Even as regulatory hurdles around cryptocurrencies are causing a free fall in their values, initial coin offerings are continuing to gain popularity. Several startups are now opting to raise funds via ICOs
In 2017, $5 billion was raised through Initial Coin Offerings (ICOs) globally. However, the past few months have been a bear market for cryptocurrencies such as bitcoin, whose value fell to as low as $7,335.57 this week.
But several startups seem to be optimistic about raising funds through ICOs.
What is an ICO?
An ICO is a way of raising funds by offering investors some units of a new cryptocurrency or crypto-tokens in exchange for Bitcoin or Ethereum. The new token can be sold and traded on cryptocurrency exchanges.
Most recently, Zebi, a Hyderabad-based blockchain data protection company raised $10 million through an ICO in just 14 days.
Talking about his experience of raising funds through an ICO, founder of Zebi Babu Munagala, addressed some questions, advantages and disadvantages of raising funds through an ICO.
Why are they better than other traditional forms of fund raising?
According to Babu, the Venture Capitalist space is essentially like B2B. You, as a company, are dealing with another company to raise funds. There are middlemen involved.
On the other hand, ICO is like crowd funding. A CEO shows the demo of the product and directly deals with individuals who want to invest in the company.
In the Indian venture capitalist space, Babu says that most of the VCs are burnt. They have invested and received no returns. â€śThey canâ€™t recognize early stage innovative companies - they want proof, revenues. They want numbers which is not always possible for a true innovator. They are more conservative than banks in some sense,â€ť he adds.
Moreover, the VC space also has geographical limitations. Babu says that US funds, for example, donâ€™t always invest in businesses incorporated outside of US.
On the other hand, an ICO not only facilitates going directly to a consumer but also lets you raise funds from those who want to take the risk and participate in new ideas. And funds can be raised from people across the globe, from countries where cryptocurrencies are not banned.
VC funds always comes with major equity dilution to the investors. Moreover, investors often gain a board seat and a significant say in how the business is run.
Babu says the advantage with ICOs is that there is no equity dilution. Instead, investors are given utility tokens. A utility token is a token or coin that can be used to buy products and services of the company.
For example, in the case of Zebi, investors get utility tokens or Zebi coins, which they can use to buy services and products offered by Zebi.
Risks involved and how to convince investors
However, there are risks involved for investors. Babu says that as an individual, if you invest, you canâ€™t distinguish good coin from the bad one. It is therefore the responsibility of the company doing the ICO to convince its investors to invest.
What worked for Zebi, according to Babu, is that they have a strong team and more importantly, it has already bagged a contract from the government of Andhra Pradesh. The state has brought Zebi on board to secure over 100,000 land records. This gives immense credibility to Zebi.
Therefore, it is important for a company to have a good product, a strong team and preferably a live contract to convince individuals of the potential of the company.
While an ICO may not have to go through a formal due diligence such as in the case of VC fund raising, Babu says that crypto communities are very aggressive, and companies have to be prepared to answer very specific questions. It is therefore important to have the purpose of the token clearly laid out, due diligence done, have a clear annual budget, most of which is covered in a whitepaper.
A whitepaper is a clear description of the new currency being launched by a company. It explains everything an investor needs to know about the company and the currency before deciding to invest. There is detailed commercial, financial and technical information about the new coin. It could be understood as something similar to a Red Herring Prospectus in an IPO.
Babu says that it is extremely important to have the whitepaper in several languages to ensure it caters to investors from across the globe.
Lastly, a company needs to conduct a proper Know Your Customer (KYC) and Anti money laundering (AML) checks before taking on any investor. Zebi uses passport data and email checks to conduct KYC
Before going for a ICO, the company must have a good legal counsel and must be an expert in regulatory compliance and avoid investors coming from countries where cryptocurrency in banned.