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Borrower Lender Relationships in High Technology Ventures

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Essay title: Borrower Lender Relationships in High Technology Ventures

Information asymmetry is present when one party to a transaction has more or better information than the other party. The other party knows something about the properties of the transaction that the other does not know, and that is not directly observable.

Knowledge specificity creates a division of labour between entrepreneurs and venture capitalists . Entrepreneurs specialize in the awareness of unexploited opportunities and of the resources to exploit these. Entrepreneurs also specialize in the day to day development of new business activities. Venture capitalists specialize in creating networks of individuals and institutions to reduce the cost of acquiring capital, to find customers and suppliers and to establish the venture's credibility (Shane & Cable, 1997).

Under the Principal-Agent theory it is assumed that people are self centered and concerned with actions that lead to personal benefits. If hiding the information from the other party will benefit them, they will do so. This creates the problem of moral hazard (Reid & Smith, 2003). Moral hazard problems may occur whenever information asymmetries exist; in other words, when one side is more informed than the other. Thus, one party has an incentive to shift risk onto an uninformed other party (Shane & Cable, 1997). For instance, entrepreneurs may withhold any negative information about market and competition situation because it may affect the venture capitalist's decision about investing in the venture. The entrepreneur may not reveal underlying poor performance of the company because it may also spur the investor to bring in professional management to replace the entrepreneur (Shane & Cable, 1997).

First time lending refers to an arrangement between an investor and an entrepreneur to finance the new high-technology venture, where the investor has had no previous dealing or relationship with the borrower (entrepreneur). First time lending to a new technology venture poses great risks for the investor as we will see below, in the form of agency and business risk. In Reid's study (2003), most investors regarded lending to completely new technological firms (seed ventures and start-ups) as being risky because there is no data available on the credibility of the entrepreneur as well as the potential of the new technology. The chart below shows that lending to first time technologies is lower than lendings to ventures in other stages (Camp & Sexton 1992).

However, lenders do make first time loans/investments by gathering as much information as possible, about the entrepreneur and the proposed venture . This information can be obtained from the business plan that the entrepreneur submits to the investor for reviewal. However, as noted above the entrepreneur may not give accurate information due to moral hazard, to increase the chances of getting the funding.

Repeat lending

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