Initial Coin Offerings (ICO)a new asset class in the making?
Background and ICOs why have they developed
Initial Public Offering (IPO) is used by many companies across the world to launch themselves on a stock market. IPO has been adopted by many governments to sell national assets — such as British Gas in the UK, Deutsche Post in Germany and Japan Railway Group in Japan — as a way to raise capital for the government; in some cases, providing finance for the firm that is being quoted and encouraging private investors to become shareholders.
An IPO enables a company to be quoted on a regulated stock market so it has to ensure that any information that is given about itself is true and accurate. Investors of IPOs expect to have detailed information about the company in question and what it intends to do with any money that it raises, as a result of an IPO. Over the years, various rules and regulations have been developed to help protect investors, by attempting to prevent unscrupulous bodies bringing their companies to the stock market and using IPOs. The regulations that surround IPOs and govern organisations involved with IPO, such as accountants, lawyers and brokers, mean that is has become increasingly expensive for companies to carry out an IPO, or indeed raise further capital. This helps explain why in the UK there are over 600 firms, valued between £2Million and £50 Million 1, which are quoted but struggle to raise capital as the costs of doing so are substantial.
With an IPO the investor becomes a shareholder and an owner of the company, however with an ICO this is not always the case. ICOs are not regulated, hence those behind the ICO do not need to disclose information or be subject to on-going scrutiny, unlike an IPO, so buyers need to be careful.
Why launch an ICO?
ICOs offer companies an alternative way to raise money that may, in the past, have used Angel investors or Venture Capital funds. ICOs are often adopted by smaller firms and they are similar to a type of crowdfunding, which can be a very quick and inexpensive way to raise capital. ICOs have now been utilised by firms all over the world to finance companies involved in commodities, fashion, transport, banking, art, diamonds, food and the media — the list gets longer almost every week.
The first ICO was carried out by Mastercoin which, in 2013, raised $5million. There are now over 803 firms that have a valuation of over $72 BILLION 2.The recent rise in the price of some ICOs has attracted much attention i.e. a firm called Etherum carried out an ICO and it has risen from $0.3 to $134, a rise of over 44,000% since July 2014 3. Ripple is another example of whose valuation has gone from $200million to over $13Billion in the period March 2017 to May 2017 — a rise of 6,500% 4.
How safe is an ICO?
There are is no security offered for ICOs as they are currently unregulated in most countries. However, some ICOs do offer limited transparency as to what they will do with the monies raised, as well as details about the founders and managers. It is in the interests of those offering ICOs to ensure there is sufficient trust, otherwise it will be difficult for future ICOs to be a success. However, this is of little incentive if the company’s interest is solely in raising some money and then disappearing. Even if a company has the best intentions there is no guarantee for success, although it does offer some comfort if the founders involved have a proven track record.
There are some ICOs that have imposed restrictions on themselves by setting up the company involved as a legal entity, with documents detailing how any money raised will be spent. These documents often produce an explanation and road map with clearly defined goals for the company, along with analysis from experts. One very important characteristic to look for in a well-structured ICO is, who are the founders and what is their track record and previous successes in business?
ICOs to avoid
One should remember that ICOs are typically funding start-up businesses which, by their very nature, are risky. The facts show that 50% of firms fail within five years in the UK 5 and in the US. According to the U.S. Bureau of Labour Statistics, only 50% of all new businesses survive five years or more, and about one-third survive ten years or more 6.
If the ICO has scant information about the directors and founders, or the business plan is unclear or unrealistic, it may be best not to participate in the ICO. Simple rules such as, if it sounds too good to be true or you do not understand what they are doing, it may be best to avoid. A common mistake many businesses fall into, and not just those looking to issue an ICO, is what is the exit? i.e how will you get your money back, and who is likely to buy the business at some stage in the future?
Advantages of ICOs
They offer the ability for small investors to get exposure to start-ups, which traditionally have not been widely available. Venture capital funds, private equity funds and angel investors have traditionally been the sources for new businesses assisting them to raise capital, but now ICOs can be a source of new funds. Many of the ICOs launched have been to fund businesses seeking opportunities to commercialise new technologies, such as Artificial Intelligence or Blockchain. The value of some ICOs have millions of $ a day being traded, hence often having more liquidity than many quoted companies ie you can buy and sell the ICOs without altering the price. Another very important feature of ICOs is that they have little, if any, correlation to more traditional investments ie equities and bonds. That is to say, they do not tend to go up and down at the same time, potentially offering both a good way to diversify your capital, together with better risk-adjusted returns 7. However, one needs to be careful about such claims, since ICOs have been around fewer than 4 years!
ICOs massively reduce the costs of raising capital — some have made a number of people tremendously wealthy in a short period of time, hence it will only be a matter of time itself before they become regulated. Remember “caveat Emptor” (buyer beware) and although the price of most things can fall as well as rise, this does not mean ICOs should be avoided.
A final thought from a professional investor
I would like to finish with some insight from Fred Wilson of Union Square Ventures, who has been one of the most successful Venture Capitalists (VC) in recent times 8. He believes that today’s technology giants (e.g. Google, Apple, Facebook, Amazon) may well be disrupted by a new protocol around how business is conducted, which could be funded by ICOs. Fred Wilson…”the corporate financial system… is broken. Small investors are not allowed to invest in the next Google, Facebook” — He hits on the fact that Venture Capitalists and similar investors receive preferential treatment under the current system, so the rich get richer as they have access to the new tech businesses because they are deemed professional investors. Banks and brokers go to VC and rich (and assumed to therefore be sophisticated) investors as it is easier; they have no hassle with Know Your Client, they do not have to handle small sums of capital, and it is simpler to deal with challenges around investor relations etc. In an ICO… any one can buy. People bought in to the ICO of Etherum at 0.30 cents which is now worth over $90. This is how it ought to work- democratise access to business opportunities, i.e. having the opportunity to invest pre IPO, and not just once the business is quoted.
It sounds a lot like conversation I keep having! Is this a new asset class in the creation??? What do you think?