By now you've probably heard of an ICO, or Initial Coin Offering, and know that it's an innovative way for blockchain startups to raise capital through the issuance of a new digital currency or "token." It's also become quite popular, with Fabric Ventures and TokenData reporting that in 2017 alone, ICOs raised $5.6 billion.
You might also know that the Securities and Exchange Commission has recently issued dozens (if not hundreds) of subpoenas, and is retroactively investigating ICOs that it suspects may have violated federal securities laws.
If you're evaluating an ICO as a fundraising strategy for your business in 2018, here are five things you must consider first.
1. In the eyes of the Securities and Exchange Commission, all tokens are securities.
Securities and Exchange Commission Chairman Jay Clayton has made it crystal clear: all tokens are securities, which means that the offer and sale of tokens are subject to federal securities laws. As such, ICOs must register with the Securities and Exchange Commission, or qualify for an applicable exemption from the registration requirements.
Even if your token has a "utility" function, it is still a security, and needs to be treated as such. If you've written your White Paper and structured your token economics, your immediate next step should be to hire a seasoned securities attorney with balanced capital markets and crypto experience.
2: Reg D 506(c) and Reg A+ are two viable exemptions.
Reg D 506(c) allows accredited investors to legally invest in your ICO, and gives you the ability to generally solicit or market your deal. The pros are that Reg D has no cap on the raise and is relatively fast and easy, with legal costs averaging $25,000-50,000. The cons are that you are limited to wealthy investors, your investors must prove they are accredited, and there is a one-year lockup on tokens.
Reg A+ allows one 18+ globally to invest, has a $50 million cap on the raise, and gives you the ability market your ICO. The key advantage is that anyone can invest, which aligns nicely with the philosophy of the crypto community. The downside is that Reg A+ requires two years of audited financials (if you have operating history), will take three to six months, and can cost anywhere from $250,000-500,000 between marketing, legal and accounting fees.
3. Figure out how much capital you really need.
Too many ICO issuers are raising too much capital. Sure, this might sound counterintuitive, but do you really need $50 million for your three-person blockchain startup? ICOs that raise too much capital limit the upside value to their investors at best, and risk being reckless and irresponsible at worst.
Plus, as famed entrepreneur and investor Marc Andreessen once cautioned, there are other negative consequences, like cultural corrosion, to raising too much money. Such startups can become "infected with a culture of complacency, laziness, and arrogance," writes Andreessen.
4. Evaluate your Advisors carefully.
It's official: LinkedIn is now flooded with individuals claiming to be "ICO Advisors." While some may have valid experience, the vast majority do not.
Here are some questions you should ask your prospective Advisors: What current and past ICOs have you worked on? What exactly was your role? Are you still engaged on the project? Was your involvement documented in the White Paper or elsewhere? How were you compensated for your work? Is that legal? What was the outcome of the ICOs you were involved with?
It's also critical to ask for references, and have the Advisor set up calls with their current and past ICO clients. An experienced Advisor should have no issue providing two to three references.
5. Only registered broker-dealers can charge success fees.
If you pay a marketing firm a percentage of your raise, and they are not a registered broker-dealer, both you and the marketing company have violated federal broker-dealer laws. It is illegal to offer success-based or incentive-based compensation to any firm that is not a FINRA registered broker-dealer.
A safe approach is to pay cash for services. You can also offer a mix of cash and tokens, but be sure to check with your securities attorney before proposing or agreeing to any such arrangement.