Startup fundraising: ICO or Traditional Venture Capital?

lawtrades blockchain ico holding bitcoin token

The sudden explosion of Initial Coin Offerings has opened up a whole new world for startup fundraising. In 2017, ICO fundraising totalled an astonishing $6.8 billion. By early 2018, blockchain ICOs have surpassed traditional venture capital in terms of funds raised in angel and seed rounds. However, blockchain and cryptocurrencies do present their own challenges and limitations for fundraising purposes. When you are planning your business fundraising strategy, be sure to take the following factors into account before making a decision.

 

Fundraising Cost and Regulation

One of the benefits of fundraising through an ICO is that it seems to be a low cost, low effort option to raise staggering amounts of funds. The venture capital process is slow, offline, region-specific, paperwork-intensive, and often inaccessible to many startups. By contrast, the decentralized and online nature of ICOs can be attractive. For an ICO there is no intermediary needed and funds can be raised very quickly. Blockchain startups that decide to fundraise through ICOs also have the advantage of facing few regulatory burdens.

However, it is important to realize that this might be changing. ICOs are indeed a lower-cost, less-regulated option to raise funds, but that might only be because regulation is lagging behind the market. Recent statements by the Securities and Exchange Commission indicate that certain cryptocurrencies are indeed considered securities – this will definitely increase the cost and paperwork associated with ICO fundraising. More on that here.

 

Public Scrutiny and Team Focus 

One of the often overlooked challenges that ICOs bring with them is the organizational effect of being funded by a cryptocurrency that is traded live. This can be especially challenging in the early stages of a startup.  If your blockchain ICO has launched, it trades. On the positive side, this does create liquidity and real-time risk pricing that venture capital does not offer.

However, it also creates extra overhead and attentional bandwidth demands that could be detrimental to the long-term productivity and focus of the team. A very big benefit of staying private is that you have time to sort out important issues and refine your business case before having to deal with public scrutiny. This is a significant advantage of traditional venture capital that ICOs do not offer.

 

Types of Investors 

The investors that a startup attracts with ICOs differ significantly from the types of investors attracted with traditional venture capital. This is, again, a consequence of the fact that once a blockchain ICO goes live, the coin is listed on an exchange and traded within weeks.

The result is that investors are able to cash out shortly after investing in the blockchain ICO. This attracts speculation, creates bubbles and volatility, and opens up the possibility of investors interested only in short term fluctuations and not the long term success of the blockchain startup.

The mindset of a traditional venture capitalist is one that is invested in the success of the startup. Often, the VC offers not only funds but advice, connections, expertise, and guidance. This is a significant advantage of traditional venture capital that has been essential to the success of many startups. Using a VC often means that business fundraising is about more than just cash: it is about setting your company up for success.

 

Equity and Shareholding

An important difference between ICOs and traditional business fundraising efforts is its effect on equity in the startup. With an ICO, one need not give up equity in the company. That is of course very attractive – you keep on to as much ownership of the startup as possible.

Another benefit that arises here is that shareholders in a company might be skeptical of new and risky projects, but because ICOs don’t require you to sell equity, shareholder sign-off is not needed. It might be easier to raise funds for something risky and unproven through ICOs than VCs for exactly this reason.

 

Security

Security poses a significant concern to the viability of ICOs. There are many haunting examples of blockchain startups being hacked, and losing all of their funds in the process. In addition, the fact that blockchain and cryptocurrencies are vulnerable to money laundering, terrorism, and financing risk keeps many mainstream investors away from the ICO space.

 

Business  Model 

It is no secret that the crypto space is extremely volatile and at times unpredictable. To really understand the underlying value of ICOs and cryptocurrencies, it is always important to draw a distinction between price and market fluctuations, and the real economic value underlying it.

ICOs have grown in prominence because they offer cryptocurrency projects something that traditional venture capital cannot offer. The ICO process raises funds whilst serving as part of the user acquisition and developer community creation process. This is especially important in the case of cryptocurrencies that allow developers to build on the coin (think, for example, of Ethereum).

However, whether or not this will be valuable to your startup fundamentally depends on the nature of your project and your business model. If your business model is not structurally reliant upon blockchain and cryptocurrency users buying and working with your currency, the benefits of ICOs can seem less attractive. In addition, this would also be a good signal that your cryptocurrency might be considered a security by the SEC.

The first step towards making the right decision is knowing your product, business, and market very well.

 

Experienced Cryptocurrency Lawyers 

These legal considerations can seem overwhelming, but they need not be. LawTrades works with experienced cryptocurrency lawyers all over the country who can help you navigate the ICO process.