Initial coin offerings (ICOs) are a new, currently unregulated means of fundraising for companies. This combines tiny components of angel investing, VC (venture capital) funding, and IPO (initial public offering). It is done in a way that allows a company to raise funds without offering voting rights or company equity.
An ICO usually has ‘investors’ (usual members of the general public) send in cryptocurrencies to the company and in turn, get ‘tokens’ which can be liquidated on select cryptocurrency exchanges. ICOs are usually executed by smart contracts.
Alongside their liquidity, some tokens are used as “in-app cash”. This allows access to the platform’s services, power the platform, and a lot more. So far, almost all companies that have ‘ICO’d’ have integrated blockchain into their core operations. This is as the fundraising style is considered as one for blockchain-powered businesses/platforms.
For companies, the main attraction to ICOs includes ease of fund-raising, lesser barriers, ability to fund-raise without giving away company equity thereby increasing their control over decisions, etc. For investors, the hope of getting short-mid term mind-blowing returns (as witnessed with several ICOs in the past), ease of liquidity (of tokens issued), the democratization of the process, and little to no barriers to participation are the main attractions.
When compared to their venture capital-funded counterparts, ICO-backed businesses do have their negatives. Some cons are it’s easier to carry out a fraud (e.g. hyping white elephant projects to the public). There could be a lack of adequate due diligence by potential investors (as most are merely speculators), lack of connections offered by VCs. There are also companies not being obligated to disclose financials and performance reports to investors among many others. However, in the long run, there are some reasons why ICO-backed businesses might be poised to outperform their venture capital-funded counterparts.
Reason Why ICO-backed businesses can Outperform Venture Capital Funded
One of such reasons is that with ICOs, the startups usually get to retain (total) control of the business and this reduces the occurrence of investor-founder clashes in decision making. The business owners get to raise funds and still maintain flexibility in the decision-making process. This is so because tokens do not usually reflect a stake in the company.
Startups with ICOs also get to build a community from the word go as investors are usually said with word-of-mouth marketing to raise attention to the business. It might as well as increasing the demand for the tokens as an increase in demand would raise the token price. Also, this lowers the cost of marketing which is estimated to cost 8-12% on average of companies’ gross revenue.
However, as ICOs get bigger and the participation rate increases, the big question is, will this new, more democratized fundraising style replace traditional venture capital, or will a partnership emerge to further benefit businesses? If the current trend is anything to go by, the latter appears to be more beneficial to all parties involved. As there are several ways that ICOs and VCs can complement each other to benefit both businesses and investors more.
How the general public (ICO investors) will benefit
Venture capital firms can act as thorough due diligence agents for companies that want to hold an ICO since they’re generally more experienced than the general public in determining whether a company is real. This is whether the number checks out, the product’s prospects in the markets. This will greatly help to trim down the number of white elephant projects. And it will ensure that only serious projects get recognized. While this wouldn’t totally eliminate the number of empty air businesses trying to ICO as technically, conducting an ICO involves just coding a smart contract which anyone is free to. But it will help in informing potential ICO investors of which projects are worth backing.
How businesses will benefit
Businesses that plan to ICO and later on raise venture capital (or vice versa) will have better leverage. As they’ll look more for strategic partners rather than looking for any VC which might result in conflicts.
They will also benefit from the potential connections to their respective industry leaders which venture capitalists offer.
How VCs will benefit
Venture capitalists love to minimize risk. This is why they typically fund below 1% of the businesses that pitch to them. With an ICO-VC partnership, risk can be minimized. For example, a business that held an ICO and is now raising venture capital will typically be looking for less cash. And more of strategic partnerships than a business that is looking for venture capital as its first major capital.
Also, liquidity has been an issue with VC-backed businesses. An estimated 90% of businesses do not return initial investments to the VC backers. So, companies can issue part of their tokens from the ICO to private investors (angel investors, VCs, partners, etc.). This makes it difficult for an initial investment to go to zero. These tokens can be traded on cryptocurrency exchanges. This increases the chances of getting a return on investment as well as reduces the chances of totally losing it all.
In the long run, it’ll be exciting to see how both fundraising systems play out. ICOs are relatively early compared to venture capital which has been around for decades.