ICO vs VC Funding: What Are Their Differences?
The space of cryptocurrencies has been growing rapidly over the past couple of years. ICO, or Initial Coin Offering, is a way to raise funds for a project within the cryptocurrency industry, typically after the creation of new coins. In the same way that companies raise funds through an IPO (Initial Public Offering), except it is in cryptocurrency. While VC funding or Venture Capital is a traditional or institutional way to finance startups. Are you wondering which one is better for your project or company? Well, this article will outline the difference between ICO and venture capital funding, their pros and cons, and the working models.
Initial Coin Offering and Venture Capital Funding
An ICO is a way to raise funds, usually for products and services that are related to cryptocurrency. It is similar to an IPO in traditional finance, except it is executed in the digital sphere, i.e., through the issuance of new tokens or coins. Due to the popularity of ICOs, they have begun to be used in recent times as a tool to raise funds for blockchain startups and companies.
On the other hand, venture capital funding is an investment mechanism in which investors provide funds to startups or early-stage businesses. The funds are provided in exchange for equity, in other words, a percentage of the company’s ownership. It is a long-standing and still widely used funding method and is the most popular form of funding. Now that you have a basic idea of what ICO and VC funding are, let us take a deeper look at them.
What is ICO?
ICO stands for Initial Coin Offering; it is a form of investment in which the investor provides capital to a company or project in exchange for a new crypto coin or token. The general structure of an ICO is similar to a traditional IPO other than the fact that the coin or token is digital rather than a stock. It is like a fund-raising campaign where the developers of the crypto coin raise funds to finance their project development, promotion, and marketing.
In ICO, the investor can be any individual, private investor, and even a company. The ICO is mostly unregulated, which can make funding attractive, but it brings a huge risk of fraud and scams. As an investor, due diligence and research are necessary before investment. Thus, an investor should research the team, the project, the projections, and the whitepaper before investing. So, how does ICO work?
How does ICO work?
The ICO process usually starts after the creation of a crypto coin or token, which is the base unit of exchange for funding. Tokens are considered tradable units that have a specific value and can be used as a form of payment within the platform or project. Basically, under the ICO fundraising process, the startup team or project (the coin developer) begins its crowdfunding campaign by listing its new coin on a crypto exchange platform to raise funds.
Once the coin is listed, the company uses the funds to enhance further, develop, promote and market the coin to investors. In exchange for funding, the investors receive the purchased coins, which can be traded or transferred to other individuals. Therefore, ICO is a form of crowdfunding in which the developer or company issues digital tokens as part of a way to raise money for their project.
What is VC?
Venture Capital or VC is a form of investment focused on early-stage companies in which the investors provide funding in exchange for a percentage of ownership. The investors are usually high-net-worth individuals or private equity firms that have considerable industry knowledge, business experience, and financial strength. The primary goal of venture capital funding is to increase the startup’s value by providing the right expertise, mentorship, and resources to help the company succeed.
This, in turn, helps VCs increase their investment returns, which are normally based on the appreciation or rise in the company’s value over a given period. The investment is usually for several months to several years, followed by recognition of profit or an exit. But how does VC financing work?
How does VC funding work?
While VCs provide capital to early-stage startups in exchange for equity, they are also looking at the future prospects and strategies of investment. The mechanism of venture capital funding works in a way that the funds are allocated to the startups for a defined period of time, and at the end of that period, the exit of investment takes place through either a sale of the company, merger, or acquisition, management buyouts, or even by IPOs.
While as a founder, you are required to present a business plan, financial projections, business valuation reports, and other documents to demonstrate their credibility, prospects, and marketability. Further, the founders must have the necessary skills, abilities, and industry experience to pitch their ideas to the VCs. Based on all these factors, the VCs are able to evaluate the viability of the business and decide whether it is a good investment.
It is essential to note that business valuation plays an important role in the financing process. Since venture capitalists are looking for more than just projections, assumptions, or visions, they analyze the complete valuation of the company that is being pitched to them. Hiring third-party valuation experts like Eqvista will help you correctly establish a startup’s valuation and ease the fundraising process. The team at Eqvista will thoroughly review all the relevant elements of a startup and provide a fair and accurate valuation of the company.
Pros and cons of ICO
Now that we have taken a closer look at ICO let us discuss the pros and cons of ICO.
- ICOs have no geographical restrictions, which gives anyone the opportunity to participate in any part of the world. This makes ICOs inclusive and accessible to people from all over the world.
- ICOs have no intermediaries since any authority does not regulate them. The only intermediary is the platform on which the tokens are sold, which means that there are no middlemen. This helps founders to reach out directly to their target audience.
- With less paperwork and documentation, ICOs are a fast and convenient way to raise funds for your crypto project. The entire process is easy to navigate, and the funds can be raised within a short period of time.
- ICOs are unregulated, so it is often difficult to analyze the viability and future prospects of a project. There are no restrictions and regulations on ICOs; thereby, the process can be abused for fraud or other scams. Founders should be aware of such scams and identify them at an early stage.
- As per the trends, it has been noticed that the success rate of ICOs is quite low, which means that many projects fail after raising funds. The failure can be attributed to either the lack of required resources, high competition, or poor marketing and management. The valuation of tokens in ICO is based on future value and the possible success of the project. As a result, the token value might not always be reflective of its real-world use and utility, which makes it a volatile option.
Pros and cons of VC
The VC fundraising process also comes with its own pros and cons. Let us take a closer look at them.
- Venture capital funding has a longer-term focus, and it is more suitable for early-stage startups that require time and support. Since VCs are usually longer-term investors, they can offer valuable assistance and guidance to startups, which will help them get off to a strong start.
- By building connections, resources, and expertise, venture capital funding helps startups gain the attention of several investors and thus increases their chances of success. It is, therefore, easier to raise follow-on rounds of financing and achieve the desired valuation.
- Typically, a significant amount of capital is required to kick-start a startup. Venture capital funding, therefore, provides the much-needed and large sum of capital to grow and develop the business. This can help the startup achieve significant milestones.
- The dilution of ownership percentage in venture capital funding is inevitable. As the startup progresses, it could require multiple rounds of funding that can reduce the percentage of ownership held by the investors.
- Finding the right VC firms requires considerable research. This makes it a time-consuming, tedious, and often stressful process. The entire process, from presenting the idea to the investors and making the right deal, can take several months.
- With a lot of paperwork, documentation, and due diligence involved, it is often required to hire lawyers and accountants to ensure that all the terms are carefully defined. In this way, it may cost an additional amount of money.
Key differences between ICO and VC
While ICO and venture capital funding serve the same purpose, i.e., raising funds. However, there are still several fundamental differences between them. Let us take a closer look at the key difference between ICO and VC:
Are you looking for a quick and easy way to raise funds? ICO is the way to go. It is a fast and convenient way to generate funds through crowd sales in a short period of time. As a result, when the primary goal is money and no expertise or mentorship is required, ICO is the solution of choice.
While on the other hand, venture capital funding is the option to choose when your goal is to build connections or get expert advice along with the required finances. Here, the focus is on building a strong network and getting valuable advice, which can help you achieve your desired goals in the long run.
Cryptocurrencies are unregulated; therefore, the legal requirement for ICOs is minimal. The process is easy, quick, and convenient. Once the investor receives the token, there is no legal framework to provide any further information or documents, and even no taxes need to be paid as long as the tokens are held as digital assets.
For venture capital funding, some percentage of the ownership rights of the startup may be diluted. This means that the process of granting equity in return for capital will be completed under certain agreements and legal terms. Therefore, legal and financial experts should be hired to ensure everything is done according to the agreed-upon terms and conditions.
ICO is perceived as a high-risk investment, as the degree of anonymity and lack of regulation makes it easy for scammers to lure people into investing in fake or scam ICOs. This makes it difficult to identify fraudulent schemes that might lure you into investing in the wrong ICO. In past years many ICOs have failed, making it a negative perception of ICOs.
Venture capital funding is perceived as a positive and highly-regulated investment option. When reputed investors become a part of the venture, trust, confidence, and a positive reputation are developed. This, in turn, provides a good reputation for the startup and leads to further funding opportunities.
ICO investors can be anyone interested in cryptocurrencies. There is no specific target audience nor the requirements to be a member of a certain group. Anyone who wants to invest in cryptocurrencies is eligible to invest. Furthermore, ICOs are open to anyone worldwide; people can invest from any part of the globe.
While in venture capital funding, founders look for investors that are industry experts, business consultants, and mentors with experience in investing, financing, and other valuable insights to help your startup achieve success. It is usually specific according to the type of business or industry the startup belongs to.
When it comes to the experience required for investing in ICO, there is none. ICOs are open to everyone and anyone, which makes it easy for individuals with a bit of curiosity and interest to invest in ICOs. Hence, you can make an educated decision by researching extensively and reading through the whitepapers and other published information.
For venture capital funding, investors are highly educated and experienced in terms of financial deals, as well as business and industry. Therefore, it is important for founders to understand and find the right investor as per their requirements.
Under ICO, starting from designing a website to preparing a white paper, everything is your responsibility. Further, you are required to advertise and market the ICO through various channels. As a matter of fact, you should have the required technical skills and knowledge to conduct a successful ICO; that is all.
In comparison, venture capital funding requires more detailed and in-depth planning and preparation. Usually, a minimal viable product (MVP) is first developed, which allows startups to raise funds effectively. The planning and inner workings can be complex and challenging, which is done to ensure that the venture capital is invested in the correct sector.
7. PR value and deals
ICOs are usually a one-time affair. Once the sale is over, and the tokens have been distributed to investors, there is no further value to be obtained from ICOs. As such, the public relations (PR) under this model is limited. Moreover, it has been noticed that in the case of ICO funding, it is not able to capture the media’s attention.
Venture capital funding, as such, does not involve a one-time affair. Instead, it involves long-term relationships with investors who can provide valuable advice and guidance throughout the growth of the company. In addition, it results in positive PR, which is something that ICOs cannot offer.
Should startups consider raising finance through ICO rather than VC?
Well, when it comes to blockchain startups, ICOs perhaps seem like a better option to raise funds and build a successful startup. However, the unregulated nature of the market makes it more risky and complicated. The high degree of anonymity of ICOs, coupled with the lack of legal requirements, makes it easy for people to invest in fraudulent or scam ICOs. Therefore, it is important to know what you are getting yourself into before investing in ICOs.
While venture capital funding is more secure and regulated, in addition to this, the experience, expertise, and knowledge of investors make it a more reliable option. Thus, to answer the question, the choice to raise funds is ultimately dependent on the startup and its requirements. Proper analysis should be conducted to determine whether ICO or VC is a better option for your startup.
Get an investment valuation from Eqvista!
Whether you are looking forward to an ICO or venture capital fundraising, getting an expert to help you raise funds will ensure that you get the best deal. The experts at Eqvista enable businesses to plan, organize and execute the entire funding process efficiently. As a part of fundraising, conducting the token valuation for ICO and business valuation for VC is crucial. Eqvista’s high-tech software is designed to provide an accurate and fair token or business valuation, which will help you raise funds effectively. Visit Eqvista today and get ready to raise finance for your company!