The scale of informal capital markets

Abstract

Informal capital markets are the leading source of external risk capital fueling entrepreneurial startup and small business growth. They are virtually the only practical source of risk or venture-type capital for most entrepreneurs once their capital needs surpass family resources. Informal risk capital is equity and near-equity dollars invested by private individuals directly (informally) in entrepreneurs without formal intermediation.1 The importance of understanding how and where small firms obtain their risk capital is reenforced by the growing recognition of the role of small business in U.S. economic performance.2 Continued and enhanced supply of informal capital requires rational public policy. Because of the lack of reliable empirical data, it has been difficult to formulate effective policies that would guide markets where necessary, leave them alone where desirable, and accelerate their growth where possible. Such policy is best built on an accurate appreciation of the scale of informal risk capital's contribution to U.S. economic growth and change. New microdata evidence just recently available contributes a wealth of empirical data about how informal investors and entrepreneurs interact.3 The object of this paper is to use the new data to reach preliminary estimates of recent aggregate flows of informal capital. To achieve this goal I also provide collateral estimates of the stock of informal investors, recipient firms and annual transactions volume.