We are hearing more and more these days about ICOs – Initial Coin Offerings. Bitcoin, the most famous cryptocurrency, is certainly getting lots of attention. But, is this the new way to raise money for startup companies?
ICOs in a Nutshell
Let’s start by describing what an ICO is. The Initial Coin Offering is not a formal legal process. It is an evolving process that is not well defined, in the regulatory and legal sense, and the SEC is rushing to help add some structure to it.
A company can decide to create a new cryptocurrency. Then, it can ask potential investors to purchase “coins” from this cryptocurrency. Investors hope that there will be 1) an increase in the value of the coins over time, and 2) a market for the coins where they can be exchanged for cash or other liquid assets with recognized value. The company issuing the coins must attribute some value to the coins. For example, this value could be in the form of future dividends or in the trade of the coins for products or services. If the coins represent equity in the company, they cross an SEC regulatory line. In this case, they become securities subject to SEC regulations, including those regarding Accredited Investor qualifications. Thus few, if any, coin offerings represent company equity.
New Venture Capital?
Getting back to the original question, are ICOs the new venture capital? It seems that through an ICO a company could raise lots of cash and be responsible to no one outside the company. One comment we hear from some entrepreneurs is that if they raise “traditional money” they would be responsible to investors for producing financial results on a timeline that the entrepreneur might not like. They think that by raising ICO money, they won’t have a “boss” to report to. However, such thinking is misguided.
Even with ICO money, your “boss” is the investor community that is backing you. If you don’t show results, the coins will be stagnant at best and worthless at worst. As more people lose money in the ICO world, this method of fundraising will dry up, and only the companies with the best prospects, controls, and results will be able to do an ICO. That’s natural. Furthermore, it’s healthy for the startup world.
But there’s a huge missing element that the ICO ignores. Venture Capitalists are in business to help you succeed and get the results you deserve. It’s not altruism; it’s so they can pay the types of returns their investors are expecting. Most VCs got there after they built successful companies themselves. They can be a wealth of knowledge, advice, counsel, sounding boards, connections, and much more. You and your VCs are on the same team, and they’re the All-Stars of experience. Raise money in an ICO, and you’re missing out on the most valuable part of the equation. So, no, ICOs are not the new Venture Capital.