【正文】 ion problem whereas in practice VCs often hold convertible preferred equity. Indeed, a defining characteristic of the venture capital market is that contracts are fairly highpowered in the sense that expected payoffs e disproportionately from the equity ponent or “upside”. These questions can be addressed by reflecting upon the costly due diligence to which Barry refers. By directly revealing the project’s quality, due diligence reduces information asymmetry between entrepreneurs and the VC. By contrast, if quality were signaled—the traditional solution to the adverse selection problem—costly due diligence would be unnecessary since there would be no more information to convey. In otherwise, either signaling or costly due diligence can solve the adverse selection problem. The two mechanisms are substitutes。 the question then bees which is more costeffective. The first contribution of the paper is to show that signaling can be prohibitively expensive in entrepreneurial financing markets, and so costly due diligence dominates. The “cost” of signaling is driven by the incentives of bad firms to pool. Yet, for startups, if funding is not obtained then the firm may have almost no value. With such low reservation values, bad entrepreneurs attempt to pool at nearly any cost. As the analysis shows, securities is unattractive enough to drive out bad entrepreneurs—and thus to serve as a credible signal—tend to be unattractive to good entrepreneurs as well. Costly due diligence emerges as the preferred solution. As testament to the empirical importance of due diligence costs in venture capital markets, Fried and Hans characterize the VC funding process as posed of six distinct, progressively rigorous stages of screening. This due diligence takes an average of 97 days to plete even before the first round of funding is initiated. The majority of funding proposals do not successfully pass through the first screen, let alone subsequent screens, and the full process is described as “much more involved in bank loan reviews. The second contribution of the paper is to illustrate a link between costly due diligence and highpowered (or equitylike) financial contracts. The intuition behind this link is simple. By definition, lowpowered contracts are safe。 that is, contracts are acceptable only if the residual claim has expected value V or higher. In a model of mature firm financing, V is most clearly interpreted as the value of assetsinplace, because this is the continuation value of the firm in the absence of new investment. Such an interpretation is valid in entrepreneurial settings as well because without attracting financing the entrepreneur owns the existing assets outright. The key difference is one of magnitude. Compared to models of mature firms, in entrepreneurial settings the value of assetsinplace is small relative to other parameters. The present value of projects, Vτ ? V ? K, is assumed to satisfy EVG ? V ? K ≥ 0 ≥ EVB ? V ? K. (1) Equation (1) justifies the nomenclature “good” and “bad.” The present value of a project is positive if and only if the project is good. Finally, it is assumed that present values satisfy θ (EG ? V ? K) + (1 ? θ )(EB ? V ? K) ≥ 0, (2) where θ is the proportion of good projects in the economy. Because present values are positive (on average), the model admits pooling equilibrium. One source of capital is an uninformed investor who conducts a mechanical credit evaluation based on observable characteristics. This investor may be thought of as a proxy for the petitive mercial banking market. Consistent with this i