Ash Egan is a venture capitalist at early-stage investment firm Converge, where he lead the firm's investment in blockchain startups Chainalysis and Enigma.
In this opinion article, Egan outlines how the issuance of a publicly traded cryptographic token might affect the ability of a startup to be bought or acquired later.
Today, entrepreneurs are flocking to the green pastures made possible by token sales, a relatively new way to bring capital into an early-stage tech company. In fact, ICOs and token sales have outpaced traditional venture funding, not only for blockchain companies, but for all companies, according to Goldman Sachs.
Given this traction, it's easy to dismiss the cryptocurrency and token markets as a bubble: Peter Schiff and Howard Marks have each voiced their concerns in the space.
However, there is enormous value in issuing tokens, and there are reasons token sales are booming.
- Entrepreneurs can bring in millions without embarking on the typical months-long fundraising roadshow. (Legendary VC Fred Wilson even believes there is a paradigm shift happening.)
- Introducing tokens often incentivizes token owners (potential users) to contribute to the network, as they now have a vested interest in the network's success. In this sense, tokens are a solution to a network's chicken-and-egg problem.
- Token sales make a company sexy again... Holding an ICO is a sure way to get media attention in 2017. (On the flip side, they may bring the wrong type of investors to the table).
- Companies are now able to raise their seed, A, B and C rounds with pre-revenue traction, and can focus exclusively on building the network and recruiting, rather than fundraising.
As a venture investor at Converge focused on crypto and blockchain businesses, I am curious how tokens will affect an acquirer's decision-making. Blockchain company buy-outs, even those without their own tokens are not yet a norm, although we've seen small acquisitions - Skry, Mediachain, CryptoWatch, Bitnet and CleverCoin.
Before retrofitting an M&A framework and jumping into the logistics of how a corporate might purchase company X with blockchain tokens, it's important to know that many of these tokens are governed via a separate entity: i.e. a foundation, often based overseas (exampled below).
Additionally, tokens offer unique properties: some pass the Howey Test (and are considered securities), many are offered via a foundation (not the company), some have immediate utility, while others may not be distributed for months to years following the token sale.
Wary of cryptocurrency FoMO (fear of missing out), corporates are having conversations on how they might acquire a tokenized blockchain company.
Corporates may want to acquire a company for the team, for the large open-source development community, or simply because the corporation finds the build-your-own token process overly cumbersome.
But, while interest is there, corporate M&A teams do not have a status quo to rely on.
Here are five possible viewpoints:
- Company has value, tokens are irrelevant
- Company has value, tokens seem interesting
- Company does not have value, tokens are important to our go-forward
- We don't know which has value, but we want to own it all
- This is going to be a regulatory, compliance nightmare -- let's sit this one out.
Scenario 1: Company has value, tokens are irrelevant
"We want the company, we don't care about the tokens."
The company owns the patents, the team is superb, but the M&A team does not understand why tokens are necessary for the business or how the tokens merit a high price.
As diligence, the M&A team will try to acquire the company, and ignore the tokens. Just in case, this team will check token sale documents to find out corporate structure of tokens (i.e. was it the C-corp or foundation which issued the tokens?), details on how the team is compensated and token distribution plans. If acquiring tokens is absolutely necessary, the number of tokens issued will likely have a material impact on the exit potential.
If the token market cap is high, and many of these tokens have already been issued, it will be a stretch to see a deal proposed, let alone done.
Scenario 2: Company has value, token has value
The team is great, the technology is great, the protocol makes sense and the team taps into its valuable network of users.
In this instance, there may be an existing relationship between a company and corporation exploring an acquisition. Because most of the activity happening in blockchain is experimental, or the product isn't as far as long as market cap, I think we won't see any corporate pay full equity price plus total outstanding price per token.
The structure of tokens were issued will significantly impact the acquisition price.
Scenario 3: Company does not have value, token does
This company got very lucky in being first to market, but the team is just not up to snuff - maybe there are even signs of fraudulent or malicious activity.
If the market position, developer community and technology are superb, corporates may take an active approach of buying tokens in the wild or even the outstanding tokens.
This is going to be the last strategy an M&A team wants to present to its C-suite.
Scenario 4: We don't know which has value, but we want to own it all
This is the FoMO scenario.
Whatever the reason might be (i.e. a corporation is under pressure from its shareholders and board to develop a blockchain strategy, executives realize they have no one internally who understands blockchain), price sensitivity becomes an afterthought, and the M&A team makes a bid to buy a blockchain token C-corp, alongside outstanding tokens, at current price per token.
Depending on the token acquisition strategy, this scenario could cost billions for the corporation. Biggest question for corporate is what happens to tokens in the wild? And will those token holders remain loyal? Or flock to a competitive blockchain system?
An existing company (say, gambling company Betfair) may shell out $100 million (not $1 billion) for something with regulatory advantages. Companies are clueless about peer-to-peer betting services - let alone blockchain.
Scenario 5: This is going to be a regulatory, compliance nightmare - let's sit this one out
Today's sole corporate strategy for token and C-corp M&A.
The M&A team and C-suite find the landscape difficult to follow, and are worried about losing millions on token volatility, or even how they would go about acquiring token network. Because pricing and acquisitions will be so complex, many corporates will sit on the sidelines and let their competitors dictate price, or may make their own play at the 11th hour.
In this vein, corporates may (Scenario 6) explore potential acquisitions, and ultimately release their own blockchain token, similar to what Kik is doing through Kin Interactive.
Corporates, especially public companies, will drift to Scenario 5 for the next few years, or decide that tokens have immense value and issue their own.
For all of the entrepreneurs thinking of issuing tokens, it's important to understand the downside risk maybe even more so than the benefits of bringing in extra capital. Take the long term view. Ultimately, how would you articulate the value of tokens to your potential buyer?
Other areas corporate M&A teams will analyze, not include above: Who powers the network? Miners?
As entrepreneurs, investors and corporates, we will need to think outside of traditional corporate M&A in the web 3.0 era. If you have thoughts on how tokens affect M&A, come to Boston Crypto's upcoming event, or get in touch (details below).
I run Boston's blockchain group, Boston Crypto - we'll be hosting a discussion on tokens September 5th. Please join if you'd like to discuss more.
Follow Ash on Twitter here: @AshAEgan and @CryptoVC. Thank you to Maia Heymann, Ty Danco and Justin Gage for reviewing this article.
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