IPO, ICO, STO: What’s the Difference?
IPO: TRADITIONAL CROWD FUNDING TACTIC
IPO (Initial Public Offering), the method of offering shares of private companies to the public in a new stock issuance, have been among the popular ways for companies to have access to more money and liquidity. Although IPOs are enticing because anyone can have a share in the company’s accomplishments through the purchase of their shares on an exchange, the trend has slowed down due to many issues raised.
Unfortunately, the value of IPO is taken out by multiple parties before the option to purchase stock is finally made available for the average investor, which is contradicting to the “inclusive” idea of IPO. Several accredited investors, banks and institutions take their turn to the early investment opportunity. Then, there is the round of high-net-worth individuals who would take majority of the retail value of the IPO at the initial launch. As a result of the pre-allocation, by the time the public has the chance to invest, they are given the options of stocks at inflated prices. Furthermore, not anyone can easily take part in an IPO share. Even though they go through a brokerage that secures part of the allocation to gain access, they would need to compete with larger investors who want the same piece of share.
Plus, there are limitations faced by the business owners as well when going through an IPO. Firstly, according to PWC, 83% of CFOs noted that they spend more than USD 1 million on one-time costs associated with IPO. Underwriting makes up the largest costs of IPO and based on a survey done by 315 publicly registered companies, an underwriter fee equal to 4-7% of gross proceeds on average. Furthermore, there are costs associated with post IPO whereby expenses must be spent to satisfy with new level of regulations and accounting management. Plus, companies would need to undergo an IPO readiness assessment prior to the launch which could take between 12 to 18 months to complete. The information gathered is relevant to defining how much the company’s IPO will be worth.
With the many barriers to entries for both the business owners and retail investors, it’s no surprise that IPOs are underperforming and slowly declining.
THE RAPID RISE AND FALL OF ICO
ICOs entered the market with the aim to lower the barriers for entry for all investors. ICO is Initial Coin Offering and it’s similar to an IPO. When a company wants to launch a new cryptocurrency or fund an existing project, they can create a whitepaper that discusses the idea around their project and launch an ICO where investors can take part in the offering with their fiat currency or alt coins. In return, the investors receive that new alternative coin.
The ICO runs on a blockchain system whereby each investor’s details become part of an encrypted chain of information known as a ledger that can’t be forged. This allows anyone from anywhere to invest in entrepreneurial ventures and removes financial and regulatory gatekeepers that contribute to the high costs and amount of time taken seen in IPOs. Hence, there was an escalated rise in the amount raised through ICOs. In 2017, more than USD 13 billion was raised through the booming growth of ICOs.
However, due to the lack of regulatory bodies taking part in the process and management of ICOs, their popularity soon turned into a “Wild West of Investing.” According to a report by Boston College, more than half of all ICOs failed within four months of completing their fundraising. Also, scammers launched ICOs of their own and ran away with the investments as soon as it ended. The top ten ICO scams made off with USD 700 million of investments. The many issues surrounding ICOs eventually led to a major drop of 78% in total capital raised among ICOs between Q3 and Q2 in 2018.
STO: Latest Form of Blockchain Crowd Funding
STOs stepped in as a regulated version of ICO and a simpler version of an IPO. STO is Security Token Offering where the security token represents an investment contract, asset or share recorded and issued to accredited investors on a blockchain. STO is gaining popular because they embody a safer form of crowd funding. On a global scale, the growth of STOs have increased significantly by 130% in 2019 Q1 with 47 STOs taking place compared 20 STOs in Q4 2018.
- STO vs IPO
Contrary to when an investor purchases traditional stocks, their ownership information is written in a physical document and issued as a certificate. The difference in STO is that the ownership information is stored and verified on blockchain and issued in a form of a token. The fundamental nature of blockchain gives token holders the ability to trade without gatekeepers. Typically, individuals would need to pay high brokerage and lawyers to get access to a deeper investor base in IPOs. Hence, it’s more cost effective even for smaller businesses to run a STO.
- STO vs ICO
Both ICOs and STOs run on blockchain technology; however, ICOs position their coins as utility tokens. The main purpose of their coin is towards usage (hence, the name “utility token”) rather than as a form of investment such as Security Tokens. Unlike ICOs, the value of the token is tied to the value of the company rather than the community sentiment towards the project, coin or company. This gives a more realistic and safe evaluation of the tokens value. Hence, commendably, the failure rate of STO is reported at 3.65% compared to ICO’s failure rate of ~15%.
However, since STOs are more regulated, both the companies and investors would face more barriers to entry compared to ICOs. The company would need to complete upfront paperwork to fulfil under securities law and internal processes to ensure tracking of ownerships and Know-Your-Customer (KYC) checks. Regardless, they are a faster means of fundraising in a secure and transparent environment for both the business and investors.