ICO and VC 101 — which one should you choose
What is ICO?
ICO, ICO, ICO. There’s no doubt everyone is familiar with or at least heard of cryptocurrency. If not, you are really living under a rock! Even my taxi driver is familiar with the most popular form of cryptocurrency, Bitcoin!
If you are like me, interested in investing in cryptocurrency simply because everyone is talking about it, I’m sure you’ve come across terms such as ICO (aka. Initial Coin Offering).
ICO is a way to crowdfund by issuing cryptocurrency tokens for blockchain projects. And no, these cryptocurrency tokens are not Bitcoin if you are wondering. Instead, they are tokens made by the company which explains why there are thousands of cryptocurrencies circulating in the market right now. ICOs have proved to be valuable fundraising tools for investors since the concept was brought into the limelight in 2013. So far this year, investors have used ICOs to raise over $1.8 billion.
During an ICO, there are two kinds of token you can purchase. First being the utility token, it’s meant to be used on goods and services developed by the cryptocurrency company and nowhere else. The second type of token is the security token, it works very much like stocks where you buy part of the company during IPO. However, unlike IPO, you will not get the equity that comes with regular stocks.
Let’s say now that you have decided to invest in a security token, how can you trade it? You must register yourself on an exchange to trade tokens. However, please do extensive research on various exchanges as not all exchanges will accept the token you own unless you’re holding to the popular ones such as BTC, LTC or ETH. Popular exchanges include and not limited to Coinbase, Coinmama, Luno, Bitpanda, and Kraken.
ICO has achieved its goals if the soft cap is reached. The soft cap is a minimal amount for the project to move forward. And of course, there’s a hard cap, the maximum acceptable amount. However, if the soft cap is not reached, most ICO will return its funds to investors.
ICO is considered a high-risk investment. One of the recent tragic cases on ICO happened in 2016. DAO launched its ICO in 2016 and raised over $150 million through the ICO campaign. However, the smart contract behind the DAO had a small bug that was later exploited by a hacker who eventually made off with $50 million. Both the fundraisers of the ICO and the investors were devastated by the news.
If you decided to test the market or are very interested in investing in ICO, practice doing extensive research around the project by researching about the whitepaper, understanding how the projects apply real-world value and knowing who the key stakeholders of the company are.
If you are a founder and want to know how much does it cost to launch an ICO from scratch, it would cost an average of $60,000USD, read the break down here.
The main difference between ICO and Venture Capital
What is VC?
Venture capital is raising money from a group of venture capitalists by pitching to them your idea/project to convince them to invest in your company in exchange for your company’s equity.
A VC firm is structured into limited partners (LPs) and general partners(GPs). LPs are someone who commits capital to the venture fund. They mainly comprise high net worth individuals, insurance companies and institutional investors. They do not concern themselves with the day to day running of a VC fund, but these are the guys who have put up the capital for the VC fund. While GPs are the venture capital partner of the management company. GPs raise and manage venture funds, set and make investment decisions, and help their portfolio companies exit because they have a fiduciary responsibility to their LPs. They are the guys who decided which ventures to invest in, and the guys who generally take a board seat post-investment.
To put it simply, the LPs invest into the venture capital fund and the GPs manage the venture capital fund. The venture capital fund invests into the portfolio companies.
Interested in pitching to venture capitalists? Get your Capitalization Table in check!
How to choose between VC and ICO?
VC over ICO
Addition to funding, if you are seeking to expand your reach, consulting services, and business guidelines, this option is for you. VC investors are more reliable since they are experienced businessmen.
If you are looking for long-term support on your project, you can rely on VC investors as they have part of the company’s ownership and hence in the long term, without question, they would want the company’s equity value to rise.
In addition, VC has a stronger advantage when it comes to public perception. Raising money from VC gives you a stronger trust credit since they are business professionals and they will carefully vet through your project before investing hence if they decided to invest in your project, it proves to the public that your idea is brilliant. Whereas for ICO, individual investors could be scammed by companies who are only interested in raising money, there are many cases of fraud currently and this will likely continue to increase. In fact, New Study Says 80 Percent of ICOs Conducted in 2017 Were Scams.
To summarize, benefits of VC includes building valuable connections, investors’ support, and PR credit.
ICO over VC
If you are only looking for a quick way to raise money by reaching out to the mass, this option is for you. Everyone, including a taxi driver, can be an ICO investor.
You can raise enough money from everyone. It is an easy way to raise money if your idea can convince the mass. Previously only certain centers around the world had access to capital, usually first world countries. Now any individual can raise money, even from a village in India. Whereas for VC, it has a so-called “geography” problem hence it will be harder to raise money with ease. While this may not be the case for North America startups, it definitely posts a serious limitation for the third world startups.
Also, your investors do not have any ownership right, hence you get the freedom to decide over things instead of gathering all the company’s stakeholders before moving forward with your decision. To add on, founders can retain more control of the company focusing more on innovation. Whereas for VC, it usually means giving away a big portion of the company with significant control to the VC investors since the money is flowing from them, usually leaving the founders as minority stakeholders and has little say in the company.
In order to go for VC and then hopefully IPO, your company will have to meet various regulations. However, for ICO, there are no regulations. However, while that may be the case now, it might not be soon. While crypto friendly countries such as Canada and Switzerland are allowing ICO to operate freely, in the US, SEC is starting to tighten the restrictions on ICO and hence it will be harder to launch an ICO in the near future. Just 2018 itself, the SEC has significantly widened its crackdown on certain initial coin offerings, putting hundreds of cryptocurrency startups at risk.
To add on, ICOs risk is lower because it’s spread out amongst thousands of individual investors. Whereas for VC, the risk is borne by a single entity which is the VC firm.
To summarize, benefits of ICO includes easy reach in fundraising, freedom, no equity required, unregulated and lower risk.
Which is better for me?
While ICO and VC are similar processes, they can be very different and each at the opposite end of the spectrum. Which method is better really depends on your objectives and the nature of the company. However, both are promising and a necessary way of raising funds in order for your company to strive.
I hope that you’ll arm yourself with the right knowledge regarding which funding method is best for your company. Please leave any comments if you have burning questions and I’ll be ecstatic to acknowledge them.
VenturX is a web platform that helps entrepreneurs through their journey from idea to launch and beyond. VenturX uses data-driven analytics to score and connect startups and investors at Seed and Series A financing.