An important puzzle about labor-managed firms is why wealthy entrepreneurs do not create them. This question is particularly significant if one believes that at least in some cases, LMFs would have higher productivity than similar capitalist firms. The usual arguments about this issue are unconvincing. But adverse selection with respect to the quality of entrepreneurial projects might cause workers to place a low value on LMF membership, and this may cause entrepreneurs to create capitalist firms instead. In the formal model entrepreneurs have projects that are either good or bad, and those with good projects can achieve higher productivity by giving control rights to workers. But control rights also give workers increased bargaining power, so there is a tradeoff from the standpoint of the entrepreneur. There are always separating equilibria that lead to the formation of capitalist firms. There may also be pooling equilibria leading to the formation of LMFs, but these equilibria rest upon fragile beliefs. The chapter argues that problems of this kind can help explain why entry of cooperative plywood mills in the U.S. Northwest ceased in the 1950s.