By Alan McGlade
Crowdfunding promised to change the way start-ups raise money, but it is the emergence of token offerings that are giving it the momentum it needs to fulfill that promise.
Entrepreneurs have traditionally had to power their way through a fundraising gauntlet that includes multiple investment rounds that begins with Angels and escalates to increasingly challenging Venture Capital deals. This process can be as punishing as navigating the highest Zombie levels on Call of Duty, dominating a founder’s time and energy.
Equity crowdfunding offered a way to circumvent the professional investor gatekeepers, allowing entrepreneurs to market and build relationships with their own individual investors. According to Statista, the transactional value in the US for this form of investment is projected to be $11 billion in 2018. Not bad, but still a fraction of the $72 billion flowing from venture capital in 2017, a number that should easily be surpassed in 2018.
Token offerings are basically a new form of crowdfunding but one that is poised to eclipse equity crowdfunding. CoinDesk reports that in the first three months of 2018, the transactional volume for token offerings was $6.3 billion and the number and size of these offerings continues to expand.
This growth is being driven by the inherent advantages of token offerings compared to what many entrepreneurs argue is an antiquated venture capital model. Companies that make a convincing case that they can transform industries using blockchain technology have been able to raise more money, faster by selling tokens. A key reason is that they can tap into a large international community of crypto investors and receive funds in currencies such as Bitcoin and Ethereum as well as Dollars or Euros.
There is also the prospect of shorter term liquidity. To see a return, venture investors in startups have to wait for a company to be acquired or become one of the select few to conduct an IPO. This can take five years and often much longer. By participating in a token offering an investor becomes part of the crypto economy with its own exchanges and active investor community. This offers a potential path to liquidity that doesn’t exist for traditional private equity investments.
And then there are the tokens themselves. In an Initial Token Offering, investors receive digital assets or “tokens” which are vastly more versatile than stock certificates. They can be programmed to represent a share of ownership in a company or provide other forms of value such as a revenue share or access to a product or service. This means that companies can be creative in structuring deals that work for their business while providing the right incentives for investors.
The SEC has taken a much different view of most token offerings to date. They generally regard tokens as securities and plan to go after ITOs that don’t conduct their offerings as registered security sales. Jay Clayton, the Chairman of the SEC recently said,
“If you have an ICO or a stock, and you want to sell it in a private placement, follow the private placement rules. If you want to do any IPO with a token, come see us.”
It turns out that crowdfunding has paved the way for regulatory compliant token offerings. Equity crowdfunding is conducted under SEC exemptions including Regulation D for accredited investors, Regulation Crowdfunding or Reg CF for non-accredited investors, and Regulation A+ for accredited and non-accredited investors. These same exemptions can be applied to register tokens as securities and conduct token offerings with accreditation, KYC (Know Your Customer) and anti-money laundering checks. The sale of security tokens will serve to further accelerate ITOs as a crowdfunding tool. If you raise money through an ITO, make sure you let investors know that token offerings are speculative, and investors may lose some or all of the money they invest.
Not all companies are suitable candidates for token offerings. Some are better served by equity crowdfunding and others may do an ITO combined with raising money through an equity offering. Either way, crowdfunding is now poised to scale at a vastly accelerated pace with tokens as part of the mix.