Many people would have heard of an Initial Public Offering (IPO) before but an Initial Coin Offering (ICO) is less well known. It is important to understand not only what each entails but also the advantages and challenges of both. Here are the main considerations for each of the offerings.
What is an Initial Public Offering?
An IPO is one method in which a company can raise capital, there are many alternatives. An IPO works by offering shares from a private corporation to the public. Issuing shares to the public allows the company to raise capital and public investors to participate in the company. This is a necessary step for a company to become public.
Subsequently, an underwriting process is used to price the shares for the IPO. This means the company negotiates the sale of its stock to one or more investment banks as an underwriter. These underwriters go on to sell their stock to investors in the public markets. Underwriters in return receive fees and underpriced stock when purchasing from the company.
Still confused? Here’s an example to clarify. In 2012 Facebook held one of the largest Initial Public Offerings in history. The first step was to ensure the shareholder and cofounder agreements were up to date. Following this Facebook filed for an IPO with the SEC, in Australia this would have been the ASX. Then the lead underwriters Morgan Stanley and Goldman Sachs priced the shares at $38 each. Through the public market Facebook raised $16 billion in just the first day.
Advantages of an IPO
Fundraising
The most commonly cited advantage of an IPO, raising capital to fund the company.
Exit opportunity
All shareholders and investors aim to see positive financial return and an IPO enables this.
Credibility/Publicity
Due to the stringent regulations involved in an IPO, a successful offering is an indicator of a credible business. An IPO also offers exposure in the public spotlight.
Challenges of an IPO
Increased reporting requirements
ASIC and other regulatory bodies require public companies to make greater disclosures.
Potential loss of control
Founders may lose majority decision making power. Even if shareholders hold non-voting shares the company has an inherent duty to shareholder interests.
Cost
Underwriting fees, legal costs and regulatory costs all combine to make IPO’s an expensive process.
What is an Initial Coin Offering?
It is important to first recognise that cryptocurrencies are a digital currency which work as a medium of exchange. An ICO can be simplistically explained as the cryptocurrency space’s equivalent of an IPO. More specifically when a cryptocurrency startup firm wants to raise capital it may perform an ICO.
One of the most important steps, particularly for a cryptocurrency company is to protect all intellectual property. This is an important step to protect the company before public exposure. During the ICO campaign, investors will purchase distributed crypto coins with virtual currency. Much like an IPO provides investors with shares, ICO investors will receive tokens. Potential investors receive their money back if the company fails to raise the minimum money required.
Advantages of an ICO
Fundraising
Similarly to an IPO an ICO is commonly used for raising capital to fund the company and relevant ventures.
Fraud Prevention
Blockchain is the platform through which crypto currencies operate. Blockchain’s decentralised nature makes this highly secure.
Limited red tape
While there is white paper in an ICO this is significantly less than in an IPO.
Challenges of an ICO
Can be highly speculative
ICO’s are often based on projects that do not exist yet. Subsequently, there is no guarantee that projects will be completed.
Unregulated market
Currently, crypto currencies are largely unregulated. Therefore if there is an issue the avenues for redress are limited.
Attracts a lot of scammers
The lack of regulation leads to fake white papers being created from scammers.
Conclusion
It can be challenging understanding what is entailed in an IPO and an ICO. However, using the guide above is a great way to develop your understanding.
It also becomes clear that both have advantages and disadvantages. Consequently, to avoid encountering such challenges and minimise your own risk you should contact a business lawyer.
