- Initial Coin Offerings: A New Form of Raising Capital for Start-Ups
- August 8, 2017 | Author: Anthony L. Millin
- Law Firm: Shulman, Rogers, Gandal, Pordy & Ecker, P.A. - Potomac Office
A start-up company that needs to raise capital has traditionally done so through the issuance of equity or debt, customer-based financing (pre-selling products and services) and, more recently, through crowdfunding platforms offering tangible rewards and/or experiences in exchange for their funding.
A new and potentially powerful form of raising capital available to start-ups, an Initial Coin Offering (ICO), has emerged through the advent of blockchain technology. Blockchain is a digital ledger that uses cryptography to keep exchanges secure, in which transactions are recorded chronologically and publicly. These transactions can be any movement of money, goods or secure data.
In an ICO, a company sells a portion of its own cryptocurrency through a “crowdsale." Digital tokens are exchanged for an amount of an existing liquid cryptocurrency, such as Bitcoins or Ether (Ethereum), at a fixed or tiered exchange rate. The company usually retains a portion of its own digital token supply.
The company can then use the Bitcoins or Ether it raised in the ICO, or it can convert them into a fiat currency (i.e. dollars) and use such currency to finance the development of its products and/or services and to grow and operate the company. Buyers of the company’s digital tokens will, in a well-designed ICO, be able to use the digital token as part of the system, platform, product or service being created by the company, creating value for the buyers. Also, if the value of the company’s digital tokens increases, buyers can also sell their tokens on secondary markets.
Since Mastercoin launched the first ICO in 2013, raising $5 million, ICOs are now experiencing very rapid growth. As stated by the research firm Smith & Crown, there have already been dozens of completed ICOs in 2017 with more scheduled for the remainder of the year. The 30 companies reporting their gains have raised about $540 million through ICOs in 2017 alone.
An ICO does bear some resemblance to the more formal and regulated IPO, but there are key differences in a properly structured ICO. For example, shares issued in an IPO represent equity interests with ownership rights, while ICO tokens generally represent rights to access, use, license or sell a system, platform product or services and/or to directly or indirectly participate in the product’s development. ICO tokens are fungible, tradeable and can have value, much like a license or franchise can appreciate in value as an application or concept is accepted and adopted.ICOs are not without risk. If you are considering this new form of raising capital, it is extremely important to structure and implement the ICO in a manner that minimizes the financial, business and regulatory/legal risks of an ICO.