With the Initial Coin Offering boom gone for good, and the euphoria for digital currencies issuance is over, IT startups are back on the hunt for traditional and regulated means of fundraising.
It was well expected that one day everyone in emerging startups will have to generate fiat revenues and profits in some form, and startups could no longer depend on crypto issuance, or traditional startups could no longer be attached to the fat checks of venture capital.
Deja vu, but we see the same pattern being repeated since the dot-com bubble. There were companies like Pets.com, which have raised huge amounts of money, but failed to become profitable and soon they have declared bankruptcy. On the other hand, many have developed sound business models, digitizing the society, and today are enjoying valuations of billions.
The Wall Street Journal has suggested that the ICO market is dead. Many analysts suggested ICOs will evolve to regulate Security Token Offerings (STO). The argument for this transition has been that STOs are regulated and held under a particular legal framework. Just when many industry professionals were considering STOs as the Panacea in the ICO bubble, the financial watchdogs have raised concerns about the STO model. So far, the “security token market” is almost non-existent. The popular website Securities.io, which tracks the progress of Security Token Offerings, lists only 13 companies as successfully funded via STOs, limited to blockchain companies, real estate, and venture funds.
Domantas Jaskunas, COO at NOIA Network, “The blockchain space has matured rapidly in recent years. Fundraising routes have reflected that maturation. By 2019, most of the funding transitioned to equity sales. The great thing about most blockchain projects is that they democratize technology like never before. Anyone can directly participate in the mass adoption of new protocols and applications. Crowdsales were a big part of this effort. Today, the blockchain ecosystem is much larger. Many projects don’t require crowdsourced mechanisms to function. Others recognize a place for traditional investment during the development phase.”
Every project is approaching this differently, but it’s clear that there’s a role for multiple sources of fundraising including crowdsales that still align incentives for all parties.
Return to Traditional Fundraising Mechanisms — IPOs and Convertible Bonds
An IPO, or an Initial Public Offering, is the first time when a company sells its shares to the public. 2019 has been the year of tech IPOs, with anticipation over the most expected IPOs such as Uber, Lyft, Pinterest, Slack, and Zoom. Zoom has achieved 85% performance during 2019, as a result of the pandemic. Technological companies are really appealing to investors since software companies have low costs and high-profit margins. On the other hand, logistic businesses have high operating costs and thin margins, hence the poor performance of startups such as Uber, Lyft, and WeWork.
According to the research firm Renaissance, 243 companies could go public in 2020. The 2020 IPO market, despite the uncertainty, is featuring big names, such as Airbnb.
A few of the most expected in the market are the Airbnb — the famous vacations rental marketplace, Wish — an unbranded stuff marketplace, Doordash — a food delivery startup, Casper — a company selling mattresses through its online platform, Robinhood — a startup offering free stock trading through an app, GitLab — an essential tool for developers competing with Github, Asana — a project management tool.
Of course, some IPOs didn’t go as expected with companies such as the Chinese mining machines producer Canaan experience -79% return, YayYo -91%, Similar companies that didn’t make it to the IPO phase such as WeWork fiasco, valuing the co-working company to $47 billion, has turned into a ridiculous story. In just one month since the initial announcement in August 2019, the coworking company cut its valuation down to as low as $10 billion from $47 billion, removed Adam Neumann as CEO, and delayed its initial public offering indefinitely.
Understanding convertible securities, and how they are different from IPOs
Convertible notes are now becoming the preferred fundraising instruments for many startups. They represent hybrid debt and equity participations. While originally structured as debt investments, now they feature a provision that allows the principal plus accrued interest to convert into an equity investment at a later date. This method facilitates an initial investment to take place without time constraints, significant lower legal fees, while giving to investors the economic exposure of an equity investment. Those who are interested in participating in a Convertible Note offering need to be familiar with the terms such interest rate, maturity date, conversion provision, conversion discount, and valuation cap.
The most important element for a convertible note is the avoidance of placing a valuation on a startup, which is useful for earlier stage companies. This fundraising medium is a bridge-capital between round financing options.
All of the high-growth startups are relying on external capital from venture capital and investors to identify their market fit and grow their market share.
Recently, Yandex, one of the Europe’s largest internet companies operating the famous search engine in Russia, has announced an offering of approximately $1.25 Billion in aggregate principal amount of convertible senior notes due by 2025. Goldman Sachs International acted as Sole Global Coordinator and Joint Bookrunner and J.P. Morgan Securities plc, Morgan Stanley & Co International plc, UBS AG, London Branch and VTB Capital plc acted as Joint Bookrunners in respect of the Offering.
Similarly, PRNEWS.IO, the leading martech startup, which represents more than 26,000 publications in its ads marketplace, has announced a €2 million convertible placement. The European startup is set to head for its IPO on the Nasdaq Baltic European stock exchange in the coming two years, making the issuance of convertibles a pre-step to the major launch.
For startup PRNEWS.IO, this is not the first case of entering the market through the loans. In March 2019, the Estonian Virtue Capital Fund credited the Ukrainian startup unit PRNEWS LLC for 0.5 million euros for a period of 1 year. The deal brought the fund a 16% return. Therefore, the fund intends to re-invest in bonds issued by the parent company PRNEWS OÜ.
Which are the unique factors to convertible debt raising:
Convertible notes are often used in high-growth companies such as technological startups, which are hard to predict with precision their future valuation. Investors participating in convertible Notes typically seek economic interests to be increased due to the equity appreciation, and they don’t want to limit into an interest payment.
- Most convertible debt instruments require interest payments at maturity, usually paid in equity at conversion
- Most convertible notes convert automatically upon a preferred equity round that occurs after the closing of the convertible debt financing. For more progressed startups, this refers to IPOs.
- The conversion price is typically based on a discount rate or valuation cap negotiated when the notes are issued.
Famous venture capitalists such as Naval Ravikant, co-founder of AngelList noted that “Convertible notes have made variable pricing possible”, while Paul Graham suggested in a post that Convertible notes is a “High-resolution fundraising”.
The third and fourth quarter of 2020 is going to bring many opportunities, since numerous offerings were postponed due to the coronavirus.
The Insurtech startup Lemonade floated on 2 July, with shares doubling during the first day of trading. Lemonade’s shares originally priced shares at $29, slightly above its initial estimation of $26-28, later traded for as much as $64 on the first day, raising $319 million in the process. Deliveroo, the well-known food-delivery startup headquartered in the UK, with operations across the world.
The list and the opportunities available is long with leading tech startups such as Palantir, Airbnb, Instacard, Robinhood, Postmated, PRNEWS, and Yandex raising money during 2020, and investors waiting eagerly for double digit returns.