IPO and ICO are both methods of raising money for a business, IPO’s are the traditional and long-established route while ICO’s are the new kid on the block. Both ICO’s and IPO’s vary significantly both for the companies conducting them and for investors. This article intends to describe the differences between an ICO and IPO in order to understand when it would be appropriate to use which method and what the considerations need to be for investors comparing opportunities presented by the two methods.
What is an IPO?
Let’s start with the more traditional and established method an IPO. IPO stands for Initial Public Offering and describes the process whereby a company moves from being privately owned to being listed on a stock exchange and being publicly owned by its shareholders. Going through an IPO allows a company to pull in money in order to expand the business or to release funds back to venture capitalists and other early investors. The IPO process is well established and highly regulated.
What is an ICO?
An Initial coin offering or ICO for short is a new way for businesses to raise investment. In 2017 the most successful ICO for File coin raised 257 million dollars. ICO’s are a type of crowdfunding and work by investors exchanging either their fiat currency, Bitcoin or other cryptocurrency for the branded company token.
Now we have defined what an IPO and ICO mean and have some understanding of them let’s take a look at a number of areas where there are differences between them:
Regulation and Process
The IPO process is well established and highly regulated, companies already need to have met minimum earnings thresholds and be profitable or at least near to profitable plus have a strong track record. Companies trying to IPO must work extensively with a number of external bodies including the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) in the US. Plus they must be liaising with exchanges, investment banks and other institutional investors. This formalized process plus the accountability to a number of interested parties whom will be conducting their own in-depth checks acts as a kind of natural selection to ensure solid companies make it to IPO.
Securities and Exchange Commission
The company performing the IPO must also produce a prospectus which is bound by legal obligations to contain certain key information and must be transparent.
At the other end of the spectrum is Initial Coin Offerings, since this is such a new form of funding first seen in 2013 there is currently no regulation. Most ICO’s produce a white paper to explain their offering to potential investors, but there are no standards for what must be included in these documents or how they should be written. Since there is no regulation or close partnerships with established bodies such as investment banks and exchanges as seen with IPO’s the natural selection process does not occur to weed out weaker companies. The result is essentially anyone can create an ICO, making this type of investment more susceptible to scams. Either, from those who set out to take investors’ money with no intention of starting a project or those which have good intentions but the team do not have the skills to deliver it.
Both IPO and ICO are funding mechanisms for a company but when they could be used differs, since with an IPO the company must already have a proven track record and evidence of good earnings it is more suited to established companies. However the fluidity of the ICO lends itself to startups who have an innovative idea they can present well through a whitepaper but as yet do not have a product or track record of earnings.
While this ability to fund a project with no live product or earnings can assist a start-up it creates an additional challenge for investors who cannot rely on traditional tools such as P/E ratios to access projects. They must instead rely on less well defined indicators such as team strength and quality and clarity of the whitepaper.
Due to the processes and legal requirements involved with an IPO completing this process is time consuming, ICO’s take place much quicker and offer a faster method to raise funds.
The IPO process involves many parties including the exchanges, brokers and underwriters, whilst this helps with a kind of natural selection to ensure only the better projects make it to IPO, it also complicates the process and makes it more expensive.
ICO’s are based on the blockchain which promotes a decentralized approach that cuts out the middle men making the process easier, quicker and allows the companies performing the funding to retain a greater proportion of the money raised.
Through an Initial Public Offering investors are in return given shares in the company, they are a part owner of the company. This allows them benefits such as the ability to vote on decisions during shareholder meetings and they are also entitled to receive dividends.
ICO’’s allow a company to remain privately-owned whilst still raising funds. Investors are given a company token in exchange for their funds, this does not give the investor a share or stake in the company. Investors hope for a return through the project based on the coin becoming successful and being perceived as being more valuable leading to the coins value rising. Some coins do offer the ability to earn more just by holding the coin through master nodes, however these usually require very large holdings.
IPO’s are far more selective than ICO’s. To invest in an IPO, investors must meet certain thresholds and be accessed by a broker to prove that they are a sophisticated trader. Eligibility will be accessed differently between brokers, for example TD Ameritrade will only allow you to participate in an IPO if you have $250,000 in assets and have traded 30 times minimum in the last 12 months. Investment is also highly regulated to prevent money laundering.
There are no background checks or threshold requirements for ICO investments, anyone can take part. This makes ICO’s much more open to smaller private investors.
IPO versus ICO is not an either/or choice, they both offer distinct advantages and disadvantages to both investors and the companies running them.
ICO’s offer companies a way to raise funds quickly without the red tape of IPO’s and at an earlier stage in the company’s development. They also allow the company to remain private and move forward quickly where time to market is pertinent.
IPO’s offer companies a tried and tested route to raise funds, the process is very clear and well defined with many within the ecosystem to support the process and interested investors ready to take part. There is a certain prestige with being listed on the stock market and the act of going public can serve as a good marketing event to drum up interest in the business.
Any investor with an internet connection can participate in an ICO, it is very inclusive for investors and does not favor institutional investors like an IPO. Investors do not need to understand the complex process of IPO’s and must only digest and access the white paper. However due to the unregulated nature of ICO’s investors need to be diligent in their research of potential investments and be selective with the projects they select.
IPO’s have traditionally been available to only institutional investors, due to the highly regulated process they generally offer a more certain investment vs ICO’s which are easier to assess with traditional investment measures.