As initial coin offerings (ICO) grew in popularity, the amount of money contributes by early investors to cryptocurrency projects exceeded that invested by traditional methods. Both investors and ICO startups should understand the fundamental difference between ICO and venture capital funding: with venture capital, you always build up your business first, make it worthwhile, then talk to venture capital funds. With ICO, you raise the capital first and build the business. But there are more differences than that.
Due to the nature of running digital businesses, ICOs are a lot more cost-effective way of raising capital than an application for venture funding.
Because VCs are the more experienced entrepreneurs, they want to ensure that they can get better Return on Investment (ROI) as well as a fair share of the company’s equity. In most cases, VCs get a percentage of equity ranging from 10% to 50%.
In case of an ICO, business owners keep possession of full equity of their new company.
Control over the business is another important aspect. When the company receives funding from venture capital firms, they also understand that such investment will result in stakeholders controlling the way the company is run.
ICO funding does not empower investors to exercise any control over the business, so the founders are free to operate as they see fit.
Due to the nature of the digital business, ICO founders expect significant liquidity. A good project with substantial followers’ trust and solid advising team can quickly get hold of tokens worth millions of dollars.
In case of venture capitalist funding businesses cannot enjoy the same level of liquidity without handing over securities in some way. The funding lifecycle usually takes 3 to 7 years and could involve 3 to 4 rounds of funding.
While the quick availability of funds clearly plays to the advantage of digital token sales, when the new cryptocurrency is listed on the exchange, and trading begins, the project team often becomes less focused on productivity. Teams are distracted by the media scrutiny and the competitors examining their every step.
TYPE OF INVESTORS
ICOs typically attract either beginner investors or speculators with a taste for a high-risk, high-yielding investment. They may not believe in the viability of the project or its ability to generate profit. With VC, a venture capitalist invests with long-term potential, keeping farther in the company until it goes public or is acquired by another company for a profit. This is not an attractive opportunity for speculative investors.
VC funding is often more than cash injection in return for equity: it is an excellent way to improve the business perspective for a new company. Many venture capital companies educate the new business, sharing strategic business advice, assisting in networking to offer new business opportunities, and even help with headhunting. ICOs are often left on their own relying on the expertise of their advisors.
It’s good to keep in mind that many venture capital funds have mandates – minimum investment would be $1 million or $10 million, so if you are just seeking a smaller amount of capital, they will not talk to you.
SIGN OF TRUST
Start-ups rarely get the attention of VC firms and should go for alternatives rather than venture capital funds. To win the trust of angel investors and pass the due diligence the company has to be on the market for some time and has a strong history of success. Similar to the filing of a bank loan or asking for a line of credit, you need to show proofs that your business has a high potential for growth, particularly during the first three years of operation. Any company seeking capital must ensure that their business is bankable.
No wonder that only one percent of hopeful applicants pass this strict test and receive the funding. In return, they not only enjoy the capital for growth but also a badge of honor for meeting high standards set in the industry.
ICOs are not regulated in any way. All that you have to examine and build the level of trust in the project is the website, personalities of the team and a white paper. This creates a sense of uncertainty and a feeling that anyone can do an ICO.
While it may seem that ICOs are a more progressive and beneficial method of raising funds for a startup, investors should not be fooled by the impression of simplicity. Even though launching a new token is relatively easy on a platform such as Ethereum, a successful fundraising campaign requires careful planning and initial investment, a solid team, and of course a great product idea. And even though tokens may be available in a matter of weeks, it takes a good preparation and specific steps to access funds and start using them.
There are certain benefits and disadvantages to both types of raising capital. We will still have to see if ICOs end up a reliable and popular method of seeking investment and whether the new regulation changes the cryptocurrency system. Initial token offerings are ideally suiting digital projects that thrive on agility and quick changes on the technological landscape.