Synopsis: Crowdfunding appeared several years ago as a new alternative for startups to use the Internet to raise money. And even more recently, the arrival of ICOs (initial coin offerings) has heralded yet another wave of innovation. This article shows the major similarities and differences between crowdfunding vs ICO from the perspective of both investors and capital-hungry young companies.
Disrupting The Disruptors
It was only 10 years ago that when a startup wanted to raise money, they would have to go to a venture capital firm to get it, because no alternative existed. This created a huge power imbalance between those with the money, and those seeking it. A venture capital firm may hear 100 pitches for every one they accept. Even if an investment was forthcoming, it was usually done on highly onerous terms.
The fact is, getting investment from a venture capital firm is damn tough. A startup can spend months going to pitch meetings, negotiating, and in due diligence, but still eventually get nowhere. Or they can go to a bank and try to get a loan, only to have them insist that the entrepreneur’s house secures the money lent – and who wants to risk having no roof over their head?
Equity crowdfunding arrived in the early 2010’s as an Internet-enabled alternative that provided more power to the entrepreneur.
“Crowdfunding is a way of raising finance by asking a large number of people each for a small amount of money. Until recently, financing a business, project or venture involved asking a few people for large sums of money. Crowdfunding switches this idea around, using the Internet to talk to thousands – if not millions – of potential funders.” – UK Crowdfunding Association
How does equity crowdfunding work? Briefly, in equity crowdfunding, the company seeking funds gives up an ownership stake in itself in exchange for the funds on offer. The ability to promote their company to the public and let the crowd decide if they are worthy of investment is a game-changer. It means that startups and growing companies can bypass the financial gatekeepers they have had to kowtow to for so long.
This article explains the crowdfunding pros and cons in greater detail, versus other funding methods.
Few people would have expected that a disruptive new technique like crowdfunding would have to compete quite so soon with an even more recent innovation – the initial coin offering (or “ICO”). The rest of this article lays out what’s similar and what’s different between crowdfunding vs ICO.
Crowdfunding vs ICO – A Comparison
Both crowdfunding and ICOs use the Internet to raise money from investors. They are both disruptive to the traditional venture capital model, because they allow companies much more direct access to small investors. Therefore, both equity crowdfunding and initial coin offerings place more power in the hands of the entrepreneurs to set their own offer terms vs the venture capital status quo.
The big difference is that crowdfunding asks for traditional, government-issued money from investors, whereas ICOs see investment take place entirely through cryptocurrency. What this means when comparing an effort to do crowdfunding vs ICO, is that ICOs escape practically all regulatory burden.
The fact that equity crowdfunding continues to use the traditional legal and banking system means that there are many of the same hoops to jump through for the startup raising the money. Equity crowdfunding makes it easier, but companies still need to play by the legal rulebook.
By contrast, ICOs tear up the rulebook (or rather, operate in a space where the rules are rendered irrelevant). ICOs are not using government-issued money or the banking system to accept funds, meaning there is no way for a regulator to “freeze” the account of the fundraiser. Nor can they stop any investor from making a deposit to the cryptocurrency wallet.
Also, an ICO offers “tokens”, rather than shares of equity in the traditional legal sense – meaning that the whole activity falls outside of the purview of regulators. While it is true that regulators are moving to try to create rules for ICOs, the very nature of cryptocurrency (anonymous, borderless) makes this impossible.
An ICO can take place anywhere on Earth and cannot be regulated. From the startup’s point of view, it means they can do practically anything:
- they don’t have to adhere to any regulator-imposed rules over what they need to disclose about the project, the history of the founders, or financial forecasts
- they don’t have any limit over how much capital they can raise
- they can accept investment from anywhere in the world, without restriction
- they can set any valuation of the project
- no-one is going to say “no, you cannot do this”.
Equity crowdfunding almost always takes place via a platform – as in, a centralized place that acts as a go-between between investors and startup looking for funding. This is another big difference to consider between crowdfunding vs ICO, as ICOs do not have such platforms.
A crowdfunding platform gives a startup an ready audience of investors to access, but also charges a fee for providing this service. An ICO will need to generate their own interest, but doesn’t have a middleman taking a cut of the funds ultimately raised.
What Does This Mean For Investors?
The lack of enforceable rules means that investors need to exercise even more of their own caution with ICOs. The law doesn’t provide any recourse if an ICO turns out to be a scam. It’s a completely free market. Buyer beware.
But it’s not all bad for investors. Tokens in ICOs are often able to be traded a lot sooner than shares gained through equity crowdfunding – meaning nearer-term liquidity.
Comparing crowdfunding vs ICO, the ICO also offers a greater range of potential opportunities. One criticism of equity crowdfunding is that the platforms that characterize the industry have become gatekeepers – filtering and evaluating which startups will be allowed to show themselves to investors. Again, the cryptocurrency facts disrupt this kind of censorship – ICOs allow any willing investor and willing fundraiser to get together.
This article is an excerpt from my bestselling book: Equity Crowdfunding.
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