ICOs vs. IPOs : What you need to know before investing

By Aaron Wagener, COO, MXC Foundation

Initial Coin Offerings (ICOs) have the potential to become a powerful means for start-ups to amass capital. Disruptive technologies are changing the world and wrestling the scope of opportunity away from the powerhouses of Wall Street and other institutions in major financial capitals around the globe. While it’s doubtful that ICOs will replace IPOs, the prospect of coin offerings sitting alongside public offerings as a fundraising alternative is a probability.

The technology boom has changed the landscape significantly. And the paradigm shift is still in motion. The onset of crowdfunding meant initial public offerings (IPOs) opened the door for average investors to opt into high growth potential with firms such as Uber, Facebook and Airbnb.

In fact, in 2017, IPO projects raised an estimated US$196bn. In contrast, ICOs accumulated US$5.6bn. Though the fundings accumulated by ICOs may pale in comparison to IPOs, entrepreneurs see plenty of potential in blockchain technology to accelerate interest in the ICO fundraising model.

Crowdfunding: Key considerations around ICOs and IPOs

The first step is understanding the differences between ICOs and IPOs. Both use forms of crowdfunding, which is a branding exercise that can help start-ups attract new customers quickly. Whilst attracting multiple shareholders builds confidence in a company and builds up its stock, the downside for stakeholders is that dividends are shared among a bigger pool of investors.

An IPO involves floating public shares with the goal of collecting funds to develop and expand the business. The advantage IPOs have over traditional “private” company funding is a low-cost solution for raising funds and simultaneously raising public awareness.

ICOs are also a means of crowdfunding and, in that sense, are very similar to IPOs. The advantage for investors, however, is that when they buy shares in an ICO they are investing in a digital coin which accrues a store of wealth when more investors opt-in.

There are additional pros and cons to consider.

A closer look at IPOs

The IPO model is an established financing opportunity. Before a company can launch an IPO, the project’s lead team typically has to go through several investment banks to develop a promise and a prediction. Crowdfunding platforms also perform stop checks and have limitations. It is crucial for companies to meet the requirements of crowdfunded platforms before preparing a project launch.

The benefit for both companies and investors is that a bank’s underwriters help companies to prepare a business plan, estimate a projection of earnings, and determine the type of investment vehicles that can be sold as securities.

IPOs’ strategic initiatives have clear advantages. However, the legal requirements and processes involved to launch a crowdfunded IPO typically include the scrutiny of auditors, form-filling, endless meetings and compliance tests.

Regulations make the IPO a drawn out and frustrating process, without alleviating the volatile nature of investing in shares. There is also the potential that terms favour the banks over the interest of the company owners or their stakeholders.

There is always a risk in setting up a business and buying shares. Just because financial experts and a regulatory body have authorised an IPO crowdfunding project, there are no guarantees capital ventures will succeed or earn significant dividends.

The business case for ICOs

Does ICO crowdfunding alleviate any of the issues that frustrate IPOs?

One of the underlying solutions of blockchain technology and cryptocurrencies is to make financial processes easier, quicker, fairer and more secure for investors. To start, the duration of a project is under the control of the project team. Once a white paper is made available to the public, investors can make their own decisions whether they consider a project has enough potential to succeed.

Before investing in an ICO, stakeholders should conduct due diligence as they would any investment. When analysing ICOs, they should consider whether the financial projection is realistic and evaluate the proposals provided by the management team.

ICOs certainly present start-ups with uncluttered solutions, but will investors see it that way? It’s doubtful that ICOs will replace IPOs but the prospect of coin offerings sitting alongside public offerings as a fundraising alternative is more than probable.