We analyse the nature of financial contracts in a passive learning environment where the arrival of information is private to the entrepreneur and past investments are sunk costs. Projects are either high cost (negative NPV) or low cost (positive NPV). A self-financing entrepreneur who early on during the investment process learns that the project is high cost will terminate it. While, since past investments are sunk, that same entrepreneur who observes the high cost state when the investment process is nearly complete with continue the project. An entrepreneur with no initial wealth will need to raise finance from investors who learn about the project's state only after the critical, "point-of-no-return" stage. Thus, knowing that outside investors cannot credibly commit to refuse finance for the final stage, entrepreneurs may conceal their private information until the project is past the "no return" stage. This "stopping problem" is developed in the context of a risk neutral version of the Principle-Agent model where the mean expected return is determined by the level of entrepreneurial effort. We show that the stopping problem can be resolved (with an efficiency loss) by a two-stage mechanism. We believe this mechanism bears some resemblance to combinations of convertible and redeemable Preference shared, as is observed in venture capital contracts. The model also predicts that entrepreneurs will have at least partially limited liability. A novel feature is the distinction between human and non-human wealth which arises endogenously within the model, and appears to be consistent with casual observation.
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