The concept of buying shares in a public company by participating in an Initial Public Offering IPO isn’t a Wall Street invention. The earliest form of raising capital from the public can be traced back to the Romans. So-called publicani – legal bodies like joint stock companies of today – raised capital. The shareholders were the owners of the company in proportion to the number of shares that they had bought.
At the beginning of the 17th century, the Vereenigde Oost-Indische Compagnie (VOC) – better known as the Dutch East India Company – was the first modern company that used an IPO to raise capital. The original raised capital was 6,424,588 guilders, equivalent to 3,2 million USD. The company was able to raise this large sum of money since its owners had decided to let participants share ownership of the company by letting them buy shares. Today, IPOs are complex procedures based on extensive regulations. In the US, a small company with a very efficient CFP could manage to IPO within 3-4 months, provided that there are no substantial SEC comments, lawsuits, compliance mistakes or unfavorable market conditions. This timeline is based on perfectly prepared initial filing documents that need additional 2-3 months to be prepared.
Enters the Initial Coin Offering, or ICO. With the birth of Bitcoin in 2008, the first digital token was created, that, after the 10,000 Bitcoin payment for a pizza by developer Laszlo Hanyecz in 2010, could be used as digital cash, or a cryptocurrency. Since then, many other cryptocurrencies have entered the market that has a total value of around $30 billion. In April 2017, about 800 different cryptocurrencies have been launched, roughly 12% of them through an ICO.
We won’t explain ICOs in detail – that has already been done very well before, e.g. over at our friends of Outlier Ventures or here.
How to ICO
Instead, we want to suggest how to design an ICO in a way that not only helps the project to be financed but that also makes investors comfortable and happy. Since the ICO market is relatively new – the first ICO was done by Mastercoin in July, 2013, and raised 5,000 Bitcoins worth around $500,000 at the time – there is no jurisdiction at all, except in two countries: Switzerland and Singapore. Both countries have already issued guidance on the tokenization.
Whereas Switzerland’s guidance was explicitly applicable to the Ethereum token Ether (the Ethereum foundation had their ICO in July, 2014, raising more than $18 million), the Singapore Monetary Authority and the Singapore law classify a cryptocurrency as an asset – and not as a security. This clear guidance and the lack of such in the US, was the main reason for Blockchain Capital to structure their venture capital ICO as a closed-end fund out of Singapore issuing BACP tokens under two specific exemptions – Regulation S and Regulation D exemption – by the SEC.
Requirements of an ideal ICO
Different to IPOs, the regulatory framework for ICOs is not yet outlined at all. For the first wave of ICOs that means to raise money in a somewhat grey area. The ICO project team can’t be sure whether they act in a compliant way And that’s the reason for everyone planning an ICO to come up with the best possible process for either the project and its investors. The better the ICO is designed, the higher the opportunity to raise a significant sum of money in a quasi-compliant way.
First, there is no idea ICO and there might not be in the future. You might always find some aspects of an ICO that could be criticised. However, we want to share our perspective on how to do an ICO in the right way.
If you think about giving your money to another person or an institution you don’t know, this person or institution should create trust in order to justify the money transfer. Trust always begins with transparency. You would lend a person money if she is your friend or at least very well known to you. In former times you would have given your money to a bank because you might have thought that banks were trustworthy just because of being a bank. Having experienced one or more financial crises and/or having watched The Big Short, you might select your bank more wisely. However, regardless of any specific banking institute, most of them participate in a financial system that at least guarantees that your money will be safely wired to a bank account.
Now, do some blockchain project teams use their bank accounts? Not necessarily: they will more likely ask you to send over some of your Bitcoin or Ether, either into their cryptocurrency wallets directly, or to a cryptocurrency platform or exchange you might have never heard of. That could require you to open a new account with that platform, which might be headquartered in Eastern China. We have nothing to say against cryptocurrency platforms in Eastern China in general, but the ICO investor should be prepared to work with an entity whose credibility she might not be able to research thoroughly.
What does that mean for the project team? It means that the ICO Responsible ICOR should:
- carefully select the institutions that will distribute his tokens,
- describe these institutions in a detailed way and
- ideally provide potential investors with specific information on how to open accounts; s.a. limitations regarding nationality, required documents, etc..
The next transparency aspect refers to to the ICO process in general. The ICOR should openly communicate:
- What is the general purpose of the ICO (market, business, challenge, solution, etc.)?
- What is the product or service the project team is working on and that will be financed?
- Who are the members of the project team (background, credentials)?
- What are the token offering terms (denomination, cap, trading terms, structure, roadmap)?
- Which opportunities and risks are known and/or could occur?
The more transparent the ICOR is in describing the ICO, the easier it will be for investors to establish the required level of trust.
As long as there is no real guidance to carry out an ICO, the best advice is to act in a quasi-compliant way. For the ICOR that means, she should:
- inform herself about the guidance and the compliance aspects of IPOs,
- get herself professional support regarding capital market and general legal as well as tax-specific aspects,
- carry out a due diligence of the ICO’s structure and process (she might need professional support) and
- install an advisory board consisting of experienced professionals in in the fields of Finance and Law,
- add comprehensible controls, s.a. lock-up periods for members of the project team and investors, that should minimise the volatility of the token’s value in the first trading period and
- select and cooperate with third parties, s.a. cryptocurrency exchanges that themselves are compliant and have a sound track record in doing business.
- Investor Relations / Communications
The term Investor Relations IR stems from traditional stock markets and defines how publicly listed companies have to communicate to their shareholders. There is no such definition regarding ICOs and their investors, yet. Still, in reference to a quasi-compliant behavior, the ICOR should:
- communicate openly and in a timely manner
- communicate all relevant aspects of the ICO
- install a support channel for investors who have questions and/or problems
- coordinate press coverage
- release relevant financial data and news and
- be prepared to handle a potential crisis (hack/attack, high token price volatility, etc.)
It would be wise to not outsource the communication to investors to internal or even external PR, but to completely integrate this task into the ICO project team. This should ensure that token holders are provided relevant information and that the ICO team will be informed about potentially changing regulatory requirements and advised how to cope with that.
Transparency, quasi-compliance and communications are the main pillars of an ICO. As long as the ICOR takes these aspects seriously, the ICO team and investors should expect a successful project progression. The closer the ICOR sticks to these requirements the lower the risk of acting in a non-compliant way. And, speaking not only of risks but also of the opportunities – a well-managed ICO levels the playing field between financial institutions (s.a. venture capitalists) and individuals, offers lower fees compared to traditional investment processes and opens up the market for consumer-facing investment opportunities.
If you want to evaluate an ICO you might use this as a guide. Since we believe in practicing what you preach, you may evaluate our own forthcoming ICO based on the principles mentioned above. Since we will be raising money to invest that money in Blockchain startups we manage our ICO in a quasi-compliant way. Since we’re based in Germany and all investments will be done in Germany, we will act within the given regulatory framework and we will communicate in a transparent and meaningful way.