When Should Startups Consider Doing an Initial Coin Offering rather than a VC Round of Funding?

Initial coin offerings (ICOs) are a relatively recent phenomenon. Technology companies, unsatisfied by the traditional routes of securing operational funding, created a method of raising funds without the use of debt funding or venture capital. In summary, the company develops a platform through which it will sell its own virtual currency. Purchasers of the currency believe that the currency will have significant value once the company’s platform is fully developed and operational. The company’s platform will generally offer some form of service or value to the public. The coins or tokens issues in the coin offering can be used to purchase value on the company’s platform. The number of coins issued by the company are finite (I.e., there is a fixed number sold). The coins thus rise in value as the total value of the company and its services rises. Investors seek to purchase and hold the coins, as they represent some percentage of the company’s total productivity. Basically, the company is selling an asset indirectly. The coin is a speculative asset (it has a perceived value) that may ultimately represent actual value on the company’s platform. If the company’s platform never fully develops, the coins will have little or no value.

Debt or Equity Funding is Not Available

As discussed, the ICO process allows the startup company to raise money without selling equity or taking out debt. The ICO process avoids many of the negative attributes associated with incurring debt or seeking investment from venture capitalists, Notably, Incurring debt burdens the company to repay the debt and make interest payments. This can stifle the company’s ability to use revenue for growth and development. The ICO is not debt and allows the company to grow without siphoning off any operational funds. Selling equity in the company diminishes the founders’ ownership interest and ultimately surrenders a level of control to the investors. The ICO does not provide any ownership interest to the coin purchasers. The coins have some intrinsic value that is backed by the company’s productivity. It is not tied to company ownership.

Earlier Access to Capital than Traditional Routes

Companies seeking debt to fund operations must be able to secure loans from lending institutions. Banks frequently require proof of company revenue adequate to repay the loaned funds (plus interest) over a specified period of time. An early-stage technology company may not have available revenue to repay the loan. Further, the bank will generally require physical assets to serve as collateral for the loan. The most valuable asset of the technology company is its intellectual property. This type of asset generally is not readily accepted as collateral for such loans. As such, it is difficult for a company to acquire debt funding early in its existence. Venture capitalists generally place money in a company that has a proven business model and has the possibility to scaling. Many tech companies need funds before they have a proven business model. As such, obtaining venture capital generally comes at a far later stage of business development.

The ICO generally allows the issuing company to raise capital before it would otherwise be able to through venture capitalists or lenders. The ICO generally takes place before the company’s platform is fully developed. The company can begin to sell coins on its platform before the core value proposition (generally some software as a service) of the platform is complete or being offered to the public.

Ease of Offering

An ICO may seeming like a daunting process to non-technologists. The process, however, is made far easier by the open source nature of the platforms used to sell, distribute, and store the coins or tokens. The software used to build a virtual currency platform, such as Bitcoin and Etherum, is generally available for free as an open-source platform. Companies do not have to entirely construct their own platform for issuing and storing coins. As such, the company is able to employment this structure and make modifications to the system to accommodate the specifics of the coin offering. This makes the coin offering process less burdensome and available to a greater range of companies.

Lower Competition for Purchasers

Coin offerings are far less common than traditional stock offerings. As such, finding investors for coin offerings may be easier than finding investors for traditional stock. The reason is because of the headlines that ICOs typically garner. It is easier to grab the attention of investors focusing upon ICOs are an investment vehicle.

ICO Regulation

ICOs are generally regulated the same way as the sale of traditional securities, such as stock or bonds. There are scenarios, however, where the ICO could be exempt from securities regulation. Generally, any ICO that is backed by the company offering the coins is considered the sale of issuance of a security. If, however, the coin is not backed by the operations of the company, it is not regulated as a security. Virtual currencies, such as Bitcoin, are not backed by a company’s productivity. Rather, it is backed by the scarcity of the asset and the demand of individuals who have confidence in the value of the system. The system itself verifies transactions involving Bitcoin and is decentralized. As such, it is not a security. Of course, it is far more difficult to structure a coin offering that is not back by the company, it is still a possibility. Avoiding the heavy regulatory burdens of a security offering is a strong incentive to orchestrate this type of offering.

For these reasons, company founders strongly prefer the coin offering to the these traditional methods of raising capital.