Startup Funding: Venture Capital is Out and ICOs Are in
Posted On: October 27, 2017
During June and July 2017, more capital was invested into technology companies via ICOs than traditional venture capital. This fundamental shift in tech fundraising seemingly came out of nowhere, stunning venture capitalists around the world. These teams are raising millions, some with little more than a white paper and a landing page. The tech is a promise, the team is ephemeral, and the numbers are huge.
Traditional VCs place their bets on companies in rounds to limit their exposure and reduce risk. With each new round that a company raises, there comes a decrease in risk. Call the rounds what you want (Seed, Seed Plus, A, Bridge, whatever), but the real delineation between funding rounds is the decrease in risk (the VCs hope), and increase in valuation (the founders hope).
ICOs turn this risk model on its head. All capital is raised (and called) up-front in the form of crypto transfers. These funds are traded directly for coins in the new venture (usually). Now sometimes this makes total sense, the technology is built, and there is a defined equation behind what you put in as an investor and what you get out. It’s an amazing advance in technology and a radical democratization in fundraising. The value is liquid, the code is open source, and all is well.
Except when there is nothing built.
Some pre-sales are running with no real products. They are pre-selling tokens that don’t exist, and may not ever exist in the future. There are no non-performance clawbacks, contracts, or regulatory oversight. Once an investor’s value is transmitted into the presale, it is up to the founders what happens to that value. Some have been using the functionality of smart contracts to protect investors, but this has only been seen in a small number of the most professionalized ICOs.
The rise of the ICO is a result of several undercurrents in the startup world converging and forming a rogue wave of innovation.
Some notable examples of these trends:
- SecondMarket. A company that was meant to allow early equity holders of successful startups to capture some of their gains prior to an IPO. The goal was simple: Allow owners of private company shares to sell them to qualified investors. Most large startups quickly barred their equity owners from selling on SecondMarket, due to optics issues and external valuations coming into play (cough… Uber).
- The JOBS Act. A massive undertaking designed to improve the fundraising process for small businesses. The idea was to facilitate equity crowdfunding, but in practice the regulations were so burdensome and confusing that most companies who had the ability to raise traditional venture capital opted for this method instead.
- eShares. This company seeks to make the ownership structure of startups comprehensible, and to bring it into the 21st century. With multiple classes of shares, hundreds of owners, and seemingly endless exceptions, eShares finally allowed transparent and collaborative cap tables for startup founders, employees and investors alike. As a venture capitalist, this is one of my favorite companies of all time.
These three core ideas have all been executed brilliantly within the ICO fundraising model.
With the correct architecture, this model of fundraising has a bright future. However, in its current form there is much to be desired from an investor perspective.
As an early cryptocurrency investor and believer, I love the pace of innovation and radical exploration that is taking place in the current market. However, as an institutional investor, I dislike the fly-by-night nature that many of the ICOs in the market are currently operating under. It is short-sighted and deceptive.
The regulatory controls in place for things such as accredited investor status, general solicitation and insider disclosure have been put into place for a reason. While some regulations can be seen as overstepping, or intentionally burdensome, most are in place to either protect the individual retail investor, or to add transparency to the market. Cryptocurrencies have always been a bastion of transparency. Recently, we have seen a shift away from that core ideology.
It is time for the crypto markets to professionalize.
No more public acceptance of shady practices; no more ignoring the issues that bad actors create. It’s time for us to take a good, hard look at the potential of the technology, and not waste the small window that we have to prove legitimacy to the general public or institutional investor.