The process hasn’t been slow and neither has it been steady, but digital crowd sales (commonly known as token sales or ICOs) continue to emerge as a form of public fundraising mechanism. Many of the projects that pursue this form of fundraising benefit by raising capital from their communities and early adopters, without the involvement of VCs. Indeed, VC funding and token sales are often seen as mutually exclusive and most VCs are apprehensive both when it comes to participating in token sales and supporting their portfolio companies in raising additional funds in this way. But what if these two forms of fundraising are not mutually exclusive and could potentially coexist in synergy?
VC investment generally employs a fundamentally different approach to that of the token sale. They expect companies in their portfolio to run for the benefit of shareholders. In return for their investment, they also get a board seat and voting rights over a centralized company. Ultimately, as a VC you care solely, or at least mostly about returns. ICOs decentralize raising capital by opening it up to a network of participants. After a token sale, the company often has additional stakeholders, a new governance structure and needs to address the interests of the community it has built around the project.
This apparent clash of interests can make VCs reluctant to invest in companies that are also issuing tokens. Understandably, they want the managers’ undivided attention. They fear that the additional focus on the token sale community will negatively impact on this relationship. It’s true that community management takes significant time and energy. A token sale is a very public exercise and constant communication and engagement are vital across many different platforms.
Teams, in other words, need to deliver to their community of token holders, as well as the VC. As stakeholders, they can be very different entities, but this difference doesn’t have to pose a problem. The community built around the token sale is ultimately interested in one thing only: that the company delivers on its promises and builds the product it set out to build. Ultimately, this push would benefit VCs as well, since a successful product means bigger returns.
A strong incentive for VCs
Crypto is the hottest industry sector at the moment and looks likely to carry on expanding throughout 2018. Naturally, VCs want their slice of the pie and investing in blockchain-based companies has been a top priority for many VC funds as they look to enter this fast-growing sector. Indeed, it looks like 2018 will be the biggest year yet in terms of VC investments into blockchain projects. According to CrunchBase, the VC investment total into blockchain projects is already “at more than 40 percent of the way to 2017’s high water mark, just a quarter into the year.” While some VC funds are diversifying their portfolios by investing into this new vertical, a new type of fund has appeared on the landscape: a number of funds are investing exclusively into blockchain-based projects.
Despite the fact that blockchain technology is now such an attractive investment option, VCs may find it hard to invest in the most sought-after projects. Some companies decide to forego VC funding altogether, choosing instead to fully pursue the tokenization route. Others yet are such attractive investments, that average VCs may find it hard to enter the investment round they are after.
VCs are waking up to the possibility of the token sale becoming a way to express their investment thesis. Mega-firms like Sequoia Capital can perhaps participate in any investment round by any company, but many smaller VCs often miss out on opportunities. For these smaller firms, taking part in token sales directly is an alternative to both participate in projects they might otherwise miss out on and to diversify their portfolio of companies.
This is especially apparent in the wake of a new trend: the private token sale. This form of fundraising uses the token sale model, but limits the number of token sale participants and introduces sometimes rigorous limitations on who can participate. Since a private token sale is less dilutive, VC firms may see them as more attractive. Ultimately though, when a company, or indeed, a whole industry shows great potential to succeed, many VCs will follow the money, rather than sticking to their traditional approach.
Not all about the money
Although ICOs may look like a threat to VC funding altogether, the blunt truth is that ICOs can never fully replace VCs. The value of a VC firm stretches far beyond the financing. They are uniquely qualified to assess high-risk, high-reward projects and make sound financial decisions. Over the last decade or so, VCs took a chance on companies that violated hotel licensing laws (AirBnB), airspace laws (drone companies) and encouraged their users to take a ride in the car of a stranger who happened to be violating municipality laws (Uber). The blockchain world is full of legal and regulatory issues and challenges. The skills and experience of a VC can prove invaluable in these fields. Plus, if a VC chooses to back a particular company, that is a boost to confidence and credibility.
VC firms also come with pre-established contacts and experience in networking. As anyone who has launched a project knows, strong relationships are key to success. It’s no good raising 40 million if, say, you then want to propose a deal to Microsoft and they’re not picking up the phone. VCs understand the business of building a business, which is a different skill set to successfully performing a public fundraising exercise. VCs are crucial to a disciplined allocation of capital linked to milestones, rather than full upfront capital allocation as happens in all ICOs.
From the VC’s perspective, it is a rare and extremely valuable situation to find a portfolio company that could unleash its full potential as an open-source utility project. They keep their eye out for such opportunities and are sufficiently knowledgeable and willing to chart new frontiers. They usually set up a separate business that works on a utility model. Then the original company becomes one of the utility company’s clients. It takes a certain amount of guts to make a company in which you have a stake into an open source utility. But as VCs know better than anyone, the greater the risk, the greater the reward.
Hand in hand
VC investment and token sales have the potential to complement and support each other, particularly if both sides have good knowledge and understanding of the other. Differences in mindset and approach can be a challenge but not an insurmountable one.
Crypto companies can benefit hugely from the financing provided by VCs, as well as the skills and networking power they bring. However, the biggest added value from VCs is governance, financial discipline, and oversight in business execution. Blockchain can be a tricky world to navigate, not least when it comes to regulations and the law, and VCs have decades of experience to draw on. On the other side, VCs naturally want to engage fully with the burgeoning crypto industry. Increasing numbers of firms are participating in token sales and acknowledging the benefits that come from a decentralized network. In some cases, they are left with no choice if they want to be a part of some of the industry’s biggest success stories.
As the crypto industry continues to grow, combining VCs and ICOs may prove an attractive solution for many. Far from being mutually exclusive, we see a great potential for strength in variety.
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