A Behavioral Finance Approach to Decision Making in Entrepreneurial Finance

Three central decisions in entrepreneurship and entrepreneurial finance – entry/seed funding, financing/investment, and growth/exit – are discussed and case is made for applying the behavioral finance theories and concepts to better understand the involved decision processes, and consequently, to help improve the decision-making process for both entrepreneurs and venture capitalists. The behavioral finance approach is important because the traditional finance has remained silent on the first issue, and the Agency Theory (financial contracting), which is effectively the only theory that is applicable to issues in entrepreneurial finance, has produced mixed empirical results. (See for example Bitler et al. [Bitler MP, Moskowitz T J, Vissing-Jorgensen A (2009) Why do entrepreneurs hold large ownership shares? Testing agency theory using entrepreneur effort and wealth. Working Paper. Graduate School of Business, University of Chicago].) Attempts are also made in this chapter to introduce some new concepts – “Perception Asymmetry,” “Resident Risk,” and a preliminary behavioral risk framework – that as complements to the existing constructs could be used in discussions on decision making under risk and uncertainty. Although the focus is on individual decision making under highly uncertain entrepreneurial environments, the suggested risk framework and the related discussions can be extended to decision making in other uncertain environments.