ICOs, the New Investment Tool in Venture Funds’ Chest

August 25, 2017 3:10 PM UTC

While the industry observers theorize whether initial coin offerings will kill off the entire industry of venture funding, two venture funds, Blockchain Capital and Starta Capital, have already raised money using precisely that method. And yet another fund will follow suit soon. It’s entirely possible that these few sparks presage a new hot trend in the VC industry – using ICOs to fill up the investment funds themselves.

It was last year when talk of the new, serious threat to the existence of venture funds as such emerged among the insiders. According to the industry figures, during the first half of this year the nascent blockchain businesses raised more capital in ICOs than in traditional venture funding: $327M vs. $295M. The trend has accelerated in the second quarter, catching many by surprise – no one saw this coming last year.

Positive Experience

It is looking like the venture funds are paying increased attention to blockchain and are seeking a way to exploit the new opportunities. The first signs came in April: Blockchain Capital which is very well known for its investments in the area has launched an ICO-fueled fund, based on the technology of smart contracts by Ethereum. Despite the initial plan to spend a month raising funds, the entire $10M came in just about 6 hours. Thus, the VC firm is putting its money where its mouth is, doubling down on the core idea of blockchain and simultaneously inviting a somewhat wider circle of stakeholders to feast on it.

The fund’s founders expect the new mechanism to become the future of venture capitalism, offering access to higher returns to just about anybody. In this case, however, only certain accredited investors from the US were allowed to join in.

Unlike ICOs by little-known startups, Blockchain Capital’s new product offers a much clearer path to profits, taking into account the highly qualified team of experienced managers at the helm. The fund provides an added layer of protection, committing to buybacks in case the tokens fall below the net assets. Industry experts have dubbed this move a revolution in venture funding, and Bitcoin Foundation’s chairman Brock Pierce expressed confidence in the long-term transformative potential of the new technology. “It is a well-balanced deal that protects the interests of both the shareholders and the fund. Besides, it has been achieved in full compliance with the current regulatory framework, unlike many other ICOs that are done in a legal vacuum”, notes Julian Zegelman, a partner at the Valley-based Velton Zegelman law firm and advisor to The Token Fund.

The lead was soon followed by Starta, a Russian-American accelerator. It launched an ICO for a diversified portfolio of tech startups, expecting to raise at least $1.5M but ending up with over $5M in just 16 hours. According to Starta, the new mechanism bridges the access gap between regular and venture investors. When the clock strikes the exit hour, the fund will buy back the tokens at their new price. “It shows there are people out there with large quantities of cryptocurrency on their hands, willing to diversify their investment strategy between the tokens of businesses and those of professionally managed venture funds,” says Zegelman.

Managers at Homebrew fund haven’t joined the party yet but said they’re considering the option. “We intend to raise capital for our next fund using ICO,” said Satya Patel, co-founder and partner at Homebrew, at CB Insights “Future of Fintech.” The fund is well-versed in the field: fintech startups amount to about 1/4 of its current portfolio. But Patel does not think that ICOs will displace traditional venture funding because the latter entails more human contact between the investors and the team. He cites a few cases where startups raised money using both ICO and traditional funding: Kik, Civic, and Brave.

Prospects for VC

ICOs offer a number of advantages over other financing instruments because coin offerings vastly expand mutual access between promising nascent businesses and a wider crop of investors.

Another great benefit for startups is minimal regulatory hurdle involved. However, this in turns complicates things for the funds whose structure and capital raising procedures have not changed for the past 40 years. Stakeholders of venture funds are often large, conservative structures that want legally binding safeguards that are yet unavailable in case of ICOs due to lack of appropriate regulatory framework.

Moreover, ICOs allow funds and businesses to raise only a limited amount of money which is a non-starter for major VC firms. The market is still reeling from Tezos raising a whopping $232M in an ICO, but for now, this is more of an exception. A more curbed, realistic expectations for a startup or a fund would be around $30M, but this pales in comparison with major funds like Sequoia raising around $1B in traditional ways. “For now, I see no way to raise even $500M in an ICO”, laments Zegelman.

ICO isn’t a silver bullet, but the number of funds raising capital in this way will continue to grow. We expect more and more VCs jumping onboard the coin train to attract the attention of investors. At the same time, the trend may soon enough claim a few victims unable to compete in the new crowdfunding environment. However, most funds are playing it cool, preferring to wait and see what happens and what regulators say before making any bold moves to change their proven ways.

This article is penned by Vladimir Smerkis, an entrepreneur and private investor in blockchain startups of early stages. Smerkis is also the co-founder of a crypto-assets fund The Token Fund. He was formerly deputy Vice-President for international development at the Mail.ru Group, a major European internet company.

Featured image from Shutterstock.

Last modified: May 21, 2020 9:36 AM UTC

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