ICO vs Venture Capital: What is the Difference?
By Alan Ware
An ICO (Initial Coin Offering) provides an interesting alternative for the entrepreneur looking to raise capital. To the casual observer, the natural inclination might be to think of it as a replacement for an IPO, but the truth of the matter is quite different. Despite the similarities in names, ICOs when viewed against the traditional venture capital framework differ in construction and implementation.
Through the Fundraising Lens
Angel investors, Venture capitalist firms, and corporate funds have the roles that they play along the road from startup to established company. Depending on the disposition of the investor, along with funding often comes some aspect of governance, networking, advisory, or some other support that the investor brings along(sometimes to the chagrin of the entrepreneur). Often this manifests in a board seat, equity stake, or some other preferred option for the investor.
With an ICO, what’s being offered is a digital token that is intended to be used for some service on the eventual platform. For example, tokens could be issued to generate capital for a cloud computing platform under development. The expectation is that when the product launches, these tokens can be redeemed for services on the platform (i.e. hosting, storage space, database access). This article goes more in depth over at Medium.com.
So in comparison to the venture capital models discussed earlier, where funding is often distributed with at the least an advisory component, coin offerings function as way to support a project with the aim of patronizing the service on completion, and can look much more like crowdfunded capital.
Through the Investment Lens
The token/service aspect is an important part of an ICO, as that is what defines the coin (digital token). However a great number of individuals are treating coins as speculative investments, looking to make money on the rise and fall of various cryptocurrencies(digital tokens) on the open market. As nice as it would be to just focus on the functional aspects of the tokens, the realities of this market must be taken into account when considering an ICO.
The regulatory environment is still murky, or rather nonexistent, when it comes to ICOs. The SEC recently has made moves to block or throttle questionable ICOs. These tokens being tied to the product is essential, this characteristic defines and justifies their existence. At a glance one might notice coin offerings and cryptocurrency trading bears similarities to securities trading, and that distinction is a rather important one to make given current US securities law. That is not to say that cryptocurrency trading and ICOs are inherently bad, just that the regulatory structure is rather light and undefined, and it will take a while for governments and other regulatory entities to catch up.
With that regulatory environment, there is always the danger of less than honest actors on the stage. There are numerous documented examples of fraudulent ICO activities. However, scams notwithstanding, is undeniable that offerings have worked well to generate capital, and with the interest in blockchain, cryptocurrency, and related technologies only increasing, this is just another rule of the road to keep in mind.
A beneficiary of the ICO craze would be business to consumer applications. Traditional investment in B2C applications has waned in recent years, and ICOs present an alternative(albeit unconventional) method for capital generation. With the current fervor for all things blockchain/cryptocurrency, there are a number of entities that have tried to capitalize by rebranding to include blockchain technology, even if it isn’t a good fit.
Looking through both Lenses
Before embarking on your (potential) ICO journey, you would do well to ask a couple of questions. First, how will the token for service model work with your product? It’s one thing to create a digital currency but what is one to DO with it? Another question to ask is, “On top or against what services will you create your token?” The Ethereum platform is a popular choice, and its smart contracts feature allows for many custom applications with derived tokens.
ICOs are an interesting alternative for the entrepreneur looking to raise capital, especially for business to consumer applications. B2C efforts have found it increasingly difficult to find funding in recent years, and ICOs can be thought of as a sort of innovation or evolution in the space. It is important to remember that coin offerings are by their nature quite a bit different from traditional investor arrangement, so the thinking of ICOs as a whole replacement for angel or seed funding is a bit off. However, given due diligence, proper planning and preparation, this emerging and unconventional approach can reap rewards in the difficult search for early stage funding.
For more information on raising capital, please visit our entrepreneur’s business blog. Chompff Consulting can help you find the right funding option for your business and show you exactly what investors want before pitching your business.