Traditionally, two methods have been used in order to raise capital to fund a new venture – issuing debt or issuing equity, via private institutions or an initial public offering. Becoming increasingly popular in the tech industry, is a method of raising capital without giving up ownership stake, and without putting liabilities on the balance sheet. This method, which has become increasingly popular in 2017, is known as an Initial Coin Offering (ICO).
It is imperative that the worlds of tech and finance are aware of: (a) what an initial coin offering is, (b) the pros and cons associated with an ICO, and (c) how to successfully launch an ICO, in order to prepare for the way that this technology might effect the industry permanently.
Initial Coin Offerings (ICOs)
An Initial Coin Offering is selling a new digital currency known as a “cryptocurrency” as a way of raising capital to fund a new venture. Unlike stocks traded on the public market, these digital tokens or coins do not confer ownership.
Cryptocurrencies offer a unique form of transacting, based on blockchain algorithms on a completely decentralized network. Data regarding the currency and transactions are kept on a shared ledger, giving everyone access across the globe, making it impossible for someone to fake a transaction. Each transaction must be verified by individuals using the platform.
The value of these coins is based on market speculation of the blockchain platform on which the coin is exchanged. Due to the technology required to support a blockchain platform, most companies that ICO are typically tech companies with a focus on blockchain technology.
Late this summer, blockchain based assets passed a market cap over $150 billion. This year alone, more than 220 ICOs have raised more than $3.5 billon. Initial Coin Offerings provide an extremely efficient way in raising capital, with one ICO raising over $153 million in under 3 hours, and another raising $35 million in just 30 seconds.
Pros and Cons of an ICO
Several reasons exist as to why a company would or would not want to ICO, depending on the individual needs of a company as well as the surrounding circumstances.
Opportunity: Often times, there are projects that would not be funded by venture capitalists due to speculation and other factors. ICOs provide necessary capital for these projects that might seem less promising, however provide incredible opportunity for entry into new products.
Efficiency: An ICO provides close to immediate access to capital without those in control needing to give up ownership or a portion of their stake – or incurring costly liabilities.
Awareness: Due to the nature of an ICO, extreme amounts of advertising is needed in order to raise awareness about a venture. This in turn helps to increase potential investors and support, as well as creates a community and a constant exchange of ideas.
Scams: A number of Initial Coin Offers are actually scams – disguised as an ICO. The probability of investing in an illegitimate ICO makes it increasingly more difficult to trust and invest in a real potential project.
Pure Speculation: The success of an ICO typically has more to do with the advertising and marketing campaigns that surround it – rather than the actual success of the project. The project might not be the best, but if the marketing and hype surrounding a project is the best, it will most likely be the winner. Many factors can come into play, because the investor is truly investing in an idea, not necessarily a finished product.
Government Regulation: Due to the nature of an ICO and all the potential scams that can be involved with it, the government could potentially shut all cryptocurrencies down (much like it recently happened in China). In this event, all these projects would be deemed as useless, and would completely undermine the purpose of a decentralized network.
These key considerations must be analyzed critically before deciding on whether or not to fundraise via ICO.
Launching an ICO
Successfully launching an ICO requires planning and anticipation, and must be approached with the investor’s point of view in mind. Several legal factors should be taken in consideration. Launching an ICO typically follows this process:
The first three steps help to gather all of the important information. A company must determine whether or not it makes sense to develop a token or currency, and if an ICO will really meet their needs. If a company focuses primarily on agriculture and transportation, most likely it would not be prudent to fundraise via ICO. However, if a company focusing on peer-to-peer money transfers, it would make much more sense to invest both time and resources into developing a new token or coin.
After determining the project will be beneficial, a whitepaper (the equivalent of creating a CIM or pitchbook) will then be created, outlining all the details of the ICO. This whitepaper is essentially the why, and the mode of connecting to and attracting investors.
The process of registering one’s Initial Coin Offering (ICO) with the SEC via Regulation A+ is perhaps one of the most hotly-debated topics currently in the industry, but it is an area on which most attorneys agree. We will speak at length on this topic later, but with impending regulation for ICOs, it is best to get ahead of the inevitable future of Initial Coin Offerings as a security. While this adds cost, complexity and a host of other hoops to your ICO, it could eventually mean the difference between success and SEC attorneys knocking on your door.
The white paper should include detailed background information on the project, deep market analysis, information on the product itself, and the details involved. Additionally, specific information about the technical aspects of the project should be included. This section gives particular importance to the competitive differentiator of this product and the associated token that would be issued with it. Furthermore, information regarding the timeline of development for the project should also be enclosed.
The website is typically the place where the initial fundraising is hosted – the interface for investors to access the whitepaper, as well as to participate in the initial transactions. Potential investors can purchase the proposed token using other popular Cryptocurrencies (such as Bitcoin or Ether) and in some cases cash may be used. A certain quantity of these tokens are secured, and then can be deposited in a wallet.
If the company does not meet its fundraising goal within a specified amount of time, the ICO fails and investors will typically get their money back, and no tokens will be issued.
Emails regarding fundraising progress can help encourage investors to contribute more, or to simply keep them updated on the progress of the project.
Step six includes detailing the conditions for the investors, which explains the exchange for the tokens as described previously, as well as the total volume estimated to be issued and the means of distribution.
Social channels and advertising campaigns will allow for curious investors to have a place to ask questions and to learn more about news associated with the project. The advertising campaign provides information to be distributed to other potential investors who may or may not have heard about the project. These processes help to cast a wide net of investors and ensure that the goal will be met. Ideally, the fundraising goal will be met the first day, or quickly – the sooner that the goal is met, the more confidence that the investors will have in the project.
The investors tools must be capable of creating an account and wallet, in which the newly purchased tokens will be deposited and stored. The platform must also be able to capture critical information and identification about the user.
Lastly, the actual coins are issued at a stated price – much like during an Initial Public Offering (IPO), however no ownership is conferred. Rather, these tokens are granted and the investor hopes that these tokens will accrete as the project develops and becomes more and more relevant in the marketplace, and they begin to be exchanged.
Given the proper circumstances and positioning, an ICO can potentially lead to a very successful way to fundraise and to finance new ventures. Where venture capitalists used to hold all the control, a new player has emerged as a viable option for providing the capital necessary for these projects.
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(25), Vasilkoff, and Steemitboard (59). “How to make an ICO – 16 steps.” Steemit. August 08, 2017. Accessed November 21, 2017. https://steemit.com/ico/@vasilkoff/how-to-make-an-ico-16-steps.
“Demystifying Cryptocurrencies, Blockchain, and ICOs.” Toptal Finance Blog. Accessed November 20, 2017. https://www.toptal.com/finance/financial-consultants/cryptocurrency-market.
Rosic, Ameer. “ICO Pros & Cons: Cutting Through The Noise.” The Huffington Post. July 04, 2017. Accessed November 23, 2017. https://www.huffingtonpost.com/entry/ico-pros-cons-cutting-through-the-noise_us_595b7f22e4b0c85b96c6646e.
Schleifer, Theodore. “Silicon Valley is obsessed with ICOs. Here’s why.” Recode. September 19, 2017. Accessed November 20, 2017. https://www.recode.net/2017/9/19/16243110/initial-coin-offering-ico-explained-what-is-money-bitcoin-digital-currency.
Christopher R. Hulme contributed to this report.