Let's say you are an entrepreneur with an idea you believe could become the next Uber. As enthusiastic as you are, you do not have any money to get your idea off the ground. What do you do? The traditional solution is to seek out investments from angel investors and venture capitalists. But there are other options these days. Among them are crowdfunding and initial coin offerings (ICOs).
The ICO option is gradually becoming more popular. But if you pay attention to business news, it is clear that there are plenty of people that do not know the difference between an ICO and venture capital. Thus, there are plenty of confusing statements made in articles announcing new start-ups. It is time to change that.
From this post, you will learn the differences between ICOs, venture capital, and crowdfunding. All three forms of funding have their pros and cons. Also note that entrepreneurs do not have to choose just one. They can mix and match any combination as they see fit.
1. Venture capital
We will start with venture capital inasmuch as it is the traditional method for raising funds. Venture capital comes from private investors willing to put up their own money in support of a start-up. These are generally extremely wealthy people who make a living by investing.
Securing venture capital is a matter of pitching your idea in such a way as to convince investors to get on board. This generally means writing a comprehensive business plan and combining it with a detailed presentation. Investors will generally go over everything with a fine-tooth comb to see if:
- your idea is really worth investing in; and
- you seem to know what you are doing.
Pitch your idea well and you could end up with hundreds of thousand dollars, if not millions, to get your company up and running. Offer a mediocre presentation without a lot of meat and you are likely to be turned down.
Pros and cons of venture capital
The biggest advantage of venture capital is volume. In other words, getting venture capital investors on board generally means getting a lot of money up front. Venture capitalists are people with money to spend. They are always looking for great ideas to invest in.
Another advantage is that you get more than just money. Successful venture capitalists are also business experts. They will be there every step of the way to help you. You will get plenty of sound advice along with access to your investors' connections.
The downside of venture capital is that you have to turn over partial ownership of your company to your investors. An investor who provides 25% of your funding may insist on 25% ownership. The end result is that you will not be in complete control of your start-up. You will have to allow investors their input in every decision in which they want to be included.
Initial coin offerings
Moving on to ICOs, they represent a way to raise a lot of money by spreading out the contributions among a much larger pool of investors. They take their name from the fact that money is raised by selling digital coins. For purposes of illustration, let us say you want to start a new company known as the Acme Blockchain Company.
You would release a white paper detailing what your company will do as well as the blockchain and token behind it. You might call your token 'ABC' to reflect your company name. You would pitch the white paper to the cryptocurrency community in hopes of garnering enough interest to encourage investors to buy ABC.
Make a compelling case with your white paper and you could raise just as much money from an ICO as you could from venture capitalists. On the other hand, your white paper can also fall flat. There are thousands of inactive cryptocurrencies that are now worth nothing for this very reason.
One thing to remember here is that your ABC token has to have some sort of utility for it to be worth anything. You can create utility in any way you like, just as long as your method generates some sort of monetary value. For example, your token could give investors an opportunity to cash in on some of the value of your company once it begins turning a profit.
Pros and cons of ICOs
An ICO is an attractive way to raise funding for new start-up if you are not interested in turning control of your company over to venture capitalists. With an ICO, you're still in charge. You and anyone else on your development team get to direct how and where your company goes irrespective of what investors may want.
However, there is a danger here. Move in a direction that makes investors unhappy and you may find them cashing in their tokens. You have to be able to cover those tokens with real money. Your company could come crashing down overnight if there is a sudden run on your token.
The other downside to the ICO is that it is difficult to sell tokens if you cannot get yours listed on major exchanges. If no one wants to touch ABC, you may not be able to raise the funding you need to get your company off the ground. Your tokens could wind up being worthless before anyone has had a chance to really look into investing in your company.
The crowdfunding model was hot as recently as a couple of years ago. Enthusiasm has cooled considerably, though. Crowdfunding is based on the principle of asking a large pool of investors to contribute small amounts. The more investors you get on board, the more money you raise.
A successful crowdfunding campaign could net you quite a bit of start-up cash. The question is this: what will you offer people to put money into your business? There has to be a reason if you expect them to give you their hard-earned money.
The easiest way to do this is to structure your crowdfunding campaign as an advance sale. People who contribute are essentially buying your product in advance. If your company is service based instead, you have to find some other value to offer.
Believe it or not, there are a small number of entrepreneurs who have succeeded just by presenting a really good idea and pitching it as an opportunity for contributors to be on the ground floor of something special. The value proposition for contributors rests in the idea itself.
Pros and cons of crowdfunding
One of the biggest things to love about crowdfunding is that you can structure it so there are no strings attached. It doesn't hurt that the crowdfunding campaign can be broadcast worldwide to attract the largest possible number of contributors.
You could have hundreds of thousands of small contributors who combine to raise quite a bit of money. At the same time, you are not surrendering any control of your company. You are also not necessarily promising success. Crowdfunding is understood among contributors to be risky.
On the negative side, it is really difficult to raise substantial amounts of money through crowdfunding. Where you could easily get hold of millions of dollars through just a small handful of venture capitalists, raising an equal amount of money through crowdfunding generally means recruiting thousands of contributors. That is not easy.
The other downside to crowdfunding is its legal implications. Where venture capital and ICOs are generally subject to specific rules designed to prevent fraud, crowdfunding is not. How can this be bad? A lack of clarity could easily mean you run afoul of tax and reporting laws without even knowing it.
Raising money in the tech era
ICOs appear to be the go-to funding method for start-ups in the tech era. A lot of start-ups these days are headed by passionate entrepreneurs who have really good ideas but not much business acumen. They turn to ICOs because they have seen what a successful launch can accomplish. Unfortunately, more of them fail than succeed.
ICOs are becoming problematic for investors for one simple reason: investors are growing weary of investing in new projects that either go nowhere or are destined to fail because the people behind them never intended them to succeed. Believe it or not, the latter scenario happens pretty frequently.
More than one investor has been taken advantage of by entrepreneurs looking to raise some money and then run. As a result, investors are more closely scrutinizing new ICOs. They are not jumping on new opportunities quite as quickly as they used to.
Now you know the differences between ICOs, venture capital, and crowdfunding. If you were to ever start your own blockchain business, which funding method would you prefer? History suggests not settling on any one in particular. A better way to go is to employ all three to some degree. You stand a better shot of raising the necessary funding without putting all of your eggs in one basket.