30 3 / 2018
The state of Q2 2018 pre-seed/seed-stage fundraising: Part 1 - crypto version
This year has been crazy in the fundraising landscape. The fundraising landscape in 2018 for pre-seed and seed-stage companies has changed a lot even in just the first few months of this year.
This is what I wrote in Q1 2018 about the fundraising landscape.
Now in Q2, things are a bit different. I’ll be breaking this down into 2 blog posts. Part 1 (this one) is about the token-based fundraising landscape. Part 2 will be for pre-seed/seed companies raising traditional equity / debt / convertible security rounds.
Even though most of my audience is probably more interested in Part 2, it’s important to cover what is happening in the crypto fundraising landscape first because investor behavior in this world affects the pre-seed/seed landscape.
DRIVERS:
- A boatload of VCs are trying to get exposure to cryptocurrencies. (Sorta)
- Some VCs are doing token buys.
- Some VCs are not set up to do token buys per their legal docs for their funds. Or their investors in their funds (their LPs) are not keen on their doing token buys.
- Some VCs who were not set up to do token buys before per their legal docs are now making amendments in their legal docs to be able to do so.
- Some VCs are less interested in token buys now than a few weeks ago, as alt cryptocurrencies are down in value.
TRENDS & TAKEAWAYS:
1) Investors who are able to do token buys are active. But, they are not “the usual suspects” (mostly).
In some cases, you see well known Sand Hill VC firms doing token buys - Sequoia, for example. But in most cases, traditional VCs are not participating (or much) for the reasons above.
But, there are new VCs who are specialized – focused solely on cryptocurrency buys. And some of these are pulling away and building brands in the crypto space. My hypothesis is that there will be a real shake up in how deals are done in startups, and you’ll see turnover as some of these new brands overtake older well-established VC firms. (This is an aside for another blogpost)
And then there are also syndicates. These are groups of angel investors – individuals who are pooling their money together to purchase tokens. These syndicates are often a bit “underground”, so you won’t be able to find them by researching via Google. But a good place to find these groups is actually at tech companies. Just about every tech company has a club of cryptocurrency enthusiasts. From there, you can find various syndicates. Syndicates also know other syndicates. Even though syndicates are comprised of angels, you’d be surprised how much money a syndicate call pull together – it’s not uncommon for some of these syndicates to pull together a few million dollars in a given deal and do deals regularly (perhaps less so now that it’s crypto winter).
2) These cryptoinvestors are not buying tokens at the ICO
Most cryptoinvestors I know are trying to buy tokens pre-ICO and often in companies who are doing token sales discreetly.
I think there’s a misnomer that VCs are participating in ICOs. They aren’t. They want to buy tokens before the public does at a better price. Moreover, most companies I’m seeing these days who are doing token sales are not even doing ICOs. They are just doing private sales directly to various investors / investor groups.
This is because it’s pretty involved to do an ICO. And you have to worry about SEC compliance A LOT. As well as potential hacking / fraud issues that could arise. These companies are publicly announcing their upcoming token sale (without committing to dates) and are using those announcements to generate interest that is converted into private direct sales of tokens.
3) You now need some “traction” to successfully do a token sale (sorta)
Unlike last year when you could raise money more or less just on an idea and raise $50m, the “traction bar” has increased for doing a token sale. We’re still not talking about loads of traction – and it depends on if you are launching a protocol or an app – but there is a bar.
The bar for protocols is basically a solid idea with some development and a really reputable team. (even if it will take a long time to fully build). In contrast, the bar is incredibly high to build an app (decentralized or not). In many cases, you need a community of users already (in addition to a product) in order have a successful token sale. These days, many investors are very much leaning towards funding protocols with potential strong tech over apps. Here’s a good paper on why this is (though I don’t entirely agree w/ his conclusions, but that is also for another blog post)
4) Larger established companies are doing token sales
Interestingly enough, to the latter point, part of the reason the bar for apps is increasing is that I’m now seeing centralized apps – existing startups that are at the series A through enterprise level prepare their token sales. So if given the choice to buy into a token of a company that is already thriving vs a new app, many investors would choose the former, right? A series C marketplace that has millions of users is a lot more derisked than an idea-stage marketplace.
5) Centralized apps are doing token sales
Stemming off of point 4, companies that are doing token sales today are not necessarily decentralized. Or rather their projects may technically be decentralized but the tokens will be used in a very centralized use case. A lot of blockchain enthusiasts may find this appalling. Afterall, one of the drivers of blockchain is this notion that centralized large companies should NOT hold your data. (and technically they are not but their blockchains are for the purpose of furthering a centralized, for-profit company)
I think this is an interesting concept. I think moving forward, we will see many companies do token sales – even companies where blockchain is not at the core of the business. My prediction - and I could be totally wrong - is that we will see a new type of crowdfunding of utility tokens for centralized apps. Basically, early customers buy into a new startup’s token at a special price, and those customers benefit from that price if the company does well. But this is just my prediction of where I think the market is headed.
6) Because the bar for token sales has increased, blockchain companies are raising equity-based pre-seed rounds
Funny enough – in 2017, a number of companies who could not raise from VC did successful ICOs. Now in 2018 (Q2 specifically), a number of companies who cannot raise on a token sale are running to VCs to do pre-seed raises!
What I"m seeing here is that a lot of VCs who are not able to get into token sales (i.e. are not able to legally do token buys or their investors don’t want them to etc) are investing in blockchain companies on a convertible note or convertible security and then are receiving promises of X number of tokens during a later token sale.
This has become a common way for pre-seed blockchain companies to raise money.
7) Token-sale raises are becoming smaller
Investors becoming more wary of large raises. Startups are doing much smaller token sales (and I’m glad)! I think that discipline in a startup is important. If you are basically at the beginning of your startup and someone gives you infinite resources, you still would not be able to increase your progress substantially. The adage that 9 women cannot incubate a baby in 1 month is apt here.
That being said, raises still have to be substantial in the crypto world, because there are a lot of additional considerations that don’t apply to the equity world.
A) It takes millions of dollars to get your token listed on an exchange, which people need for liquidity. For top exchanges, it could be as much as $2m-$5m per exchange.
B) Operations costs more. Legal / accounting / other services providers related to tokens = your bill will be substantially higher.
So, even if in the net you want to raise say $5m, you’re probably looking at raising $10-$15m to cover your other costs.
8) It’s crypto-winter, so investors are a little more shy to move forward even if you have some progress
There’s still a lot of crypto money floating around. But, investors are a little more shy to move forward since alts are not doing well right now. (and you now have competing token sales from larger companies – see #4).
9) Companies raising on a token need a concrete liquidity and currency plan
In 2017, investors were willing to take a flyer on projects who had built some semblance of a community. In 2018, liquidity has proven to be very important. So, it’s important to have exchange-connections, money to get on an exchange (or if you are really good friends with people at exchanges, you can get prioritized for free), and a plan / timeline for when your token will become liquid. In addition, thinking through the offering – number of tokens / release of tokens / etc is also really important.
In some sense, your success here will be based on whether you can play mini-fed. It’s not about your white paper.
This is something we’ve been talking with a number of companies – both big and small – about. How you run your token sale is something that isn’t core to people’s businesses but is really important! And I’m happy to chat with more companies thinking about doing this if they want (time permitting).
So wrapping this all up, if I were starting a blockchain startup today, I would get at a minimum get a prototype / early version of my tech working (for a protocol idea). And as an app, I would get a full v1 product and start pulling together community. For the former, you can probably raise if the tech is strong. For the latter, you may need to do a pre-seed round with traditional investors and give investors future tokens if you cannot jump straight to a token sale. I would plan for any token sale to take months – partly to raise but partly to make sure that you are fully in compliance. And, it is important to have strong legal counsel and think through the costs of this legal counsel (plus the cost of getting on exchanges) as part of planning a fundraise.
But this is just my $0.02, and I’m sure my thoughts will change as we move towards Q3 of this year.
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