SteemIt Inc funding: open market token sale VS private equity (crowd)funding

in steemit •  last year

Base jumping with no parachute

As this was pointed to me yesterday by a fellow steemian, in addition to @ned, @dantheman, and @steemit accounts that have already been powering down at full rate all the way down from ATH, the @dan account has started powering down too a few days ago. This account controls north of 4M SP. That means that starting very soon, another 40k STEEMs per week are likely going to start hitting the market. This is of utmost concern given that the price is already extremely low and the debt-to-equity is getting dangerously close to 1:10.

Why is Steemit doing that? Why are founders cashing out at maximum rate when at the same time they ask the community to make efforts and support the platform financially as Dan did in his recent interview with @dollarvigilante? Although I'm not privy of the details, there is a very simple explanation to that: Steemit Inc needs money to operate, and as it's customary for seed stage startups, probably can't afford to pay more than the most basic compensation to its founders and early staff, so Dan, Ned & co are probably powering down for the dead simple reason that they still have to make a living in the mean time.

Of course, the problem of selling STEEMs to pay for development efforts in these times of low demand where Steem is still subject to a lot of skepticism in the crypto community and beyond, is that market liquidity isn't a renewable resource, and Steemit Inc is not the only market participant tapping into the pool, far from it, as a quick look at steemdown.com will show.

Another nasty consequence of Steemit and founders powering down at maximum rate is that, when interpreted out of context (which means almost all the time given that Steemit hasn't made any statement on the matter), it sends a very bad signal to the market, including to other large stakeholders.

What can we do

But then, if Steemit & founders should lead by example and stop powering down and selling on the open market, what can they do to fund themselves?


(Credit: unknown @ yimg - Marie-Antoinette)

SteemIt potential revenue streams

Let's look at Steemit's business models and possible income flows.

  • selling STEEMS: that's potentially a massive income stream, but as we have seen, the market isn't ready and doing so crashes the market, which undermines the product itself and threatens to kill the golden goose. It's also not a very good strategy to sell a potentially valuable resource at a price way too low as compared to the price it would fetch if they waited until the market is ready.
  • selling Steem integration services to partners and customer companies: another potentially highly profitable business, but too early for its time as there are currently a limited number of partners and potential customers, and these are in a position of strenght to negotiate free integration given the experimental nature of the network.
  • selling visibility on Steem to advertizers: same as above, viable in the long run, but too early
  • selling blockchain consulting and development services: Steemit Inc is a blockchain technology company, these are highly sought after by large companies looking to add decentralization to their services. Although they could already do that, this would consume development resources and detract from the main objective of making Steem evolve. The way things are setup, the entity originally behind Steemit, Cryptonomex, is the one acting as a blockchain company and selling consulting and development services.

SteemIt Inc has value on its own

So it appears that Steemit Inc has much more potential and value, as a company, than simply giving birth to Steem and then disappear. Steemit Inc holds its own value, as a blockchain company, and as the obvious go-to service provider for anyone looking to do business on Steem, not to mention that the large stash of STEEM Steemit holds on its balance sheet also gives it a potentially tremendous value should Steem turn out to be successful. This makes Steemit's equity a valuable asset that could be sold for fiat. And that's precisely what Steemit should consider doing to fund itself going forward if it doesn't want to kill the golden goose.

Now let's look at the two options available for startups to sell private equity

VC funding

That's the obvious option that most startups are choosing. In all likelihood Steemit will have already considered that, and rejected it. It could be that they thought Steem would prove sustainable quicker and that they wouldn't need capital. Or it could be that they had put enough personal capital and thought that would last them long enough. Or perhaps they already had a low profile round with investors close to the founders like Cryptonomex and some Bitshares time investors. Either way, Steemit now has a pretty awesome product that's much more impressive than the typical underwhelming MVP VCs are requiring to show the money, so they are in a good position to negotiate good conditions for a funding round. If this post is for real, some VCs are already drooling at the perspective of investing in Steemit. Now, given how obvious this option is, I sense that there must be some deeper reason for Steemit to have ignored it so far. Dan has been sharing quite a bit on his blog about his philosophical views, which I share for the most part, and I can see how he wouldn't want to have to accept to lose some control on the company and the project, and prefers having to work with a community than investment funds. This is only speculation on my part of course.

Equity Crowdfunding

Equity crowdfunding is a relatively new approach to private equity funding that allows small investors to pool their capital via a specialized web-based platform and invest together in private equity via a type of company called a SPV (Special Purpose Vehicule).

There are three main reasons that startups usually refrain from accepting direct investments from small investors.

  • overhead: having to deal with communication, pitching, negotiation, legalities, fund settlement, shareholder registration etc. for a couple thousand bucks at a time with hundreds to thousands of investors just isn't worth the hassle.
  • compliance: this is a strong deterrent. Modern financial compliance is a mine field with as many different rule sets as there are jurisdictions, with harsh penalties going as far as jail in case of regulation breach (read @charlieshrem's blog for a very good example of how harsh consequences can be if you overlook compliance).
  • VCs reluctance: the last reason is no less dissuasive: because of the two first reasons and the huge future headaches that come with them, VCs tend to refuse to deal with startups that have included many small investors in their earlier funding rounds.

That's where SPVs and equity crowdfunding platforms come in the picture. A SPV is a sort of holding company with a single and unique purpose and extremely simplified legal requirements. It is used in this context to serve as a proxy for smaller investors to invest in a startup. What happens is that small investors become shareholders of the SPV. And the SPV invests in the startup as a single shareholder. A new SPV is created each time a fundraising occurs, so that each SPV only ever has as shareholders the small investors who participated in a particular round of a particular startup, which gives a good level of direct legal control and tracability to small investors.

This is all managed transparently by the equity crowdfunding company. From the perspective of small investors, the experience is very similar to that of regular crowdfunding: companies publish a pitch on the web-based platform, answer questions via a forum, and investors back the pitch using common means of payment like credit cards, bank transfers or even crypto. From the perspective of the startup, it's equally transparent: from a legal standpoint they have to deal with a single share holder, the SPV created by the equity crowdfunding company, and from a practical standpoint, the fund raising process is not really different of a crowd funding pitch.

This mode of fundraising is very advantageous for all parties. It gives to small investors access to the high-risk high-returns segment of private equity funding that used to be the monopoly of VC firms. As for startups, they get the benefit of dealing with a very neutral investor (the SPV, represented by the investment firm) that won't act nosy, bug them with petty requirements, or try to co-opt C-level officer seats with acquaintances. What the SPV wants is the aggregate of what all the small investors wants, that is to say exposure to potential future large returns on exit if the company is successful. and as little headaches as possible in the meantime. Another big advantage is that small investors will often become clients and supporters of the startup they help funding, and help promoting it, just like a regular web community.

There are many crowdfunding platforms, some specialized in particular sectors and some more generalist. The most famous are WeFunder, AngesList and bnktothefuture (pronounced "Bank To The Future"). Of the three, BnkToTheFuture is the only one to be specialized in Fintech and Crypto, and effectively the one that is the most commonly used by crypto space startups.

What are other blockchain companies doing

Let's look at what other blockchain companies with similar revenue structure and/or business model are doing.

  • Ripple: raised funds with VCs and strategic partners. USD 93M raised with equity only in 3 rounds at undisclosed valuation. Also selling XRP on the open market under contraints of volatility (XRP curve price is remarkably stable). Holding a ~80% premine of all XRPs including partners. In joint venture with SBI Holdings to sell XRP over Forex platforms of the group.
  • Synereo: raised funds with public token pre-sale and equity + tokens sale on BnkToTheFuture. USD 4.5M raised with equity + tokens (around 2M with equity alone) in one round, at valuation USD 10M. Holding a ~90% premine. Not selling anything on the open market: tokens released exclusively during fundraising events, and for future network promotion and giveaways.
  • Maidsafe: raised funds with private individual investors, ICO and equity sale on BnkToTheFuture in this order. USD 1.6M raised with equity only in one round at valuation USD 40M. No premine held but coins to be diluated 900% by future mining, and company to receive 5% as revenue.
  • Factom: raised funds with ICO and equity sale on BnkToTheFuture. USD 1.1M with equity only raised in one round at USD 12.8M valuation. No premine held but coins to be diluted by inflation, and company to receive a cut (exact % TBC).
  • StorJ: raised funds with ICO and equity sale on BnkToTheFutue. USD 500k raised with equity valuation to be determined at Series A round (convertible note). ~90% premine lelf for network rewards.

To sum up:
Equity sale: All of these blockchain companies are financing their operations by selling equity, and all with the exception of Ripple, have chosen to do equity crowdfunding, predominantly using BnkToTheFuture.
Token market strategy: None of these blockchain companies is doing unrestricted dumping on the market. Again with exception of Ripple, nobody is even selling tokens on the market at all. Ripple is selling under volatility restrictions and volatility is extremely low out of major news or market movements induced by Bitcoin, as can be seen from the charts. Another interesting point about Ripple is that they forced insiders who got large amounts of XRP to sign an agreement limiting their selling rate.

So far, all these projects seem to be doing well, and although correlation doesn't imply causation, it's interesting to note that these companies made the choice of funding themselves by selling equity and not dumping large amounts of token on the market and the only one that does some selling is doing it responsibly and holding insiders selling at arm length.

Conclusion

Given that the market can't take anymore dumping without triggering a blackswan, another model needs to be found urgently. Looking around, it appears that selling equity is a good funding model, and that equity crowdfunding in particular seems to be popular for doing so.

Accordingly, I'd like to suggest to Steemit to look into applying this model, stop as soon as possible open market selling and refrain from resuming it, or resume it under a controlled model, and consider negotiating limitations with insiders to restrict or mitigate selling.

Personal note

Disclaimer: I'm not holding any interest in BnkToTheFuture. I'm a regular user of this platform however, and my experience so far has been good.

I think both Cryptonomex and Steemit Inc would make interesting investment opportunities in an equity crowdfunding context. As an investor, I'm still very hesitant buying Steem due to the ongoing dumping, the increasing blackswan risk, and the fact buying from the market helps short sighted profit-taking insiders more than it effectively supports Steemit. On the other hand, I would be looking to buy a fair amount of equity in both companies provided that valuation is reasonable. And I wouldn't be surprised if many steemians turned out to be equally interested in holding equity in Steemit Inc and Cryptonomex.

This post is primarily addressed to Steemit Inc. Given the low chance that Dan and Ned would read this post before it disappears into oblivion, if anyone has got a direct access to Dan or Ned and finds this potentially useful to them, please make sure to let them know about this thread.

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Good analysis. I'm not sure that crowdfunding is the best way to handle this transition, but I would like to see it applied to some side projects by third parties.

We're in the early days of this movement/experiment. Steemit is just one use case for Steem. And in a way, it's the cart before the horse. Perhaps Steemit is a proof of concept, but it also can be an important pillar of this economy. It cannot be the only one.

If I were an investor, I'd be pretty impressed with what they have achieved so far. Clearly, the model needs some adjustment, but they've proven that it can work. One of the smartest things they have built in is the ability to make adjustments as the whole thing evolves, and I think we all see the need for some adjustments now in terms of the Steem supply and demand.

Supply: The inflation needs to be addressed, at least until there is some more demand for Steem. It sounds like this is on the table for the near future.

Demand: We need more businesses using Steem. I think Steemit Inc needs someone who can really market this well and explain to various businesses why they need to get on here. Without a concerted marketing effort, my suggestion would be to make it is simple as possible for business, apps, and third parties to integrate with and use Steem. The back end is awesome and we need to make the integration really user friendly for others.

Also, I don't think all of us should simply offer critiques. We should be building our own businesses and layers and apps and sites that are powered by Steem. Maybe you have one in mind that would be better than Steemit.com. The blockchain is there for all of us to build on; Steemit Inc does not own that.

And the really cool thing is that we all have a stake in every single one of those projects that's powered by Steem.

In the short term, there will be a transition with the price crash. Those who continue working on Steemit and Steem either love it or believe it has a future (or both). You won't be making a living on here right now (or anywhere close to it) and this won't turn around overnight, but I think that with some adjustments, it can be very attractive to investors. I think they won't have much trouble attracting investors, and that may be one reason the main team is letting the price crash (so the price will not be an obstacle to investment).

Sure, investors could be given a stake of Steemit Inc or Cryptonomex, and I think those entities have some investors already, but it makes more sense to build future investment right into Steem rather than separating it off into a crowdfunder that just creates more bagholders and more potential obligations.

I would LOVE to see more side projects by third parties (community members) that involve crowdfunding to get started. There are a ton of opportunities here right now. I'm buying more Steem.

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Great points @donkeypong! I just wish there was a little more communication between the founders and the community... Great post though and thanks for sharing!

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I just wish there was a little more communication between the founders and the community

Communication is already good. But community also have to try approach founders in appropriate way. There was an Oslo hackaton last month... and Ned was available for everyone for all 4 days longs.

Everyone could come, there was no a special ticket required.... in fact @bitspace give to everyone who come 100 SteemDollars.

Next chance to meet Ned is... SteemFest.

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I'm talking official communication via the website. Not everyone is able to attend things like that, even when they are free. There are numerous other costs associated including a time cost that not everyone has.

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And to get that, STEEM needs a better API, period.

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Great analysis :)

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I have ideas for projects but I haven't developed pitches or have any idea who might have any idea how to get it started. I just write the ideas and note some month or two later it is in early stage implementation, so obviously I must be seeing these things amongst the first.

It is just frustrating to me because this is the best I can do right now, and I am really not getting much out of it but reputation. Well, maybe some day soon I can power down some of my rep for the opportunity to work more intensively and have a warm bed and good food on a regular basis.

Very helpful analyze. What altcoin you suggest to buy atm . Which one have amazing future ??

I can definitely relate. When STEEM was worth three dollars, I was able to fund my own steem-related projects like Steem Center, a support center for newcomers with multilingual operators. I had a the offices lined up and a staff ready to go... and then the price tanked and I had to take a step back to wait for a recovery before resuming. When the price finally does bounce back, I suspect new life will be breathed into various other projects like mine and we'll see a lot more third-party development.

I think this is a great write up. Those in leadership positions should take a hard look at some of these possibilities and determine if there is anything at all that can be adapted to steem/it in an attempt to strengthen the network and the stakes of existing users.

However, I do want to push back against the idea of anything going on with Steem/it being some sort of black swan. By definition, black swan events are unforeseeable and all but impossible to prevent. We may be facing a catastrophic failure of the underlying economics of Steem/it, but it has been anything but unforeseeable, unpredictable, or even surprising.

We have been brought to the point where catastrophic failure is not a remote possibility, but seemingly inevitable. But the people responsible, the people in leadership positions, will never be able to claim that they couldn't have done anything about it. It is their decisions that have brought us to this point. It is hard to argue that it could have turned out any other way, without some viral growth which was a pipe dream at best... it was never cultivated.

We can still turn this all around, but I've lost faith with the leadership. I'd love nothing more than to be proven wrong, though.

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"blackswan" in my post refers to the event in Bitshares lore where a market pegged asset position isn't sufficiently collateralized anymore to maintain the peg. I agree that this is a rather liberal use of "blackswan" that departs significantly from N. Thaleb's original definition. And as you highlight, it's particularly ironic this time around because its occurrence will have been entirely predictable.

This is an interesting line of reasoning. However, isn't SP a form of ownership? Folks power up based on the promise of receiving more and the long-term potential of Steem to increase in value. If equity is sold in Steemit, Inc, it seems apparent that the holders of SP will have the value of their investment diluted.

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Good points. The better solution for current SP holders would be for investors to buy large chunks of steem and immediately power up to SP.

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My thoughts too. Thanks!

Why are founders cashing out at maximum rate when at the same time they ask the community to make efforts and support the platform financially as Dan did in his recent interview with @dollarvigilante?

@Tone_LLT ;)

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Are you on steemit chat?

Good analysis.