Attention, Founders: That ICO Is About To Dilute You, Too
ICOs are nothing less than a tectonic shift in the startup-funding environment. Alas, one of the most common misconceptions about ICOs is that they allow “non-dilutive financing.” You aren’t selling any shares, so there isn’t any dilution, right? Wrong.
Welcome to the Fallacy of Non-Dilutive Financing. Clearly, when selling shares or tokens to investors, the investors expect those to appreciate and increase in value. If that’s the case, they will be sharing some of the future value of your venture, so there must be some dilution hidden here.
To understand this, we first need to understand the difference between owning equity and owning tokens.
A share represents part ownership of a company.
A token has two functions: Firstly, it represents the future value of a service. Secondly, it also is a key used to access that service. The number of tokens multiplied by the value of each of them is the “network cap” value. This is very similar to owning a share of the equity of a company. The key difference is that a network token has a second function: It is a means of access to that network service.
This dual functionality of a token, encompassing both value and access can be demonstrated with Ethereum. As of January 24, 2018, the total number of ETH tokens in circulation is (roughly) 100 million. Each is valued at (about) $1,000, which is about $100 billion of “network cap.” As an investor, if you believe the network will eventually be worth more, you can buy ETH. At the same time, if you are a user that wants to execute a smart contract on the network, you need to pay for the transaction with ETH, driving demand and thus increasing the value of the ETH token.
This second function is what’s so exciting about token networks. It’s like the Berkshire Hathaway share that gets you a seat at the Warren Buffett show, but on a mass scale. This aspect of tokens creates a constant, growing demand and thus an increased intrinsic value to the token.
But the fact that tokens have two functions — they're both a "share" and a ticket to using the service — is bound to create diverging interests.
Let’s analyze this using an example. Assume you are the founder of PigeonCo, the developer of an incredible new decentralized pigeon delivery network. You took an investment, selling 50% of PigeonCo to an Angel Investor. Since ICOs have become expensive, you finance the early building of it with a SAFT, representing 25 percent of the overall tokens. You plan to sell another 25 percent in the crowd sale you’ll do once the tokens have utility. Things go well, the pigeons are airborne, the crowd sale went through. Let’s assume the total value (“network cap”) of the token base is $200 million.
Pause. What’s the value (“market cap”) of the company at this point? If you ascribe to the “company holds assets” camp, then since its holding 50 percent of the tokens, its market cap is $100 million. If an additional 25 percent of the tokens were granted under a vesting schedule to the team, then the company only holds 25 percent of the tokens, and has a market cap of $50 million.
If the company depends on value creation via the appreciation of token value and doesn’t get paid for providing a service, it won’t have revenues. If the company sells off the remaining 25 percent of tokens — and thus holds no tokens at all — the company is value-less to you, the founder and your Angel Investor. None of its shareholders own anything. As a founder of a tokenized company, selling equity is not dilutive as there is nothing to dilute. The pigeons generate value for the token holders, not the shareholders. This means that selling tokens is the dilutive event.
The shareholder vs. token-holder issue gets even more complicated if you want to IPO an ICO’ed company. How could you pitch “increasing shareholder value” to the public when the shares don’t hold the economic value of the company?
This means that once you've "tokenized" your business, an IPO or even possibly equity financing isn’t an option. If an ICO is an “initial coin offering”, shouldn’t there be follow-on coin offerings (FCOs)? As the network cap increases, it makes sense to do additional offerings. The community frowns on such a practice today, and it isn’t even possible unless you pre-plan, pre-reserve, and pre-commit a portion of tokens to all your future funding needs. This isn’t flexible and is a disadvantage compared to the traditional company equity structure, where the board of the company can decide to issue additional shares. Understanding follow-on financing is yet another one of the areas that will need to be figured out in the token economy.
If the value of a token network truly is decentralized into its token, an exit in such a company won’t look like the selling of a private company. Instead, the exit takes place via on-going secondary sales. Unless the company equity holds a value like controlling interest in the token base, there is nothing for a would-be acquirer to buy. The company is an empty shell. Amazon bought Audible to own yet another vertical in retail and media. Can you imagine Amazon buying Filecoin for its storage business? It makes no sense to own a decentralized asset because it’s not really in your hands.
Therefore, not diluting the equity cap table is actually… meaningless. Welcome, friends, to the sticky, strange, and fascinating world of token sales.
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5 年Ceo & co Founder ? Cast-tv?Infinivy SA?tv2go.co.za? "I like to buy into the overall vision of a company" welcome #Philip Staehelin#??
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6 年Your desire to educate on the issue of whether ICO/STO funding rather than equity investment funding, is truly "non-dilutive" for tokenized businesses is laudable, but you write with a sense of authority which may cause the marginally knowledgeable reader (in terms of crypto and traditional economics) to believe everything you say, which unfortunately, is a disservice to them. Your analysis is unfortunately flawed to the extent that you imply that a company's true economic value is either resident in its equity with an asset ownership base, or is resident in its token holdings. That is only true for those Blockchain companies whose founders and advisors have no proper understanding of economic value design. The truth is, a company's true economic value can and should span both its non-token AND token asset holdings, via a properly designed token + company economics valuation design and plan, which fit together like hand in glove. Far too many blockchain/crypto entrepreneurs blindly follow the nascent industry's very "blinkered" status quo thinking, attitudes and opinions, erroneously believing that they need to conform to such thinking/opinions, in order to secure the investment support of the community and so they fail to innovate in the area of both token and company economic value design. That's a shame.? Fortunately, I have no such shackles and the Blockchain enterprise I am building will bear witness to that. Once truly exceptional equity + token value, is properly communicated and demonstrated, it cannot be denied and the community will naturally be drawn to that exceptional value like iron to a magnet. Building a token-centric Blockchain company is equivalent to an opportunity to build a new "smart city" from the ground up, that will compete with the world's best cities. It is an opportunity to thoughtfully design, not shallow, but deep 'Xtraordinary value for ALL potential stakeholders and value contributors. Sadly, 99.99% of Blockchain startups focus on building just a "product/service solution", because they simply do not recognize the unprecedented opportunity that tokenization offers, to craft "an 'xtraordinary value creation and distribution ecosystem vehicle". That's why the marketplace is filled with valueless "legalcoin, medicalcoin, cannabiscoin, sportscoin and similar tokens, as if the average consumer is ever going to want to deal with a wallet full of 100 different tokens needed to get through one day of their life. Human psychology comes first, not the technology. That's exactly Bitcoin, Ether and all of the other touted future mainstream cryptocurrencies, can never be a universally adopted cryptocurrency. There were designed with a focus skewed way too heavily of "technological features". Any serious investor in Blockchain companies should not be saying "show me your MVP"... they should be saying, show me your "Economic" XVP (Xtraordinary Value Proposition?). Kudos to you Philip Staehelin?for quickly recognizing the intrinsic weakness of the author's argument. The "valuation logic" of?split equity/tokenized companies, as you put it, is indeed more complicated, but inherent in that complexity, is a degree of economic design flexibility and opportunity that VASTLY exceeds the Valuation, the Revenue and the ROI possibilities, of pure play equity companies. So the "logic" which as you say is now being worked out, is not a "standard" logic or model as pertains with pure play equity companies; the flavors of that new logic will be many and the architect of the most potent equity+token economics design, not the owner or developer of the best Blockchain technology, is the company that will stand head and shoulders, no... MOUNTAINS, above all others.
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7 年You're missing a key point. If you do an ICO and shift your newly acquired crypto funds into a fiat currency, then the value of the company is at least the value of the cash in the bank. You suggest that if you sell ALL of your tokens (for e.g. EUR 200m) the company's value would be zero. I'd gladly buy that company for any discount on the cash value, which means that if nothing else, the company has a value approaching EUR 200m. The valuation logic of split equity/tokenized companies is still being determined (and every ICO story is a bit different), but I would argue that using the ICO proceeds (the EUR 200m) to develop a robust product, a functioning ecosystem, and a lot of passionate users, then shareholder value will grow. Think if Amazon had tokenized its original book business. Would those same tokens be required to pay for its massive and profitable cloud business? They could be in theory, but they certainly don't have to be. So as an equity investor, I like to buy into the overall vision of a company. The good ones are not one-trick ponies. Rather, they contain upside in their option value. It gets more complicated with tokenized firms, but it's not nearly as black and white as you suggest.
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7 年great insights
Co-Founder & Managing Partner at theDOCK “What is to give light must endure burning”
7 年Hannan Carmeli Idan Cohen Carmit Glik