Anti-hype approach: What is ICO in terms of Venture Capital financing?
During the operation of ICOscoring, its team has collected a huge amount of statistical information. Processing such data resulted in the understanding that the vast majority of ICOs have their most crucial risks in the “financial indicators” category. Detailed investigation reveals the true beneficiaries of seemingly five-star projects — management, ICO arrangers, but not tokensale investors.
This article touches upon the issue of ICO projects valuation and aims to compare financial parameters of ICOs and aggregated data of venture capital (VC) market.
ICO projects selection for the research
We randomly have selected 25 projects with the end date in Q3-Q4 2017 from Coinschedule list providing up-to-date information. ICOs much different from the median value, crypto funds, mining companies and infrastructure projects have been removed beforehand such as Kin ($97M), Filecoin ($257M), Paragon ($183M), etc. Total list includes projects only from Software industry.
Most of the successful ICOs did not have any sales and even a prototype
The first stage of any startup project is developing a product/service prototype. Startup is transforming, expanding and growing while an idea is evolving into a product.
The final purpose of a successful startup is being sold to a large corporation or keeping independent performance. In addition, one more option is available — initial public offering and selling shares for as high price as possible (IPO).
A project aiming to attract venture capital is experiencing several crucial stages that demand significant efforts to be invested.
Following the methodology of Michigan Ross school of business these stages aggregated accounts for the Venture Value Chain that may be described in 5 consistent stages:
· Shape (Commercial idea and Minimum viable product; pre-seed)
· Launch (Validated value proposition, prove market; seed)
· Scale (Scaling and growing; early stages)
· Refine (Sustainable business stage)
· Harvest (IPO… or M&A …or Cash Cow)
For better decision making an investor has to reduce uncertainty related to the market, project, its product/idea and team’s management skills.
As yearly stages are considered to be highly risky and an investor particularly is not able to bring investments back whole investment process is divided into several stages, or rounds of financing. Reaching crucial milestones of development a project is decreasing risks for investors and is proving its sustainability. Then investors decide whether to participate in the next round or not.
The vast majority of ICO projects choose a completely different way: setting only one round having had neither approved market demand nor a prototype.
As we can see 65% of projects had not had a ready product before the ICO and 75% of them did not have first sales.
Consequently taking into account Venture Value Chain model and other venture industry standards 85% of analyzed projects were in pre-seed and seed rounds.
In addition, the average funds raised were $19M per project. Therefore, such amount is far above the average funds raised during the seed stage in the US venture capital market as well as above the early stage rounds.
The question is whether it is an epidemic following the concept of Fat startup or just a cryptocurrency hype aiming to raise as much money as possible?
There is no saying that the rapid raising of great amount of funds in one round is detrimental for future development but nevertheless Lean Startup concept appears to be much more rational. Large-scale round and therefore, high start price for token pool undermines further price surge in case of the lack of explosive project development.
The average funds raised by ICO is 3 times as high as the average one in venture capital market
Here we have compared the average investments (depending on a stage) by VC and ICO. The source of the average values for VC is Pitchbook VC Valuation Report (2017 1H).
The result demonstrates that ICO projects raised much more funds than their comparable projects using VC financing (ICO rounds raised more than the 25% percentile of US VC early-stage comparable projects).
Only 10% of selected ICOs had indicated the explanation of needed funds by roadmap milestones and financial models and only 50% of them had clearly specified their soft cap, ignoring the fact that not working surplus funds tend to decrease investors’ returns.
VC and ICO valuation comparison: the capitalization equivalent in token pool valuation
As well as equity value measures all shares issued, we believe that ICO analysis must include the value of whole token pool and not only tokens in circulation.
Currently it is a rare case when the value of whole token pool is taken into account while analyzing, although this indicator is able to turn seemingly profitable investment to the detrimental one.
We decided to compare the value of such pool with Post money valuation for VC comparable projects (US market, Software, Round A). Token pool median capitalization for ICOs is $44.6M that is 50% higher than the average Post-money valuation for comparable projects using VC financing in more advanced stages (80% of early-stage projects have a product and revenue).
Conclusion
Our results clearly demonstrate the core ICO crowdfunding specifics:
· Even five-stars ICO projects with an operating product and ready for entering the market prefer to turn a blind eye to disclosing high quality financial information: projected revenue is not backed up with metrics, investments needed are not back up with a financial model and roadmaps and sometimes a soft cap is not stated.
· 60% of ICO projects raised more than $10M had not had initial sales and even a product developed.
· Average ICO raises 3 times as much as comparable VC projects.
· Considering a stage of development of analyzed ICO projects their token pool capitalization appears to be overvalued and is 1.5 times as high as the average Post-money valuation of comparable VC projects.
Highlighted facts prove that ICO market is still demonstrating high irrationality and demands both legal procedures to be upgraded and high quality financial information to be disclosed. The current trend is that more and more projects do not reach hard cap. This may be a signal either of a tendency to set too high hard cap level or of lower hype and stating more pragmatic approach to ICO investments.
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