Financing experimentation

An entrepreneur starting a new activity is often uncertain about how good she will be at it and must experiment in order to learn. What happens when the experimentation is financed by a lender? We show that financing experimentation can become harder precisely when experimentation is more promising, for example, when the future is more valuable or when the known activity has a lower payoff. Under ex-post competition from alternative lenders, more optimistic prior can also make financing harder. The optimal contract, which is robust to self-saving by the borrower, entails endogenous collateral requirements as observed in, e.g., micro-credit schemes