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Jeremy Khoo

Group CEO | Blockchain Entrepreneur | VeChain ICO Partner | Fund Partner | Exchange Founder | Singapore

VCs can make sense of ICOs. ICOs can make sense of VCs. 16 Aug 2018

VCs can make sense of ICOs. ICOs can make sense of VCs.

In this piece, I share my thoughts on the subject of VCs investing in ICOs. I come from the angle of discussing how it would make complete sense for a VC to participate directly in ICOs due to the emergence of revenue-generating VC-ready companies conducting ICOs, a clearer regulatory climate, and the structure and accountability that VCs can bring to ICOs. I will not be focusing on the topic of VCs investing in blockchain-based companies; at least not in the traditional sense. Neither will I be debating if ICOs are a threat to VCs. I hope this article will provoke thought and discussion, and encourage VCs to consider incorporating ICOs as an essential part of their investment matrix, due to the mutual benefit one can bring to the other.

Emergence of revenue generating, VC-ready companies conducting ICOs

The beginning of ICOs- pre-revenue, pre-team, pre-everything-except-whitepaper. These companies usually get bypassed by VCs due to high risk, and are deemed ‘un-investable’ according to their thesis and philosophy. Unclear regulatory concerns offer another inhibitor to investment.

Increasingly, solid companies with proven track records have been pushing for ICOs. On the heavy-weight spectrum, we have Overstock’s notable raise or Telegram’s secretive gargantuan ICO. We also have promising startups like Unikrn, an e-sports betting platform which started in 2014, which raised significant capital before embarking on an ICO in 2017. In Asia, startup darling Lunch Actually Group, established in 2004 and with more than a million customers, are launching an ICO based on a blockchain-based AI.

Regulatory environment is becoming clearer

The SEC recently issued subpoenas to more than 80 ICO companies over concerns they may be breaking the law, and listed a comprehensive advisory section on their website. Aggregated, these developments are generally bullish for legitimate companies looking to conduct compliant ICOs, as the SEC is making efforts to clean up and regulate the industry. With more regulatory clarity, VCs can navigate responsibly and confidently in considering ICO investments.

Relevance of VCs to ICOs

Due to the high number of scam ICOs, due diligence on ICO companies have become a necessity. This is where the specific skillsets of VCs can come in to ensure ICOs are conducted above board and are accountable to the funds raised. In particular, credible VCs in ICOs will help other purchasers/investors make better decisions, rather than blindly follow hype and marketing dollars.

Private Placements in ICOs

A private investor / pre-ICO round is typically inbuilt into ICOs. Initially meant to create a fear-of-missing-out (FOMO), the pre-ICO round evolved to reward early investors and also offer a early glimpse into how successful the ICO would turn out. This gives the company ample time to tweak strategies around timeframe and mechanics. Typically, the discount/reward for pre-ICO ranges from 10% to a (overly) generous 90%. Some ICOs have even taken it a step further to develop different pre-ICO tiers based on nature/type of investor.

Deal Structure: Equity deals + Token Discounts

Taking into account that companies in the ICO stage are increasingly investable both from a product/business and regulatory standpoint, it would make sense for VCs to take an equity stake in startups followed by a generous discount in the ICO. I see this happening more and more, potentially becoming a standard deal structure. A Series A-ICO perhaps?

With enough successful cases, perhaps it may even evolve to a stage where non-ICO startups become less favourable to VCs. Of course, this would inevitably cause startups to pursue a “insert-product-here on a blockchain” mindset, leading to a retardation of the industry — this would be a discussion for another day.

Deal Structure: ICO convertible note

For VCs with a shorter runway and looking for faster returns, the possibility of a convertible ICO investment may be more appealing. Basically, the VC can invest in an ICO in very much the same way, with triggers set in place that would auto convert the investment into equity stake in the company at a discounted valuation.

Such triggers could be:

-Timeframe-based: Not reaching ROI before a stated time frame
-ROI-based: Having reached a certain percentage of returns (e.g 30% of principal sum)
-Milestone-based: Having delivered on specific deliverables (e.g MVP, traction)
-Failed Milestones: Having failed to deliver on specific deliverables (e.g listing token/coin on exchanges)
-Deal Structure: ICO buy-back agreements

To further mitigate risks, token/coin buy-back agreements could be structured, such that the company buys back the tokens with a levied interest. These buy-back agreements could kick in by the same suggested triggers as the ICO convertible note structure. When triggered, the company can treat the deal structure as a simple loan with a low interest rate.

Many other ways, hybrids

As with traditional VC deals, there are a myriad of ways to structure ICO investments, so it’s up to the risk management of the VC to figure out a way that benefits both parties in most events. Hybrid deal structures of equity/discounting/buy-backs could even be created to suit the most creative parties.

ICO investments can serve as risk mitigation tools for portfolio

Return of investments from ICOs have been well documented. Bear-ing in mind (don’t mind the pun) the highly volatile crypto-market which can trend negatively, proper due diligence and a good selection process may even reduce the risk of the entire VC’s portfolio and/or lead to higher overall returns.

All in all, VCs taking the lead as cornerstone investors in ICOs and/or ICO investments would lead to a positive self-regulation in the industry and create a healthier ecosystem for ICOs as a means of fundraising.

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