In the op-ed column for DeCenter, Matt Krivoshein, marketing director of Forex Club Libertex, compared the mechanisms for attracting investments through venture funds and ICO, and also cited real figures on the volume of investments.
Previously, for any budding startup, the only option to obtain funding was to attract venture capital. Now with the advent of blockchain technology, each new project has one more option in the search for funds through ICOs.
Venture: Slow, Safe, and Regulated
Venture financing is a high-risk investment that has been attracted for a fairly long time in exchange for the participation of investors (mostly large and institutional) in the company's capital. In terms of European legislation, venture funds are regulated by a special document which was issued by the E.U. Parliament on April 17, 2013 (European Venture Capital (EuVECA) Funds Regulation). In the United States, the activity of venture investors is governed by Rule 506 (c) in accordance with Regulation (D) (Rule 506 (c) under Regulation D).
If we do not go into the specifics of venture financing regulation in individual countries, it can be noted that this method existed since approximately the 60s of the 20th century and is distinguished by a high degree of regulation of all procedures. This situation has both its pluses and minuses.
As a plus, it can be noted that, in addition to funding, a startup that attracts financing from venture funds receives a number of additional bonuses. Among them are consulting in the field of finance and accounting and recommendations for building business processes from serial entrepreneurs. As a result, the company gets the opportunity to use the best practices in the business sector. This allows startups to avoid mistakes associated with the routine of doing business and instead, focus on creating and improving the product itself, with which the startup enters the market.
The advantages of venture financing are also the minuses. First of all, it should be noted that venture investors are experienced businessmen. They require a detailed and feasible business plan from startups, which details all the company’s financial goals and ways to achieve them. Not all startups can make the appropriate document at the right level, which significantly limits the number of companies that are available for venture financing.
Secondly, the overregulation of all procedures implies that the company, as a rule, cannot receive funds until the moment it enters the capital market. For the company, this means that first, investors will receive a stake in the company's capital, and only then will the startup have the opportunity to use these funds for their needs. In many cases, investors receive a controlling stake, leaving the founders only as minority shareholders.
In turn, this means that the investor can influence how the company functions, for example, block transactions and change management. This can lead to conflicts between investors and the founders of the company, as investors are actively trying to interfere with its activities.
ICO: Fast, Risky, and Unregulated . . . for Now
An ICO is a much more flexible tool for raising funds. The reason for this, first of all, is that the process of seeking funding through this mechanism does not have clear regulatory standards on a global scale. In some countries (Germany, Canada, and Estonia), ICOs are officially permitted, but in others (for example, in China), raising funds in this way is prohibited. In a number of countries (the United Kingdom and Malaysia), the ICO is only partially regulated. The absence of common regulatory standards leads to the fact that the process of raising funds through the ICO differs depending on the country where the company operates.
Speaking about the advantages of ICOs, for starters, it is possible to note the possibility of attracting funds not only to startups having a "minimum viable product" (MVP), which can be shown to large investors but also to teams of enthusiasts who simply have outstanding ideas that require funds for implementation. To do this, it is enough to have a detailed white paper. Its preparation is quite a challenge, but the requirements for this document are still lower than for business plans for venture investors. This allows the use of this mechanism by a wider range of companies and teams.
In addition, the use of blockchain software helps startups build releasable tokens into their projects. This makes it possible not only to raise funds but also to form an "ecosystem" around the project in which individual actions of investors will be paid for by the released tokens. At the same time, not all businesses need to have their own token (if the startup is in an area where there is no need to create a distributed registry, for example, delivery of hot meals), and this factor may also not play in favor of ICOs when choosing a method for raising funds.
When using ICOs, company founders can retain more control over it, since initially, an ICO allows startups to raise financing without any obligation for investors to participate in the management of the firm. This allows the founders of the company, on the one hand, to realize their ideas in the way they see them, without looking at the opinions of investors. On the other hand, however, it can lead to abuse of power by the startup team, even to the extent that, after raising funds, the founders simply disappear.
At the same time, in early 2018, Vitalik Buterin proposed a DAICO mechanism, which gives investors more opportunities to manage the company. It combines certain advantages of ICO and venture financing. The first positive moment for investors is that they can control the amount of funds that the founders of the company have access to. This allows investors to take part in the management of the company, bringing it closer to the standards adopted in the venture financing industry, and making it safer for investors.
Given that the mechanism of DAICO was created quite recently, ICOs do not have a very good reputation with investors. Researchers have repeatedly stated that a significant part of ICO projects in the market today are fraudulent. According to estimates of some companies, the number of such ICOs is 80 percent. A high degree of mistrust for the ICOs leads to the fact that tokens have a very high level of volatility. As a result, investors may face a sharp drop in the price of one or another token, which can lead to a loss of funds.
"Achilles and the Turtle"
Comparing the volume of venture transactions and ICOs, it is worth noting that the volume of the venture financing market remains more than the volume of ICOs. In 2017, the volume of venture transactions amounted to more than $100 billion, and the ICO volume was only $7 billion. At the same time, the average volume of the venture transaction in 2017 was about $20 million versus $12 million of the average ICO. In 2018, both markets continue to grow, and the ICO is gradually catching up with the venture market. The average volume of one ICO has already reached $25.5 million.
The choice between venture financing and raising funds through the ICO depends on many factors and, given all the pros and cons, one cannot say that this or that way of seeking financing is preferable for a startup. Everything depends on the factors of each individual project. It is worth acknowledging, however, that at the moment, the ICO has become a worthy alternative in the search for venture financing.