ICO vs. Traditional Fundraising
Considerations for both Startups and Investors in France
Note: A French-language version of this story was previously published on Frenchweb.fr in June 2018 by Julien Sanciet and Adrien Soumagne, both attorneys at law for Bredin Prat (Paris, France). Parts have been updated or added to reflect changes that have occurred since its original publishing.
Following their spectacular surge in 2017, ICOs (initial coin offerings) have shown few signs of slowing down. According to ICO Rating, ICOs have already raised over $8.3 billion so far in 2018 — that’s more than double the total amount in 2017. And in an effort to jump out in front, France is now proposing a program as part of a larger corporate reform bill. This bill will provide a protective framework for crypto entrepreneurs and investors via an optional visa, granted by AMF (Autorité des marchés financiers, the French equivalent of the US SEC), to attract serious ICOs to France.
But even with such State support, if ICOs are to gain public trust, both entrepreneurs and investors pursuing ICOs will need to ask themselves the right questions. For entrepreneurs, this is mainly: Why do they want to have an ICO instead of approaching “traditional” fundraising channels and institutions (VCs, banks, grants, etc.)? And for investors: Who traditionally gains equity and or ownership rights in companies after investing? What benefits or advantages can be gained if they invest in tokens instead?
The Advantages of ICOs for Entrepreneurs
For entrepreneurs, offering tokens to investors is liberating, particularly due to the associated definition of rights. Specifically, tokens sold in an ICO generally don’t include voting or financial rights, which is normally the case in conventional shares. Per existing legal frameworks (the Prospectus Regulation in Europe and the Howey Test in the US), tokens do not qualify as securities. But as tokens today aren’t dilutive in capital, they’ve been a major advantage for founders; historically, startups able to raise funds the “normal” way end up losing sizable amounts of control to investors.
Instead, with tokens, holders are offered rights of a different nature: access to services, reduced fees in the case that the tokens are used as a means of payment, etc. And thanks to ICOs, entrepreneurs can pre-sell a project under development, allowing their companies to validate business models, and build customer bases and communities well before product launches.
ICOs are also inclusive of a wider base of investors (the “crowd”), whereas “traditional” fundraising is typically reserved for institutional investors. Given the risks in venture capital, financing startups is generally done in several rounds (seed, series A, B, C, etc.). The process is extremely time-consuming and energy-intensive for founders: Meet potential investors, establish a credible business plan, execute to bring our value while avoiding dilution of their shareholdings, negotiate terms with incoming investors, consider future exits, etc. But if a project is interesting to the general public, an ICO can be used to raise more money over a shorter period of time than what could ever have been obtained from institutional investors. ICOs carried out by Bancor, Cosmos and Brave (the latter which raised $34 million in less than 30 seconds) reflect this.
Contrary to popular belief, ICOs are not easy to pursue — the expenses incurred can be very high. This is due to the large number of stakeholders (developers, marketing, lawyers, etc.) necessary to execute a successful, and legal, ICO campaign. Issuance of tokens can also result in significant tax expenses compared to traditional fundraising, which is generally tax neutral. For instance, depending on the nature of the tokens issued, amounts raised may be subject to VAT and/or corporate income taxes.
And given the very open nature of ICOs, entrepreneurs who successfully raise are expected to transparently report on their projects’ advancements. This can be a double-edged sword for projects as staying on track will increase adoration and investment interest from the public; while a perceived lack of progress can result in anger and disengagement.
ICO Advantages for Investors
As noted above, a major concern for venture capitalists are the conditions for a potential future exit, which usually leads them to spend considerable time negotiating favorable terms. As startups tend to be private companies and tend to have pacts in place between shareholders, it is indeed difficult for an investor to sell a stake without a particular liquidity event (IPO, or a sale of a company’s entire share capital). Firms and funds often end up with stakes in failed companies because they can’t find buyers. But in the case of tokens, holders can sell or completely liquidate at any time.
Tokens can also be economically viewed as targeted stocks (shares with financial rights tied not to a company but to its subsidiary or to a project) insofar as they allow investment in a specific project while avoiding exposure to risks associated with an entire company. Accordingly, an entity could validly hold multiple ICOs on various projects and reach different sets of investors.
On the flip side, tokens don’t offer the same rights to information as those used by VCs, who typically negotiate agreements to obtain governance rights and provisions for financial information to track their investments. Although future regulation will likely require ICO companies to be transparent on the progress of their projects, this may not be enough for VCs who are unaccustomed to playing a passive role. Indeed, the governance of a company tends to be organized in such a way that investors are the ones who approve structuring decisions.
Future of ICOs
Going forward, a new practice of financing startups through a mix of tokens and capital could potentially develop. ICOs and fundraising are certainly not mutually exclusive, and a mix between the two could offer VCs a liquidity opportunity on the part of their investment via tokens that are coupled with rights, such as becoming a minority shareholder through tokens. On the other hand, entrepreneurs could maintain control of their company while benefiting from the added value of having experienced VCs on board. Such a practice is already beginning to develop in the US through RATE (real agreement for tokens and equity), whereby a company offers directly to investors a mix of shares and tokens so that the latter is incentivized, due to their equity holdings, to ensure the success of an ICO.
What about Quidli?
In the case of Quidli, the team has considered the above and will pursue an ICO. Accordingly, a key objective is to build a loyal community around the Quidli vision: Equity-as-compensation is the future of work. One way we do this today is involving early users of the Quidli protocol, and or the work-for-equity platform, in the product definition and development processes.
As for fundraising, Quidli, despite its ICO ambitions, still remains open to traditional equity financing from VCs/institutional investors; just as long as they’re in line with Quidli’s vision and are ready to also invest in QUID tokens. After all, we aim to build the future of work to include full flexibility.
Let’s rework work together! Follow us to learn more about the future of work, equity-for-labor, blockchain protocols, and to stay updated on Quidli’s progress.