One of the biggest innovations in the blockchain space is the ICO or Initial Coin Offering. The ICO cuts the line between donations campaigns like Kickstarter and the more traditional equity offerings of an IPO. In many ways, the ICO is superior to both models and in this post I am going to discuss why this is and what the future could look like.
“Traditional” Fundraising methods Suck
Before we dive into why ICOs are so awesome, let’s discuss why the “traditional” fundraising methods like IPOs suck.
The IPO is the most traditional of the fundraising methods for companies as they “go public”. But there are a host of problems with this whole model. First, by the time a company can “go public” it’s typically already existed for a long time and achieved quite a bit of size. Since startups and not big companies are the main drivers of innovation and jobs in an economy, this means this funding is far too late in the game to push things forward. Before an IPO, startups rely on bootstrapping, Angel investors, or Venture Capitalists. These groups come from what they SEC calls Accredited Investors or Qualified Purchasers. The differences between these groups are important but for this conversation they are the same: People with lots and lots of money.
Because there are not lots of these investors the minimum amount they typically invest is quite high. So in order for a company to raise funds in this manner, they must convince 1–5 or so of these people or groups to invest amounts ranging from hundreds of thousands to millions of dollars.
Now ask yourself this, what makes more sense for a consumer-driven company: Convincing 1 million people to invest $10 or $100 because they like the idea or convincing 10 people to invest $1 million? Which of these scenarios is more suggestive of a good consumer product? Which of these scenarios involves people experiencing serious amounts of risk?
Because “retail” investors can’t invest in pre-IPO companies a workaround was created in Kickstarter. In this case, the products are pre-sold for what are basically donations. For those buying in, the deal is absolutely terrible. Essentially, the customer is just buying a product before it is produced but with no guarantee the product is ever received, is what they wanted, or is any good at all. The purchaser takes on all the risks of an early investor but with absolutely none of the investment upside.
That’s right, thanks to our current idiotic regulations it’s OK to risk your money on a non-product but not OK to risk the same money to buy equity and get a payoff. Go-go-gadget stupid government.
Kickstarter and similar services are riddled with products that failed, were not delivered, experienced horrible delays, etc. The “backers” took on the same risk as any investor would have but with no upside. The absolute best they can expect is to get a product they paid for months in advance.
Despite this, the money keeps coming in.
The fact that Kickstarters keep happening and keep succeeding despite this absolutely terrible arrangement is clear evidence that consumers want in. They want in on sponsoring great products. They want in on bringing great things to life.
And this is how it should be. It’s a far more democratic and market-friendly model than the walled garden of accredited investors.
Why ICOs are Good for Everyone
So now that we’ve covered why the traditional models suck for everyone (except the already super-rich) let’s talk about why ICOs are the best thing ever.
ICOs: Good for Large Investors?
The only group that really benefited from the IPO model was large investors. But amazingly, the ICO model is better yet despite all the other advantages to everyone else. How could this be you ask?
In the IPO model, investors usually had to wait YEARS to get their money out. If an investor put $10 million into an early company, they would have to wait for that company to grow, build, and then have an IPO in order for the investor to sell their equity and get their capital out. Worse, the investor could have their equity diluted by follow-on investment and as a result their voice in the company’s affairs would be diluted as well. If you were an early investor in say.. Juicero, you might have wanted to pull out long before the end but that would not have been possible.
With an ICO, Investors get quickly trade-able tokens. Instead of waiting years, Investors can sell their tokens relatively quickly and make a profit after helping a company get their product off the ground. In turn, the Investor can re-deploy that capital into a new venture. This higher velocity-of-money is the exact behavior that pushes the economy forward, grows companies, and builds jobs. Investors can go from ICO to ICO helping promising companies get off the ground. Even if a few of those ICOs or Companies fail, the velocity of growth means that the large investor still makes a size-able profit.
So the ICO model is good for the investor, good for the companies, and good for the economy. Win, win, win.
ICOs: Good for consumers?
The ICO model is particularly good for retail consumers who would have to wait for an IPO to buy a traditional stock, because they are the ones most disadvantaged by the traditional offerings.
Many millions of people can afford to risk $100–1000 without suffering serious ill effects. The truth is people risk that much by trusting in shoddy car repair, but with no upside.
With an ICO, consumers can invest in companies and products they love and desire and not only get the product like in Kickstarter but ALSO derive some investment upside through the appreciation of the product token. And they deserve it. Consumers that take on investment risk by being an early backer of a product deserve more upside than just getting the delivered product. An ICO means that those consumers who take on the earliest and largest risk get the biggest reward.
The ICO democratizes the wealth gains that used to be the domain only of the very rich. If you are a reader of Robert Kiyosaki and his Rich Dad, Poor Dad series, he discusses how the best investments simply aren’t available to average people. But with ICO, that may be changing.
The ICO: Better for Companies?
Young Companies are definitely better off because of the ICO model. Getting Angel or VC capital has mostly been reserved for those who are already well-connected. This closes the door on many would-be entrepreneurs who are hardworking, smart, capable, and have great ideas. For all the talk of “Meritocracy” it’s very clear that the world of VC is a walled garden. For the vast vast majority of companies, there isno point in pursuing VC at all. In these cases, the pursuit of venture capital funding is a net expense, costing the company and its founders time and energy for no return.
Worse, the interests of venture capitalists, company founders, and consumers rarely coincide. Venture capitalists simply want a return on money — preferably a large one. They are unlikely to even touch a company unless they see a minimum 20x return at the end.
But the customers that a company serves have very different desires and expectations, ones that may be more more in keeping with the desires of company founders. A company devoted to providing a good product and to social causes such as the environment may not provide as good a return to an investor but may provide a great return to their community and their customers. And plenty of “retail” consumers would be happy to risk $1000 on a company doing something they love in return for the shot of getting a 2x return. No VC would touch a return like that, but millions of ordinary people would LOVE to take that risk. You can do double or nothing in Vegas, but not with ordinary investments. Go figure.
For this reason, it makes a lot more sense to allow potential customers to also be investors. In fact, ICOs have already provided more funding to more companies than Venture Capital.
This is great for young companies and their customers. And frankly, it’s about time disruption came to the investment industry.
ICOs: Better for communities?
One group left out of the whole conversation with traditional funding is communities. A company that moves into a region brings jobs and money. A large firm leaving a community can end up causing massive economic disruption and decay as large parts of the USA have discovered as factories closed and moved overseas.
Fundamentally, this is because while the company has no loyalty to the region, its employees, or anything else other than its investors. And if those investors aren’t also the community then, well, sucks to be them.
The ICO model allows a self-organizing community to become investors. And in the case of DAO like tokens, those investors can have a strong voice in the operation of a network or business. While tokens like this tend to run afoul of the SEC securities laws, those laws can (and should) change.
The ICO model and further funding innovations can bring the gains and prosperity of capitalism back to the people and to society. For all the talk of how blockchain will disrupt the world it is this new funding model that might have one of the biggest impacts. We are just at the beginning, and I for one am excited to see where this can go.
Everyone expects regulation to come to this space. As long as that regulation prevents outright fraud, that’s a good thing. But I along with many others worry that regulations will kill a financial innovation that’s almost as big as the blockchain itself. ICOs fill a vital need to spread the wealth of innovation and startups across society instead of concentrating wealth and ownership among the already affluent. In the meantime, ICOs are still unregulated enough that there is great opportunity in this space. In case the governments of the world decide to be particularly boneheaded, I suggest getting in now while you can.
Brenn is a co-founder of BlockSimple, a serial entrepreneur and expert in the crypto currency and blockchain space. To find out more about him and his firm check out http://blocksimple.consulting
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