ICO or fundraising? The point of view of the entrepreneur and the investor
The initial coin offerings (“ICOs”) have been the subject of a spectacular boom in recent months as 6.3 billion dollars were raised worldwide in this way during the first quarter of 2018 alone, according to data from Coindesk. France is not left out and hopes to be at the forefront of this phenomenon, the French government intending to propose, within the framework of the PACTE law which will be presented to the Council of Ministers in June, an optional visa regime for the Autorité des marchés financiers in order to attract the most serious ICOs to French territory while providing a protective framework for investors.
If funding through ICOs is expected to develop in a sustainable manner in line with the rise of technology blockchainHowever, entrepreneurs must ask themselves the right questions before choosing to proceed with an ICO rather than a fundraiser. For traditional venture capital investors, fundraising remains the preferred means of investment to this day. However, investing in tokens can also have many advantages for an investor over stocks.
The ICO, significant advantages for entrepreneurs …
The tokens offer great freedom in their structuring, in particular in the definition of the rights attached to them. Generally, tokens sold as part of an ICO do not benefit from political or financial rights as is the case for traditional shares and, given the existing applicable regulations (prospectus regulations in Europe, Howey test in the United States), this type of tokens (said equity tokens) should not prosper without adaptation of the current law. The tokens are not dilutive in capital, which therefore constitutes a considerable asset for the founders of a company, the realization of several fundraising events frequently resulting in a total loss of control over the company by the founders.
The tokens generally offer their holders rights of a different nature (access to a given service, reduced commission if the token is used as a means of payment, etc.). Thus, thanks to ICOs, entrepreneurs can pre-sell a project under development, thus allowing the company to validate its business model and build up a clientele and a community even before the launch of its product.
ICOs also make it possible to reach an extremely wide audience, while fundraising is generally only intended for professional investors. In addition, given the risks attached to traditional fundraising, the financing of a start up is generally done in several rounds of financing (known as series A, series B, etc.). The realization of these fundraisers is generally extremely time-consuming and energy-consuming for the founders, who must, during each turn, meet with many investors, establish a credible business plan allowing to bring out the value of the most important company. possible to avoid too large a dilution of their participation, negotiate the terms of the entry of investors as well as those of their future exit … Conversely, if the envisaged project is interesting, ICOs can make it possible to raise over a period of very short time amounts greater than those which could have been obtained traditionally. This is evidenced by the ICOs carried out by Bancor, Cosmos or Brave, the latter having notably made it possible to raise 34 million dollars in less than 30 seconds …
However, contrary to popular belief, ICOs entail significant costs, given the large number of players (code, marketing, lawyers, etc.), which are expected to increase given the development of applicable regulations. The issuance of tokens can also entail very significant tax costs compared to traditional fundraising, which are generally tax neutral. In particular, depending on the nature of the token issued, the amounts raised may be subject to VAT or corporation tax.
Finally, given the public nature of ICOs, entrepreneurs are encouraged to report publicly on the progress of projects funded by the ICO. If the successes of projects will thus be particularly highlighted, it risks being the same for failures …
The ICO, also an opportunity for traditional investors
As discussed above, one of the main concerns of venture capitalists is the conditions for a possible future exit, which typically causes them to spend considerable time negotiating windows and the conditions for a potential exit. Given the private nature of the actions of start ups and shareholders’ agreements generally in place between shareholders, it is indeed very difficult for an investor to sell a stake without a particular liquidity event (IPO, sale of the entire capital of a company, etc.). Many funds thus end up with holdings in companies that have failed, for lack of finding a buyer. Conversely, the tokens can be sold as easily as shares of any listed company, allowing investors to liquidate their investments at any time.
Moreover, the tokens can, in a way, be assimilated to tracing actions (actions benefiting from financial rights “tracing” the performance of a subsidiary or of a particular project of the company), insofar as they allow investors to invest money in a given project, and thus avoid exposure to risks related to the rest of the company’s activity. The same entity could thus validly carry out several ICOs, relating to different projects and amounts, and reach different investors.
However, the tokens do not offer the same rights to information as those to which venture capitalists are accustomed. The latter generally negotiate shareholders’ agreements in order to obtain governance rights and the provision of regular financial information allowing them to monitor the performance of their investment. Although future regulations are likely to require issuers of tokens transparency on the progress of their projects, this will probably not be sufficient for traditional venture capital investors, not used to playing a passive role. In fact, the governance of the company is generally organized in such a way that investors must approve certain structuring decisions for the future of a company. start up.
Consequently, a new practice of financing start ups through a mix between tokens and capital, could develop. ICOs and fundraising are in fact not mutually exclusive, and a mix between the two could offer venture capital investors an opportunity for liquidity on part of their investment thanks to tokens, associated with minority shareholder rights through shares. On the other hand, entrepreneurs could retain control of their company while benefiting from the added value of venture capitalists. This practice is starting to develop in the United States in particular through the RATE (real agreement for tokens and equity), whereby a company directly offers investors a mix of stocks and tokens, the latter having a preponderant part in the mix, in order to encourage equity investors to ensure the success of the ICO.
Julien Sanciet is a lawyer at the Paris Bar and works within the Corporate team of Bredin Prat law firm. He specializes in fundraising, mergers and acquisitions and capital markets operations. He advises many entrepreneurs and large groups in their operations.
Adrien Soumagne is a lawyer at the Paris Bar where he practices in the tax law team at Bredin Prat. He is also jointly responsible for the legal, regulatory and tax department of the La Chaintech association. As such, he has particular expertise in all tax matters related to blockchain technology (ICO, tokenization of assets).