, the cryptocurrencies that it is going to offer, token supply, pricing and distribution mechanism, and a team description (Adhami et al., 2018; Benedetti & Kostovetsky, 2021; Chen, 2018). A characteristic of ICO that distinguishes it from other forms of entrepreneurial finance is the concept of raising capital by selling tokens, which represent blockchain-based digital assets (Fisch & Momtaz, 2020; Howell et al., 2020). A token corresponds to a unit of value issued by a venture and covers a wide range of applications, which often provide access to a venture’s own ecosystem (Fisch, 2019; Momtaz, 2020a). Utility tokens assign a right to investors to redeem them for a company’s product or service once developed. For example, Filecoin (FIL)—a decentralized storage system that aims to let anyone store, retrieve, and host digital information—raised around$250 million through an ICO in 2017 by selling tokens that will provide users access to its decentralized cloud storage platform. The crypto market has been dominated mostly by this category of tokens (Momtaz et al., 2019). Some ventures issue security tokens—i.e., security token offerings (STOs)—which resemble traditional financial investments and have an underlying investment asset that investors acquire (Bellavitis et al., 2021; Fisch, 2019). In most jurisdictions, these are subject to securities laws. The campaign by tZERO, a technology company and global leader in blockchain innovation for capital markets, is one of the first STOs conducted in full compliance with U.S. securities laws. The company raised $134 million from over 1,000 global investors during its STO, issuing tokens to investors who had signed agreements for future equity (SAFEs). Regardless of the type of token, all tokens are cryptocurrencies that are meant to function as a currency in the venture’s own ecosystem (Fisch, 2019). Another key feature of ICOs is that they work on a blockchain technology—a digital, decentralized, distributed ledger that enables a novel approach to recording and transmitting data across a network in an immutable manner—on which tokens are issued and sold. The blockchain serves as a processing platform, enabling direct transactions between investors and ICO firms in a decentralized peer-to-peer (P2P) network (see Bellavitis et al., 2021; Fisch, 2019; Howell et al., 2020). Thus, there is complete disintermediation of the financing process (Momtaz, 2021), because investors can buy tokens directly from the ICO-conducting venture (Adhami et al., 2018; Fisch, 2019; Huang et al., 2020; Momtaz et al., 2019). A new variant of ICOs, called initial exchange offerings (IEOs), introduces an intermediary platform in the token offerings. IEOs rely on cryptocurrency exchanges to ensure the trustworthiness of potential projects and to connect high-quality projects to potential investors (Anson, 2021; Chen & Bellavitis, 2020). However, to date, IEOs represent a tiny portion of the overall market. ICOs enable new ventures to expand their funding opportunities and to reduce costs included in fund-raising by avoiding compliance and intermediary costs due to the elimination of middlemen, such as crowdfunding platforms or financial institutions (Fisch et al.,2022; Howell et al., 2020; Martino et al., 2020b). Beyond funding, however, entrepreneurs have a multitude of motivations for pursuing ICOs, such as community building, tokenomics, and personal and ideological drivers. Community building is the creation of a group of stakeholders interested in the success of the project. This helps to validate the market, to generate buzz, and to create network effects and a loyal customer base. Tokenomics refers to the decisions about the design of the token, the underlying blockchain, and the governing entity. Personal and ideological drivers can vary from control preferences to experimentation or philanthropy, among many others (Schückes & Gutmann,2021). ICOs tend to attract mostly unsophisticated investors. They typically are speculators who do not do any fundamental research, who invest very small amounts, and who flip their investment even before the underlying product is developed (Fahlenbrach & Frattaroli, 2021). However, several studies show that ICO ventures are becoming attractive targets for institutional investors, such as VCs and hedge funds, as well (Fisch & Momtaz, 2020; Howell et al., 2020; Huang et al., 2020). Signals about the quality of the venture (e.g., technical white papers and high-quality source codes; Adhami et al., 2018; Fisch, 2019) and its governance (e.g., quality of the team, CEO loyalty; Giudici & Adhami, 2019; Momtaz, 2021) have been consistently found to be related to the success of ICOs. #### Governance Implications of New Forms of Entrepreneurial Finance Similar to other entrepreneurial finance markets, both crowdfunding and ICOs are characterized by asymmetric information, which entails potentially substantial agency costs for investors due to the adverse selection and moral hazard problems (Bellavitis et al., 2019; Bruton et al., 2010; Chahine & Filatotchev, 2008). When investing in young entrepreneurial firms, external investors are confronted with hidden information problems that may lead them to invest in low-quality projects that have been presented to them as high-quality prospects (i.e., adverse selection). External investors will also have to face hidden action problems because they cannot perfectly observe the effort and actions of the entrepreneurs, who may engage in post-investment opportunism (i.e., moral hazard). Depending on how the crowdfunding and ICO campaigns are structured, they can also have different impacts on the ownership and governance of new ventures. Equity crowdfunding and STOs—where investors receive equity in return for their investment—allows investors to become minority shareholders who acquire ownership and voting rights (Ahlers et al., 2015; Bruton et al., 2015). Accordingly, governance problems may arise from agency issues, such as principal–principal goal incongruence between entrepreneurs and investors or between investors, in equity crowdfunding and STOs (Ahlstrom et al., 2018; Cummings et al., 2020, 2021a). The crowd usually consists of a diverse group of investors who may have divergent secondary interests (e.g., investing for fun or social purposes) in addition to the prospect of financial gains and, therefore, different time horizons (Chen, 2018; Cumming et al., 2019b, 2021a). According to Cumming et al. (2021a), these differences may lead to coordination problems and transaction costs that may limit the monitoring ability of investors after the offering, because they may disagree among themselves on how the firm should evolve, thereby providing more discretion to entrepreneurs (Momtaz, 2021). These problems are also exacerbated by the fact that usually such firms do not have traditional CG mechanisms that protect dispersed shareholders (Cumming et al., 2021a; Giudici & Adhami, 2019). Asymmetric information problems are exacerbated in crowdfunding and ICO markets because projects are in the early phase of development (Cumming et al., 2021a; Fisch, 2019) and most of the time a company is not yet established and has neither a proven track record nor a developed product (Howell et al., 2020). Accordingly, there is an inherently high risk of failure. The highly technical environment in which ICOs operate further contributes to the uncertainty, because token holders typically invest in the future promise of an idea associated with an intangible product based on the blockchain (Kaal & Dell’Erba, 2017). Most ICOs operate globally and in a decentralized fashion, without any legal incorporation or physical presence in a specific country (see Adhami et al., 2018; Bellavitis et al., 2020). Many projects do not have a dominant country of origin, while others adopt a “decentralized governance” mechanism where project promoters cooperate online from multiple locations throughout the world with no incorporation of the business (Adhami et al., 2018). As an example, The DAO, a digital decentralized autonomous organization built as a smart contract on the Ethereum blockchain, was not registered as a legal entity in any sovereign jurisdiction and had no board of directors or management team. Numerous ICOs are also anonymous and do not reveal any personal information, while others publish only limited information about the management team. Sometimes such information may even be inaccurate or fraudulent (Bellavitis et al., 2020; Shifflett & Jones, 2018). Hence, there is considerable uncertainty about the underlying quality of the entrepreneurial team and the venture idea itself, with a consequent high degree of information asymmetry between ventures and investors. Contrary to traditional external equity financiers (e.g., VCs and angel investors), small investors who participate in ICOs are less equipped to overcome information asymmetry because they typically have neither the experience and capabilities (Vismara, 2018a) nor the incentive, in light of their relatively small investments, to devote adequate resources to perform ex ante detailed due diligence and ex post monitoring activities (Ahlers et al., 2015; Ahlstrom et al., 2018; Malinova & Park, 2018; Momtaz, 2021; Vismara, 2016). The problem of information asymmetry is more pronounced in ICOs than in crowdfunding, because in the former there is not an intermediary (e.g., a platform) that performs due diligence to screen different proposals and rejects low-quality projects. Thus, screening and due diligence are entirely left to individual investors in ICOs. Moreover, formal disclosure requirements are largely absent in ICOs, with the consequence that information provided in the white papers (e.g., venture history, biographies of founders) is in most cases unaudited, incomplete, or even misleading (European and Securities and Markets Authorities [ESMA], 2017; Momtaz, 2020b; Securities and Exchange Commission [SEC], 2021; Zetzsche et al., 2017). The lack of institutions and intermediaries that could ex ante verify signals or ex post penalize biased signals exacerbates problems associated with asymmetric information in token sales (Momtaz, 2020b). Crowdfunding and ICO markets also suffer from a low degree of regulation compared to other sources of entrepreneurial finance. This facilitates opportunistic behavior and even fraud, exacerbating uncertainty and increasing investment risk (Bellavitis et al., 2020; Cumming et al., 2019c; Gabison, 2015; Huang et al., 2020; Rossi et al., 2021). The regulation of crowdfunding and ICOs is largely contingent on the offering characteristics (Block et al., 2020): while equity crowdfunding and STOs are subject to securities laws in some jurisdictions, the reward/donation-based crowdfunding and utility token offerings are conducted in a legal gray zone with no need to comply with any registration or disclosure requirements. Because many crowdfunding and ICO campaigns fall outside the regulated space, the level of investor protection is minimal, and there is only a limited basis to pursue legal action after the offering (Momtaz, 2020b). The ICO market is particularly notorious for a high prevalence of frauds (Bellavitis et al., 2021; Corbet et al., 2020; Hornuf et al.,2022). For instance, “exit scams,” in which the venture team disappears after raising funds, thereby swindling investors, are relatively common (Fisch, 2019). The Pincoin and iFan ICO frauds represent one of the largest scams so far, in which$660 million was raised from 32,000 investors, with the founding team disappearing shortly after the ICO.

Finally, unlike investments in companies listed on a stock exchange, investments in crowdfunding and ICOs can be very illiquid. This is particularly true for crowdfunding, because exits are often not realizable before a certain maturity stage, and investors may need to hold their investment for an indefinite period (Momtaz, 2020a). In contrast, ICOs provide an early exit option because most tokens can be traded on a secondary market (i.e., cryptocurrency exchange platforms) after the conclusion of the ICO, giving investors the chance to exit an investment at any time (see Benedetti & Kostovetsky, 2021; Fisch et al.,2021; Howell et al., 2020; Momtaz et al., 2019).

The minimal regulation binding crowdfunding and ICO assets and the fact that these assets are traded on portals that are also not bound by regulation expose investors to market manipulation. For example, “pump-and-dump” schemes—in which actors coordinate to bid up the price of coins before selling at a profit—appear to be relatively common in the ICO market (Hamrick et al., 2021). The pump-and-dump scheme on the price of CloakCoin, traded on the Binance exchange, represents such a case. After signals by fraudsters to foster the purchase of the cryptocurrency, the price of CloakCoin increased by over 50%, to $5.77, before dropping substantially within two minutes to almost$1, with a total of 6,700 trades worth around \$1.7 million (Akyildirim et al., 2020).

#### Decentralized Governance in ICOs

A central premise of blockchain is that traditional models of governance based on centralization are replaced by decentralized governance systems, where the distribution of power, decision-making process, and responsibilities within the organization are spread out among the community of stakeholders (Chen et al., 2021). While this mechanism can facilitate the removal of agents as intermediaries in CG, as well as provide checks and balances on the actors with more power (Lafarre & Van der Elstl, 2018; Shermin, 2017), it is not without risks (Chen et al., 2021). Dispersed governance rights can fail to mobilize collective actions, as individual participants may have little power to shape governance outcomes and thus become less engaged in governance processes. Excessive decentralization may also slow the decision-making process if token holders disagree among themselves on how the firm should evolve due to their vastly diverse perspectives and interests (De Filippi & Loveluck, 2016). Moral hazard problems may also occur among the community of stakeholders: a well-known example is the so-called 51% attack, where a participant on the blockchain with a lot of power may force a change in the software to benefit itself at the expense of everyone else (Yermack, 2017).

#### Corporate Governance Mechanisms in Crowdfunding and ICOs

It has been suggested that platforms may serve as an external and formal governance mechanism by ensuring that the information firms provide to investors is truthful, thereby reducing adverse selection problems (Cumming et al., 2021a; Hornuf et al.,2022). By undertaking an accurate and detailed due diligence, platforms may play an important role in preselecting the highest quality projects. This governance mechanism could be particularly important in the ICO market, where currently there is no platform that screens proposals.

The involvement of accredited investors may also serve as a CG mechanism in crowdfunding and ICOs (Agrawal et al., 2016; Cumming et al., 2021a; Hornuf et al.,2022). Some platforms in equity crowdfunding have a co-investment structure, i.e., they require minimum investment thresholds or the co-investment by accredited investors, such as VCs or angel investors (Rossi et al., 2019). Through this mechanism, investors may benefit from the detailed due diligence of sophisticated investors to certify the quality of the entrepreneur. In addition to screening ventures, professional investors can play an important role through their resources, contacts, and experience to assist early-stage companies in executing their business plans, as well as in monitoring their progress. In the ICO context, for example, some studies (Fisch & Momtaz, 2020; Howell et al., 2020) associate backing by institutional investors with an increased chance of success of the offering, as well as improved post-ICO performance. This suggests that institutional investors can serve as value-increasing intermediaries in the ICO market (Fisch & Momtaz, 2020).

The problem of principal–principal goal incongruence in equity crowdfunding and STOs can be addressed to some extent by the structure of the relationship between investors and firms. In equity crowdfunding, for example, some platforms use a nominee structure where the crowd is represented by one legal shareholder (i.e., the nominee) who holds the shares on behalf of the crowd investors. This can eliminate the negative effects arising from the agency conflicts in a direct ownership structure because the nominee can mitigate collective action problems thanks to their increased ability for, and more sophisticated means of, monitoring the business (Walthoff‐Borm et al., 2018). Moreover, the nominee may lower coordination costs related to dispersed shareholders (Butticè et al., 2020; Rossi et al., 2019; Walthoff‐Borm et al. 2018). This may also function in the context of decentralized ICOs, where a central authority (e.g., the team behind the venture) can help to address problems associated with decentralized governance structures.

The development of capital market-based governance mechanisms, such as active secondary markets for the shares, could also help in reducing moral hazard problems in both crowdfunding and ICO markets. More liquid secondary markets may increase the information available through the share price and thus enforce a market discipline that may influence entrepreneurial behavior. Currently, tokens can be traded, and some equity crowdfunding platforms have started to experiment with the creation of secondary markets to increase liquidity (Cumming et al., 2021a). Finally, stricter regulation that increases information availability and, at the same time, ensures that firms raising funds provide truthful, sufficient, and accurate information may be crucial for reducing adverse selection problems (Cumming et al., 2021a; Fisch, 2019; Kaal & Dell’Erba, 2017).

Table 2 provides a summary of the governance mechanisms for mitigating agency issues in entrepreneurial finance.

#### Table 2. Governance Mechanisms for Mitigating Agency Problems in Entrepreneurial Finance

Venture Capital

Active role in strategy development and monitoring of venture operations

Covenants

Diversification by investing in multiple ventures

Syndication (partnering with other VCs for investments)

Staging (sequential investing through multiple rounds)

Board membership

Active role in the appointment of venture leadership

Contractual or other mechanisms that enhance the ability for control

Corporate Venture Capital

Active role in strategy development and monitoring of venture operations

Angels

Active role in strategy development and monitoring of venture operations

Contractual arrangements

Soft-monitoring (relational/informal)

Serving on board

Equity Markets (PRE-IPO)

Regulatory disclosure requirements

Retained ownership (management, blockholders)

Founder presence

Boards (independence, size)

Auditor choice

Lockups

Compensation structures

Separation of CEO and Board Chair roles

Sunset provisions (in the case of dual-class shares)

Debt Markets

Covenants

Collateral

Crowdfunding and Initial Coin Offerings

Platforms

Involvement of accredited investors

Nominee structure

### Future Directions

Research on entrepreneurial finance has a relatively short history. New forms of entrepreneurial finance emerge either due to innovation on the part of finance providers and entrepreneurs or due to new technological developments. However, despite the multiplicity of sources of finance, the basic agency problems remain the same. How can the potential for adverse selection be reduced? How can moral hazard problems be avoided? How can information asymmetry be reduced? Each of these issues presents many opportunities for future research. Based upon the review provided in this article, a set of illustrative research questions are presented that point to avenues for future research.

First, most of the prior research on entrepreneurial finance has focused on one specific source of finance in isolation and its relationship with the entrepreneur. Yet, in practice, new ventures seldom rely on a single source of finance, and often they rely on multiple sources of finance simultaneously. Monitoring by multiple fund providers may have very different effects than monitoring by a single source. Research has yet to examine the complementarity and substitutability between different sources of finance and their governance implications. Indeed, governance factors should not be considered in isolation from each other; instead, they should be examined as “bundles” of CG practices that are aligned with one another and in certain cases mutually enhance the effectiveness of those practices.

Second, the temporal horizons of different providers of funds tend to vary considerably. VCs are looking for a relatively quick exit, whereas CVCs have much longer time horizons. Similarly, fund providers also differ in their strategic objectives. There are also differences in the risk-bearing capacity of different fund providers. Given the differences in time horizons, objectives, and risk-bearing capacity, it is important to examine how the differences affect VC governance.

Third, given the short history of new forms of entrepreneurial finance, such as crowdfunding and ICOs, there is very little research on how agency problems are addressed by investors. The new forms of entrepreneurial finance are mostly beyond the purview of current security regulations, have low or no disclosure requirements, are global in their reach, and are not subject to the legal remedies normally available for traditional categories of fund providers. Examination of the efficacy of governance mechanisms, such as platforms, accredited investors, and nominee structure, is a promising research avenue. Similarly, development of new mechanisms that can deliver better monitoring and incentive alignment should also be a research priority.

It is also important for scholars to analyze the internal nature of organizations to consider how governance mechanisms affect individual or team dynamics. Reviews of entrepreneurial finance highlight how little we understand about the effects of CG characteristics on entrepreneurial team efficiency, managerial discretion, explorative or exploitative orientation, and other top management team activities (Li et al., 2020).

Further, most of the studies in entrepreneurial finance are based upon samples drawn from developed economies. There is a need for more studies using emerging market samples, given the substantial differences in institutional contexts, cultural differences, and economic development. Similarly, much of what is known about governance mechanisms in entrepreneurial finance is drawn from traditional types of ventures. Social entrepreneurship has emerged as a growing segment within entrepreneurship, but little is known about financing social ventures and the governance mechanisms used in social entrepreneurship.

Last, studies have shown that liabilities of foreignness are pervasive in capital markets and that they affect cross-border VC activity (Bell et al., 2012). Research should investigate how international VCs can overcome liabilities of foreignness in their foreign investments, and what forms of governance are appropriate in overcoming agency challenges.

### Conclusion

The entrepreneurial finance market is characterized by significant information asymmetries between entrepreneurs and finance providers that entail potential agency problems and goal conflicts. This article addresses these issues by examining the governance implications of different sources of entrepreneurial finance. Specifically, this includes governance implications of traditional sources of finance, including VC, angel investors, equity, and debt finance. The article also examines the different mechanisms used by finance providers to address agency issues and related problems of adverse selection and moral hazard relating to their investments. In addition, the article highlights developments in entrepreneurial finance, providing an overview of new forms of financing, namely crowdfunding and ICOs. Specifically, the article’s focus is on how these new sources of entrepreneurial finance not only offer entrepreneurial firms new opportunities to access capital, but also present new governance challenges as they bring a variety of new investment goals, investment approaches, and business models of entrepreneurial financing. The analysis also suggests a host of governance mechanisms that can potentially mitigate costs associated with both adverse selection and moral hazard in the case of crowdfunding and ICOs.

The article provides a starting point for exploring governance issues in the context of entrepreneurial finance. Overall, we need more empirical research on how governance mechanisms can limit information asymmetry and related adverse selection and moral hazard issues in both crowdfunding and ICOs. Moreover, with new financial alternatives available for seeding entrepreneurship, the intersections between new and traditional sources of financing, and their impact on entrepreneurial ventures’ development, offer many research opportunities.

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### Notes

• 1. In 2016, the U.S. Securities and Exchange Commission defined rules that make equity crowdfunding a legal means by which firms are able to raise seed capital online.