Early Investing

Equity vs. Tokens? When Investors Need Both

Equity vs. Tokens? When Investors Need Both
By Andy Gordon
Date September 26, 2018

About 15 months ago, I called the founder of a company in our First Stage Investor portfolio.

The company provides a much-needed service in the global supply chain space. Its potential market is huge. And the successful development of its myriad products was finally nearing completion at the time.

The founder couldn’t wait to begin the next stage – earnest revenue generation.

I suggested (as gently as I could) that he needed to develop a new suite of services based on blockchain technology. Otherwise, I said, he ran the risk of being disrupted by a superior technology down the road.

It wasn’t what he wanted to hear.

It’s easy to see why. He wasn’t very familiar with blockchain tech. And he liked his product offerings as they were. They were the culmination of many years of toil and sweat. He told me he was ready to sink or swim with them.

“No,” I told him, “you don’t mean that. You really don’t want to sink. You’ve worked too hard. You’ve listened to your customers and you’re meeting their needs, and you think that’s enough. But it isn’t. The blockchain offers more transparency, security, immutability and speed than your current products will ever have.”

I got off my soapbox. And let the words sink in. It was a hard message for him to hear. I know. I’ve been there. I’ve demonstrated products in the past and received feedback that boiled down to “not good enough.”

He was mostly silent. I wished him luck and hung up.

These days, the company is rapidly expanding its customer base with its original portfolio of products. But, behind the scenes, it’s also exploring a new generation of products based on blockchain technology. The founder is moving cautiously and deliberately. He hasn’t decided yet whether a native token will be part of the new business model.

These latest developments are more than just a curiosity for us.

We participated in the company’s last equity round. If it were to raise a new round of capital via an initial coin offering (ICO), I’d want to have a friendly discussion with him about the terms of our possible participation.

After all, even when shares of companies that ICO rise, their native coins tend to rise faster. As early investors, we deserve a piece of that upside.

There’s a buffet of options I’d want to go over. If I’m in one of my more aggressive moods, I would ask him to grant our members (who invested) the amount of tokens equivalent to the worth of our equity stake. Admittedly, that’s a big ask.

If I’m in a less aggressive mood, perhaps I’d ask him for the right to convert our members’ shares to coins. I’d also suggest that as early equity shareholders, we get favorable terms compared to the new ICO investors.

Or perhaps I’d ask for the option of converting shares at some preset ratio while also keeping a percentage of shares.

Venture capital firms have also been known to ask for the right to block an ICO, which could delay/impede a buyout or IPO down the road because many future owners won’t want to take on the regulatory risks and/or liabilities that come with cryptocurrencies. The National Venture Capital Association recently revised its template legal documents, adding terms that give preferred shareholders the right to block cryptocurrency-related offerings.

The one thing I’m least likely to want for our members?

To keep all their shares without any tokens coming their way.

If the company does as well as I expect it to, both its shares and its tokens will rise. But tokens have the higher upside.

They’re more liquid (by far) and their price reacts to what the market thinks they’re worth 24/7. Given the scarcity of (token) supply and fast-growing demand, coins can scoot up the charts. We’ve seen it time and again.

Of course, the companies themselves also know this. As a result, they may be inclined to pay more attention to boosting the price of their native coins than their shares. That’s another reason to ask for access to their token sale.

These are real risks that early equity investors must think about now.

It’s inevitable that more growth-stage startups will be migrating to blockchain technology and the enhanced fundraising possibilities that tokens offer. This is not a bad thing. On the contrary, if this is how the companies we invest in can best compete and ultimately thrive, they should go down that road. But they should also bring along their early equity investors as allies.

In order to keep the interests of these early investors properly aligned, concessions need to be made to them. Going the token route should never mean leaving your early equity investors behind.

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