ICO Financing For Startups

Author:Dr. Daniel Flühmann and Philippe Seiler
Profession:Baer & Karrer

Initial coin offerings (ICOs) or token sales as alternative financing methods continue to generate increasing interest - in particular in Switzerland. Initial coin offerings conducted out of Switzerland between January and October 2017 raised between $550 and $650 million, which represents approximately one quarter of the volume of ICOs worldwide (including four of the 10 biggest ICOs so far). In our view, despite certain legal and regulatory challenges, ICOs have to be considered as a potentially attractive financing method, in particular for startups, as certain disadvantages of traditional financing methods may be avoided or mitigated.

Typical disadvantages of traditional financing methods

The key traditional financing methods for startups are: issuance of additional (ordinary or preferred) share capital, loans (including profit participating loans) and bonds. Taking the view of startup entrepreneurs, however, these funding methods may have certain disadvantages.

The issuance of additional share capital leads to founder dilution. Even if the shares can be issued with a low nominal value and a high share premium, minimising dilution, the issuance of additional shares still increases the administrative requirements (for example, more complex procedures for convening and conducting general meetings of the shareholders), which makes the management of the startup more cumbersome.

Loans are generally difficult to obtain for startups and often do not match their needs (for example, repayment of nominal amount and fixed interest irrespective of the performance of the startup, restrictive covenants or administrative burdens).

Bonds, which are in principle loans split into equal parts with equal terms, have similar disadvantages for startups as loans. Some of hese disadvantages may be avoided by the issuance of so-called hybrid bonds (that is, subordinated, perpetual bonds with the right of the issuer to postpone or not pay the interest). However, if at all, startups will usually have to issue straight bonds with a fixed interest and a repayment at maturity to generate interest in the market.

ICOs as a potential alternative financing method

According to a definition by the European Securities and Markets Authority (ESMA), in an ICO, "a business or individual issues coins or tokens and puts them for sale in exchange for fiat currencies, such as the Euro, or more often virtual currencies, for example, Bitcoin or Ether".

In Switzerland, depending on...

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