By Graham Jarvis, Freelance Business and Technology Journalist, for The Fintech Times.
Financier Worldwide magazine touts initial coin offerings (ICOs) as the Wild West of financing, questioning whether ICOs represent the end of venture capital fundraising; as well as the Financial Times headlining, ‘Venture capital investors urged to wake up to ICOs’, you’d probably be right to think that there is some sort of industry shake-up happening.
This industrial earthquake, despite most ICOs being start-up focused, could create the need for traditional venture capitalists, venture capital organisations (and perhaps even the banks often with venture capital arms) to reevaluate opportunities to ensure they can gain or even maintain a share of the venture capital market. To achieve this, will they need to develop strategic partnerships with a wide range of cryptocurrency finance and blockchain-based firms, including ICOs? Whenever there is disruption in the market, all possibilities must be considered – especially in the fintech industry, where technology and innovation are becoming increasingly crucial.
Before exploring this angle, let’s look at the advantages and disadvantages of ICOs and traditional venture capital funding. Joe Barnett, of Livingstone Partners LLP, writes in the Financier Worldwide article that there are five benefits of ICOs:
- ICOs are non-dilutive to equity. For blockchain startups, ICOs allow fundraising without having equity stakeholders breathing down their necks on spending, prioritising financial returns over the general good of the product or service itself.
- Second, fundraising via an ICO presents a global, decentralised investment opportunity. ICOs offer a large market to present a company’s tokens to, increasing the likelihood of finding a vast and diverse base of investors.
- Third – perhaps the most astonishing aspect of an ICO – is the speed at which money can be raised for a project that exists solely as a vision. In June 2017, Mozilla’s founder raised $35m in under 30 seconds for a new web browser start-up named ‘Brave’. The ICO sale window may last up to four weeks, which is scheduled after little more than three months of preparation (from legal to escrow services), thereby presenting quick and relatively ‘easy’ access to capital.
- Fourth, ICOs offer increased liquidity via secondary markets. One of the major issues plaguing the traditional VC space is the timeline to realise actual return via IPO or acquisition. With ICOs, however, investors are free to trade their tokens for other projects at any time (after a brief lock-in period), providing liquidity to the holders of tokens.
- Fifth, ICOs build a community of evangelists (investors or users) right from the beginning, who are also incentivised to spread the message. As a result, the start-up is not just getting capital, but also its first customers. This allows for an alignment of interests of the coin holders with the success of the platform, thereby using the wide investor base to the start-up’s advantage.
Like everything in life, ICOs also have their downsides. Barnett says they can be very challenging and raise various issues that aren’t apparent in traditional fundraising methods, such as VC finance. ICOs are perceived as being at their early stage of development and so their business models are often considered to be experimental. Also, they don’t have access to investors’ long-term experience and advice, and neither can they receive direct finance from, for example, VCs. ICOs also lack the required governance structure that comes with traditional fundraising, which may occur when a partner from a VC fund joins the company’s board of directors.
Barnett adds: “With an ICO, a start-up misses out on the opportunity to benefit from the network, advice, prestige and governance that a well-established investor would bring. Controls over financials, strategy and operations may therefore be somewhat less scrutinised.”
These factors together may send negative signals to traditional equity investors, suggesting that the company failed to raise funds through traditional fundraising channels – after all, ICOs are no more than a crowdfunding effort. So many of the firms that took the VC route 12 months ago are now launching ICOs. “An online art gallery, known as Maecenas, which failed to raise £400,000 through crowdfunding last year, raised $15m a few months later through an ICO”, reveals Barnett.
With the views of traditional equity investors considered, ICOs could gain more credence and kudos if they were supported by traditional venture capitalists, banks and other, well-grounded financial services organisations. So, while ICOs may or may not threaten VC finance, there is arguably an opportunity to create a symbiotic partnership that would be profitable for all of the market’s players.
VC’s societal role
Alexander Tkachenko, CEO of Venture Exchange, comments: “Venture capital plays an extremely important role in the modern economy. It provides some of the most critical ingredients that enable technology and innovation by helping to identify winners, provide growth capital, market and business expertise, governance and access to networks, etc. One of its successes is the creation of the internet, mobile communications and business models that have completely transformed the world we live in.”
“In 2015, Stanford Business School’s journal Insights asked: “How Much Does Venture Capital Drive the U.S. Economy?” The writers of the article, Ilya A. Strebulaev and Will Gornall, say they contacted 200 US firms “that together represent more than 80% of the market capitalisation of the VC-backed companies”, and found that venture capital is responsible for up to 57% of market capitalisation and for 82% of the R&D spending of all US public companies founded since 1979.”
Tkachenko reminds us that: “Venture capital goes beyond start-ups, serving as a vehicle for large corporations to identify opportunities to transform their businesses and evolve. Only a few years ago, everyone was talking about how fintech can disrupt and replace the centuries old banking system. However, the intensive investment of VC dollars into the fintech sector didn’t kill banking.”
Despite the early success of blockchain in helping startups raise capital, it is not here to replace venture capital because it still represents a small fraction of the $160bn venture capital industry. More importantly, the VC model and regulatory compliance, whenever applied to ICOs, can enforce good governance. With the creation of a symbiotic partnership between the two, the missing ingredients of the new blockchain-enabled world can be added to create investor confidence and trust. It can also ensure that funds aren’t misused, can prevent hacks and forestall scams.”
By creating partnerships, it will be possible to create a broader investor base, enabling the best of both worlds to thrive together. This is complemented by the free flow of capital and low barriers to entry, with professional expertise and governance standards developed over many years by the VC industry. That broader base may include private investors who’d have never thought about becoming venture capitalists in the past, due to the high financial barriers of entry into the market.
“This trend has already started to prove itself, with new hybrid VCs emerging on the intersection of these worlds (such as Blockchain Capital or SpiceVC, which are creating tokenised funds, where anyone can become an investor in the VC fund, without having to put aside millions of dollars for many years)”, says Tkachenko.
Fintech has also spurred the adoption of new technology and innovation within many large banks. Many of them, such as Lloyds Banking Group, Barclays, and Citi Group, set up corporate venture arms and their own start-up accelerators to identify new growth opportunities, often in partnership with fintech start-ups and VCs.
Tkachenko adds: “Yet, one of the major issues with VC investing is that value creation takes significant time and effort. On average, it takes 10-12 years to generate a return and often with an exit (which are the only source of profit in this industry) are highly dependent on market conditions and economic cycles. These factors can force VC investors to hold their investments way longer than expected.”
He explains that this, together with other significant barriers to entry, stalls the development of venture capital. So, in essence, only small population of investors has access to venture investing and high-growth tech companies as an asset class, although it is quite attractive given the high returns it typically generates.
“At the same time, in the last few years the development of blockchain and decentralised cryptocurrency-enabled networks and solutions have opened the doors to thousands of start-up teams from all over the world to gain access to capital through ICOs”, he explains. In fact, blockchain technology and tokens have taken crowdfunding to a whole new level. “ICOs raised a whopping $6bn in 2017 – many times more than the much older crowdfunding industry”, he claims. Commentators say this is the result of significant democratisation and unprecedented liquidity, enabled by the new token paradigm.
Venture Exchange (VNX), therefore, wants to make it simple and affordable for any VC investor or accelerator to make their investment portfolios liquid – and thus access more capital; this is while allowing almost anyone – be it large financial institutions or regular private investors – to invest in the future “Ubers” and “Teslas” of the world. Essentially, VNX is using blockchain to unlock the $1tn+ venture capital market by increasing capital velocity to make it accessible to millions of investors.
However, financial technology (Fintech) organisations are a good fit for enabling banks and venture capital organisations to explore the benefits of the blockchain. “In my view, whenever the blockchain is supported by regulatory compliance, it has some significant advantages – including transparency and trust, decentralisation, reduced transaction costs and efficiency”, he suggests before adding: “With consumer safety being of paramount concern, regulation is becoming more desirable. It will also balance the interests of all the players involved, and this is a prerequisite to attract serious institutional investors.”
He thinks this is also important because the token revolution requires three things: regulatory clarity, investor protection and compatibility with current market standards. It also requires real-time liquidity, transparency and built-in security.
In summary, Tkachenko thinks that establishing a partnership should be based on the following:
- Trust – it is a bottom line for any relations
- Aligned goals and balanced responsibilities
- A qualified team with a deep business and industry knowledge
- Portfolio and financial strength
- Business network
There is much interest and support from venture industry players in platforms like ours, proving that it is possible for banks and financial services organisations to establish partnerships with the new fintech players in a way that should benefit all stakeholders, both old and new. Together, new opportunities can be explored and shared – and they could even be highly profitable. The traditional VC industry needn’t be frightened; they exist today, and they will do so tomorrow. However, they still shouldn’t be complacent as they should embrace the token revolution now. It’s already starting!