Startup funds are essential for any new entrepreneurial endeavor, but raising those funds comes with trade offs. ICOs are newer and come with a long slate of unknowns. For some startups, however, it might be the best way for them to get an influx of much-needed cash. The turbulent track record of ICOs, however, demonstrate it is not always the ideal route for funding.
What is an ICO?
The concept of an ICO
is pretty simple. The company gets the cash they need to develop their idea, while investors get credits to use or sell at a later time. Most investors in ICOs are probably betting that the coin will become a valuable asset to use or sell.
But an ICO does not work for every business: if a coin does not fit with your current operational methodology
, it doesn't make sense to create one just for the sake of holding an ICO. It may actually be counterproductive, if the result is issuing product credits to thousands of people that you have to honor in some fashion in the long run.
Kik, a chat app that raised $100 million in an ICO for its digital coin Kin
, is an existing business that could have got venture backing. Instead of taking that route, they developed a coin that fit neatly in with their expansion plans. While Kik is now a chat app, it envisions an entire digital ecosystem
upon which Kin could be used.
Storj, a provider of decentralized cloud storage -- an alternative to data center-based cloud storage -- is similarly innovative. Its coin also makes sense. Those who hold STORJ, the company's digital token, get access to the cloud network. This company raised $30 million in its ICO
, $20 million of that in the first few hours.
Advantages of an ICO
An ICO lets you raise money quickly. Storj is just one of several high-profile examples who raised tens of millions of dollars within a day
, getting highly sought-after capital without giving up an ownership stake in the business or taking out expensive debt. Unlike an IPO, an ICO allows for a kind of crowd financing without giving up an ownership stake in the business.
Disadvantages of an ICO
ICOs are a new phenomenon that's caught the eye of regulators. Late last year the SEC announced that tokens sold in an ICO may indeed be securities
, therefore adding a substantial layer of legal boundaries for which many startups may be unprepared. In addition, if something goes wrong after the token sale, there is little recourse in the non-crypto world. The infamous hacker attack after the DAO ICO in 2016
resulted in lost funds and a scramble among coders to recover system integrity.
There is a risk of holding an ICO too early. Many -- 46 percent, according to one account -- ICOs failed in 2017
. Some folded because they had no product to sell. Because of the lack of regulation and the trendiness of ICOs, its not uncommon for companies to develop a simple white paper -- the same technique used to create Bitcoin itself -- and start asking for cash without a clear idea of how they are going to use it.
Is Venture Capital a Better Alternative?
Venture capital is a well-understood funding scheme with significant legal precedent. It is easy to establish the roles, responsibilities and potential legal fallout of any venture capital deal. Unlike with an ICO, you know what you are getting into with a VC deal. In addition, when you take on a VC investor
, you typically gain industry expertise. Your organization may lack an important part of the puzzle that is key to growth and development. A VC contact can offer this support, while also providing essential connections.
The tradeoff with VC is that you must take on a new partner -- warts and all. Depending on the ownership stake and the nature of the VC deal, you may have to take the advice, direction and opinions of your VC investor into account. This means that you do not have as much control over the company as you once did. This loss of control happens immediately once you lose a majority ownership stake, but the risk begins as soon as you take on outside investment. As new investors come into the company, ownership shares are diluted, and if you continue to raise outside funds you can end up a minority shareholder in the company you founded.
What's the Best Option?
There is no one prevailing opinion as to whether the ICO or VC is the best route for raising business capital. It depends largely on the objectives for your business, and your stage of development. For many businesses going the ICO route, they simply don't have enough established in order to convince a VC firm to take a chance on the enterprise. Essentially, people buying coins are buying into an idea. It's much more difficult to envision a VC firm buying into an idea, unless the company's founders come with a separate credential that appeals to investors.
The most crucial question for entrepreneurs to ask is what the potential fallout may be for their business and for their personal fortune if they choose VC or ICO. Reputation is as important here as is the books of a business. Anyone who starts an ICO that fails spectacularly, may be unofficially blacklisted in the financial world because no one wants to take a risk on them again. Consider your options carefully, because you may only have one chance to get it right.