ICO vs Venture funding

Many people talk today about ICOs and blockchain. I am still a virgin in this topic, but consider current learning curve, I am heading to the right direction hopefully. In this post, I would like to ask you, my kind reader, to provide me your thoughts.

Couple of weeks ago I met a friend of mine who recently closed a multimillionaire ICO deal. Please, don’t get me wrong: I like the guy, we know each other for some years, but his passion to ICOs was very unfamiliar for me. And when one day, after just few months of starting his own startup company, having no technology, no strategy, or even proper market research, he raises significant amount of investments. I was amazed. And astonished! I could not understand what it takes to go through ICO direction rather than regular “VC way”. As well as I could not understand how people with no previous VC-level of background can provide this amount of cash. Apparently, if all global ICOs in 2Q 2017 raised $800 mm (according to Techcrunch) – there are quite a few people involved.

In regular VC-startup relations the process is very clear. VC is driven by the valuation of a startup. When it goes up (there are multiple drivers for that), as VC holds part of equity, the team makes good profit. Usually VC targets to get 1-2 unicorns, which make prosperity history for them. In the exchange, a startup gets extremely supportive partner, who helps solving very specific and unconventional problems.

One example of that I had recently with one of our partnering VCs. We needed to double-check our potential investor. Legal check was ok, but business check we couldn’t do ourselves. It may be a surprise for someone, but a startup should conduct similar level of due diligence on investors as they will do in reverse. Thus, in that situation, our partnering VC helped us a lot to avoid making a mistake, because an investor, who aimed to provide us tons of cash, was a bad fit with our company. In my course at IE Business School I’ve the point that it’s crucial who is your investor. On top of that, VC can provide founders and team with tons of advices & support. In the place where you are together in the same boat, VC will try to defend both of you, until the moment you are doing something wrong. Than you, as a founder & CEO, may be replaced. Sometimes it works, sometimes not. But this is the way the industry works.

Now ICO may be considered as a disrupter to the regular VC industry. In fact, if I raise EUR10 mm in ICO I don’ t need to raise rounds in regular VC funding (seed & Series A would be irrelevant now). However, what investor in ICO receives in not an equity, but a currency, which will be spent on your products. If a startup has very demanding technology and product for B2C market, ICO may be awesome way for everyone:

  • Startup releases coins & sells them to investors. In exchange, it receives required liquidity. In the future, it will need to provide products or/and services for already released tokens. This model is very similar to Kickstarter.
  • Investor purchases coins & expect them to increase in price. In fact, if a product of a company goes up on a demand curve, the limited amount of coins will spur the price for the tokens. Sometimes, to make it attractive, investor enters with some discount, so he makes more money (this option is like bonds without interested paid).

Well, it looks like ICO is far more attractive. Right? I would say – it depends. If the project is sustainable (you can say “lean”) & can get things done with or without VCs (or already have commitments from few of them) – ICO looks like a great option to bring extra value to the company, so that the valuation of asset would be higher. VCs would consider this step as an extra filter within their funnel (e.g. not investing on seed round, but on Series A instead) & will lower their risks. In fact, a company receives first revenue before it has a product ready, so sort of a risk is around. Startup which demonstrate sustainability with the funds collected from ICOs will get much higher valuation.

However, if the model is not sustainable and there is no team with expertise behind – ICO is simply prohibited. It can be a way for a scam. Many people who never thought about their own businesses before, using ease of access to funding from ICOs, leverage it for their shady motivation. This situation will stay the same, unless it is clear for an average ICO investor the HUGE difference between a real project & a scam project – we will see negative shadow on the most disruptive instrument for perspective young startups.

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