ICOs vs Venture Capital: Where are the Seed/Series-A/B rounds?
Will we see additional funding rounds as is customary with VC fundraises by startups?
The ICO Landscape
Initial Coin Offerings (ICOs) are changing the way many technology startups raise money to fund their projects. In fact, in the past few quarters, more money was raised through ICOs than conventional early stage venture capital funding. I will talk about details about ICOs and how they work in another post. For this story, I’ll assume that you know how ICOs work.
Excess Money
A disturbing tendency we are seeing in ICOs is to raise as much capital as possible, in one single round of investment. Seriously, how are they expected to know whether $50M will suffice or whether they need $500M or $5B for the next 5–7–10 years? This leads to what I term as Over Capitalization Disorder (OCD).
OCD has a tendency to lead to bad decisions even for Venture Capital (VC) funded startups. The headiness of excess money leads to overconfidence and also overspending. I know of more startups that died due to OCD than startups that succeeded. It also leads to distractions such as market-cap and PR (and in the case of ICO, things like forks on a different platform). These are unnecessary for an early stage startup, especially at a time when the entrepreneurs should be focusing on the product, technology and finding product-market fit.
ICOs in Series
I think the ecosystem will learn from startups that have failed due to OCD. By some time early to mid 2019, we’ll see ICOs adopt structures similar to VC funding. Here’s an infographic that depicts this structure.
Similar to Venture Capital funding stages & rounds, ICO funded startups will undergo 5–7 rounds of financing, with gaps of 18–24 months between them.
The seed round would be a $500K-$2M round, for 5%–10% of total token-supply. This seed capital should allow the company to run for 18–24 months. This is usually enough for any company to hire a decent team, build the product and iterate it till product-market-fit is achieved.
Investors in this round would typically be, those who can connect with the pain point the company is trying to solve, and even potential users of the product. Traditionally over 50% of the startups have failed before moving on to the next stage, hence this would be the round for those investors with the highest risk appetite and corresponding expectation of returns.
The second round would be similar to the traditional Series A round, where the company seeks $5M-$10M of capital, for an additional 10%–15% of total token-supply. The company would use these funds to scale it’s business and expand. By this stage, a lot of data would be visible to investors on how the company has performed, allowing investors to take a more informed decision and take lesser risk.
Given that the tokens distributed during Seed stage would already been in circulation, the market sentiment can decide the token-sale price for Series A investors. The tokens would typically be priced higher than the seed round if the company has performed well and lower if not.
Then, just like in traditional VC funding, we’d see follow-up B-token and C-token issues with more dilution and hopefully better valuation. The key difference from VC funding will be that the company’s valuation (and therefore the price of tokens) will be determined by market forces.
This format and structure will also prevent bad players from conducting fraud (such as running away with $20M-30M of capital raised within the first month of operations), and also ensure that the founders are vested and interested in the success of the company after the first round.
Governance Layer
To set this all up, a governance layer is needed, which is weaved into Crowdsale contracts. For starters, it should permit the lockup of all issued & non-issued tokens (on exchanges, individual wallets, etc) for a fixed duration of say 1 week (even 18 months after they have been trading on exchanges), that prevent these tokens from trading during the second-round of token issuance.
Governance layer protocols or middle-ware that enable such behavior could see a lot of potential room for growth and adoption in the near future. If you’re working on any interesting governance layer projects that can solve this across blockchain protocols and would like to chat — do drop me a note at preddy@accel.com.
