The following text was translated with www.DeepL.com/Translator from German into English.
ICO – Digital Financing with Risk
A kind of virtual IPO experienced a worldwide hype in 2017, viewed critically by supervisory authorities. The young German market can be particularly interesting for high-tech founders.
Simon Toprak was tired of searching for a new used car in his scarce spare time and comparing offers and prices. His business idea came to him when it was similar for friends when buying a car. And so in July 2016, he founded the Frankfurt company Trusted Cars, an online shop for new and used cars with TÜV value appraisals that are delivered to the door. Toprak is planning a new project with his company: The application "Trusted Cars Flex" is to offer its users a flexible hybrid of rental and leasing vehicles.
The app customer will be able to drive a well-kept car, including maintenance, insurance and vehicle tax, for as long as he likes, and exchange it for other vehicles without having to sign long-term contracts for "favourable weekly payments". The market launch is planned for the first half of 2019. Managing Director Toprak: "Many dealers want to participate.
The app is based on blockchain technology, which, for example, forms the backbone of the crypto currencies. The translated "chain of blocks" is a decentralized database distributed on many computers. For the new app, this means that the mileage, vehicle identification number and condition of the cars, among other things, are stored in the blockchain. The founder is currently collecting the money for the development of the app on the Internet: Investors receive a digital medium of exchange based on the crypto currency Ethereum. The company calls it "FLEX" and it will serve as a currency in the car rental app.
For his project, the founder uses an innovative, digital means of financing called Initial Coin Offering or ICO for short. The term is derived from that of the initial public offering (IPO). However, an ICO is neither legally nor technically comparable with a share issue.
The background is that at the ICO an issuer, often a young company, issues so-called tokens. These are digital means of payment or exchange based on a blockchain. The company sells its tokens against a legal currency such as the Euro or Dollar or against crypto currencies such as Bitcoin or Ethereum. The ICO of Trusted Cars Flex is to issue 500 million FLEX tokens with an initial price of seven cents each.
The Berlin startup Madana, founded in 2017, is also currently collecting money via ICO. The team wants to develop an open platform on a blockchain whose users can earn money with their data without losing control over it. Spokesman Julian Schiemann: "Data producers such as companies and private individuals, data analysts and buyers of data analyses who want to use them for product optimisation, for example, are to meet on the platform". The idea is to become a pilot project in 2019, and the "PAX Token" sold by ICO will be the currency on the platform.
Madana and Trusted Cars are not isolated cases. "In the first half of 2018, 13 of the 200 startup financing deals concluded in Germany were ICOs. That's five percent of all financing from young companies," says Peter Lennartz, Partner at the consulting and audit firm EY. Worldwide, ICO issuers had raised about six billion dollars in 2017 and more than twelve billion dollars in the first half of 2018. Lennartz: "But cyber attacks and money laundering have meant that some of this has been lost.
According to attorney Matthias von Oppen, the worldwide ICO hype of 2017 is over. "Supervisory authorities are taking a close look at ICOs as many projects have not been as successful as announced. And investors have become more critical," says the partner at the Ashurst law firm in Frankfurt.
In fact, many supervisory authorities are alarmed. The Federal Financial Supervisory Authority (BaFin) has been warning consumers since November 2017 that these are highly speculative investments, and the European Securities and Markets Authority (ESMA) has highlighted the risks of ICOs for investors and companies.
Ruben Bach, partner of the Frankfurt financing consultancy svs Capital Partners: "Following the international hype, ICOs are banned in ten countries. In my opinion, only the bans in China and Vietnam are relevant, since the Asian market is very active." Although ICOs are permitted in the USA, they are strictly regulated in some federal states, according to Bach.
According to its own statement, the BaFin deliberately did not ban ICOs because they could "represent a legitimate form of corporate financing", but only published a consumer warning. This raises the question of the extent to which the instrument can also benefit German founders. EY partner Lennartz assumes that, despite the current acceptance problems, an ICO can become a serious alternative to venture capital financing for young block-chain companies: "It can be flexibly structured, investors can be found worldwide, they have no say and new investor groups are being approached.
According to Tobias Schulz, the High-Tech Gründerfonds (HTGF) in Bonn has so far only lost one deal because the start-up preferred an ICO. "But this will certainly not remain an isolated case. There will be business models that no longer need venture capital, but will conduct an ICO directly via their online community," says the investment manager. This is especially true for well-networked start-ups or those that are already somewhat more advanced. Currently, three young companies from the HTGF portfolio are planning an ICO.
What should founders who are considering an ICO know? Ashurst partner von Oppen: "The utility token that provides access to services dominates the market. In this segment, however, many business models have failed, and there have been many black sheep among the issuers. It is often most attractive for founders to issue so-called security tokens of a securities nature." They could, for example, be structured like a block-chain share. There is still no Security Token ICO in Germany, as these are more strictly regulated than utility tokens – they are subject to the supervision of BaFin. But various companies are preparing themselves according to von Oppen.
For the mortgage consultant Bach from svs Capital Partners, the "vast majority of tokens" are basically securities: "Most of the utility tokens issued so far, which provide access to a platform and are tradable, probably fulfil the character of a security. In the worst case scenario, supervision could then prohibit their trading at some point. "He therefore recommends to companies planning an ICO the security-like, legally compliant variant of the Security Token ICO.
The sticking point for founders is the high costs. "It's very difficult for a real start-up company to stem a legally compliant ICO," says Bach. He has calculated an example: Assuming that a start-up company with a prototype in a new technology that generates at most low revenues wants to collect 15 million euros from a private placement using a Security Token ICO. This requires relatively little online marketing. Nevertheless, the company would have to fork out just under 480,000 euros for the project.
355,000 of which would be fixed costs, including project management, international legal and tax advice, creation of the website and programming of the token. A further 125,000 euros plus variable payments of between five and eight percent were incurred for raising the money. Bach: "At least 150,000 euros should be available before the start of the ICO. This makes the project self-financing. I recommend blockchain founders who are planning a professionally managed ICO to look for two to three business angels who will give them around 500,000 euros for ten percent of the company's shares."
One day, ICOs in Germany could also reach investors to whom Bitcoin and Co. are previously unknown. After all, the Stuttgart Stock Exchange group is planning an ICO platform with transparent processes for issuers and investors from 2019. Dirk Sturz, Head of Primary Market at the Stuttgart Stock Exchange: "Many established companies want to test this financing. In the long term, the ICO has the potential to replace the classic IPO."
Translated with www.DeepL.com/Translator