The Pros and Cons of Initial Coin Offerings vs. Venture Capital
What Venture Capital Is
Venture capital is a type of private-equity capital. It is provided in the form of seed funding to companies that are in early or growth stages of development, and have high potential combined with a high risk of failure.
VC is a three-player game consisting of:
- limited partners (pension funds, university endowments, banks, insurance groups, sovereign funds, funds of funds)
- general partners (generate distributors)
- startups
Venture capital is provided to companies that are new, or are going to implement very new technologies. These companies are run by entrepreneurs who are professionally or technically qualified. Such companies fail to attract investments from public. Without venture capital, they would never be able to be successful on the market.
Venture capital is an equity-based investment in small- to medium-sized companies with growth potential.
In return, investors are able to explode market opportunities and reap long-term capital gains.
What Is the Right Time to Go for VC Financing?
Entrepreneurs are good to go for raising venture capital funds under the following circumstances:
- The venture is under the consideration in the start-up stage.
- The venture involves the use of new or upcoming technologies that haven’t been successfully implemented by others.
- The business is such that it fails to attract funds from investors.
- The entrepreneurs are looking for partners/mentors who have good business skills and can also provide capital for their startups.
Key Venture-Capital Selling Points
- Know the dynamics and demands of the market.
- Understand the behavior of potential customers.
- Demonstrate traction.
- Adjust the project to your customers’ needs.
- Show and prove your potential.
- Use external data sources.
- Beware your competition.
Tips for Successful Venture Capital Financing
- Don’t be greedy. Raise a little bit more than you need. Why? Because things might not go your way. Make sure your business won’t fail.
- Invest to build and establish relationships with VCs. It’s all about who you know, and it’s all about raising money from the right people. If you don’t meet investors, get to know them, provide value, and build the relationship.
- Show people you’re passionate.
- Find a cofounder (if you’re an engineer, find a business guy; if you’re a marketer, find a designer.) VC is all about co-working and cooperation.
- Pitch a big idea to VCs. Come up with something really huge.
How Do VCs Make Money?
They simply take risks. Venture capitals are like the mythological Sisyphus.
They do 3 things:
- raise money
- invest money & monitor portfolios
- exit & return money to investors
Are Venture Capitalists’ Investments Illiquid?
Venture capitalists invest in high-risk, high-growth, yet mature companies projecting high returns in the future. Their funding goes when the company is about to be started. It takes a huge amount of time before the value of the investment hits the expected levels.
In addition, there is the risk that the enterprise will not become successful, and subsequently, the risk of losing everything comes into the picture.
For these reasons, venture capitalists’ investments are illiquid — their investments cannot be easily or quickly converted into cash.
What is an ICO?
An Initial Coin Offering, commonly referred to as an ICO, is a fundraising mechanism in which new projects sell their underlying crypto tokens in exchange for Bitcoin and Ether. It’s somewhat similar to an Initial Public Offering (IPO), in which investors purchase shares of a company.
A successful ICO is evidence of public demand for your product. People believe that the product is worth having.
Benefits of an ICO
In order to go for an IPO, a company has to meet all FCC and SCC regulations, which means, in some ways, that you’ll have a little more security for the ideas in which you’re investing.
ICOs have no regulations — which, in a lot of ways, is a positive thing. It allows investors to get into the idea before any big movements have been made by the company. With ICOs, you can invest in a company before they’ve taken off.
VC establishes legitimacy and powerful connections, whereas ICOs give instant liquidity to random business. With an ICO, you can raise money from anywhere in the world, while VC has its so-called “geography” problem.
A well-written white paper is not an indicator of a successful business. ICOs need to have realistic requirements, good forecasting, and specific budget allocations.
Now it’s time to define and compare the key differences between Venture Capital and Initial Coin Offerings, and see how they complement each other.
Key Ideas for Potential Use of Venture Capital and Initial Coin Offering
The following key ideas have been mentioned at the VC vs ICO — Panel Discussion with Investors, VC, cryptocurrency experts event which took place on February 28th, 2018 at the Silicon Valley.
ICOs will become regulated by the SEC (Security and Exchange Commission).
The safest ICO investments to launch are with accredited investors in private pre-sales.
VCs are studying ICOs as an option for raising funds, but are skeptical.
There are “flight to quality” ICOs, like other angel and VC investments. They are looking for a great team, traction, a defensible position, and the ability to scale.
Venture capital has the longest holding period of any asset class.
“Distributed Trust Ledger” is new, and will become a viable business model.
If your business does not benefit from distributed ledger technology, don’t try to make your business fit it. Many companies are adding it to their business model because of current hype, not real added value. You need to disrupt a market to be valuable with the technology.
The U.S. and other countries are looking at supporting ICOs with “soft-touch” regulation to attract investors. Almost all U.S. companies file in Delaware because of tax laws. Wyoming and other states are looking at taking that spot for ICOs. Switzerland has lost privacy as its selling point, and is strongly looking at ICO investment as a potential industry cluster.
ICOs as a vehicle for startups to raise capital will surpass the use of the Jobs Act passed last year. Another panelist thought more ICOs will follow the structure of the Jobs Act as their product roadmap.
Kickstarter is not an option; it falls under SEC regulations.
A couple of VCs said startups are raising money from ICOs because they could not raise money from angel investors or VCs, so the investment quality was lower. One panelist said they were not all that way. Some do it for speed, and to go to market with a more democratized investor and user base.
One VC commented: “If you raise money with an ICO for your startup as it exists today, it will be harder to raise later rounds of capital from VCs in series A, B, and C.”
In the future, there will be more automated governance and boards of directors.
Silicon Valley invests in 2,500 companies a year, when there are only around 500 that should get capital per panelist. A small number is profitable.
Ethical questions can arise, such as using blockchain to get around San Francisco or New York, or housing restrictions (like those involving AirBNB) in which the government will never know about the transaction.
In order to do a startup, the panelists said you need domain experience in this area.
Panelist Michael Sofaer stated: “People who market ICOs should be scared. Be careful promoting an unregistered security if you are not a licensed broker-dealer.”
Michael’s pro tips:
- Define what constitutes a dividend, and all other requirements of a security offering.
- Invest in companies, not currencies.
- Don’t try to be clever with regulations.
- Don’t overstate your valuation.
- Better to be conservative.
Feel free to read more information from the Applicature’s Panel Discussion about VCs vs ICOs here.
