ICOs for Mid-Size Tech Firms Using Reverse ICOs Instead of IPOs to Exit with Excellent Valuations

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1 ICOs for Mid-Size Tech Firms Using Reverse ICOs Instead of IPOs to Exit with Excellent Valuations Copyright 2017, Pathfinder Equity Systems Inc.

2 Abstract Venture investors and entrepreneurs face a challenge: it s getting harder to exit via IPOs because of market conditions and red tape. This means less money to reinvest and less growth for the economy. ICOs (Initial Coin Offerings) are growing in popularity as a way of funding new ventures, however they face legal challenges since they often bypass securities laws. As a result, a new ICO called a reverse ICO is an attractive alternative. Reverse ICOs are designed for existing, successful companies and they are assumed to be securities (equity) from the start. It is functionally identical to traditional IPOs, following the same regulations, audits, and disclosures, but issuing tokens (electronic equity) instead of traditional stock certificates. Because tokens are a modern version of stock, they are more liquid, more flexible, and more tuned to the next wave of Web technology. Most important, token-based equity offers significantly better valuation for mid-size technology ventures. In this white paper, reverse ICOs are discussed and their future explored. Table of Contents WHAT ARE ICOS 1 OLD STYLE ICOS HAVE PROBLEMS 1 WHO SHOULD CARE ABOUT ICOS? 2 INTRODUCING THE REVERSE ICO 3 AN ANSWER TO THE IPO DROUGHT 3 INVESTOR PROFILE 4 REVERSE ICOS COMPLY WITH SEC REGULATIONS 4 ADVANTAGES OF AN ICO OVER AN IPO 5 THE BEST CANDIDATES FOR REVERSE ICOS 5 HOW ICOS INCREASE COMPANY VALUATION 6 DON T BE THE NEXT TANDEM 7 THE ICO PROCESS 7 RISKS AND CONCERNS 9 ABOUT PATHFINDER EQUITY SYSTEMS 10

3 What Are ICOs An ICO is the release of a new digital currency, and is all the rage in the investment community. A company seeks funding by creating a coin or token which is offered in exchange for investment using another cryptocurrency, typically Bitcoin or more recently Ethereum. ICOs can generate substantial amounts of capital quickly. Filecoin, a Silicon Valley ICO, raised $200 million in an hour; Brave, an open source web browser, raised $35 million in 30 seconds. ICOs leverage the latest Web technology behind cryptocurrencies like Bitcoin, not to mention the $70 billion now in the hands of highly tech-friendly Bitcoin investors. Old Style ICOs Have Problems These ICOs have significant regulatory problems and it's likely in the months to come, many of them will run afoul of regulatory laws and lawsuits. The fundamental problem is this: most ICOs want to avoid being classified as "securities" because they don't want to deal with the paperwork and obligations. Most ICOs are carried out by new startups, and not existing companies. They operate much like risk capital, where there is a very high risk in investing, but the potential for a very large return. The SEC is working to tame these excesses, but agency officials don t want to be seen as limiting innovation. They d like ICOs to succeed, but in an ethical (and legal) manner. It is for this reason that a new way of thinking is needed. Now there is a new style of ICO: one which retains all extraordinary benefits, add billions if not trillions of value to the economy, and helps cryptocurrency investors provide excellent value and liquidity for entrepreneurs. We call this the reverse ICO. Cryptocurrency Terms The following is a list of commonly used terms. This glossary is provided as a quick reference. Blockchain: ledger of all mined bitcoin. All transactions are displayed here to prevent fraud. Coin or Token: an individual unit of cryptocurrency Cryptocurrency: a currency based on math and cryptography, may include executable code ICO: the initial offering of a new cryptocurrency, similar to an IPO Mining: creation of new bitcoins from computer hardware Reverse ICO: ICO performed for established company, to sell equity in the public market Smart Token: version of a token which allows for code to trigger certain events (vesting, etc.) Pathfinder Equity Systems 1

4 Who Should Care About ICOs? Venture Investors Venture investors have portfolio firms that are successful, but not big enough for a traditional IPO. For these firms, an ICO is the perfect way to get liquidity with strong valuation from tech-friendly retail investors and alpha-seeking investment funds. Entrepreneurs There are thousands of successful firms with great technology and loyal customers, but Wall Street investors often don't care. ICO investors are more tech-savvy and willing to give higher valuation, especially to firms that embrace next-wave crypto currencies. Investment Bankers With the steady drop off in IPO activity over the years, investment banks must find new sources of deals. ICOs provide these new deals, and an entirely new source of high risk tolerant investors. Hedge Funds Crypto-currencies are the fastest growing asset, but with billions of dollars being thrown around, the potential gains are already diminished. We offer a solution: a new class of ICOs, for existing, profitable companies, more high-quality, cash-rich investment choices.. Pathfinder Equity Systems 2

5 Introducing the Reverse ICO Traditional ICO New ventures Try to avoid being securities Legal questions Reverse ICO Established firms Embraces the security classification No legal questions A reverse ICO is an equity offering with crypto-token-based equity. An existing company with solid revenue and history conducts the exact equivalent of an IPO, following all regulations, audits and best practices. The reverse ICO is considered a security from the start, and is treated as such. Instead of stock certificates issued to the investor, a token or coin is offered. Further differences between IPOs and ICOs are illustrated below. IPO Public capital market Issues equity Stock Certificates Rights, dividends, voting, etc. Little or no innovation Full IPO, Reg. A, Reg. D Stock is priced and issued via banks and stock markets Only for the biggest companies Medium valuation Purchased by stock investors Moderately liquid Not for small to mid-size tech firms Reverse ICO Public capital market Issues equity Tokens Rights, dividends, voting, etc. Huge innovation. Tokens can contain logic and become part of technological infrastructure. Breakthroughs in business models. Full IPO, Reg. A, Reg. D, 506c Tokens are priced and issued on web site, directly to purchasers Good for any size company High valuation Purchased by crypto investors Highly liquid Easy for small to mid-size tech firms An Answer to the IPO Drought For a variety of reasons, companies are not going public at the rates they previously had. Billionaire investor Mark Cuban lamented the lack of IPOs, saying he didn t understand the reticence to go public. There might be some good reasons for why this is the case. IPOs are too expensive and provide poor results for mid-size companies don t have. This is a problem for the economy, so a solution is needed. Without new companies going public on a regular basis, the economy slows. IPOs can be a major driver of job growth as the money raised is invested back into the company and new employees hired and/or wages increased. This puts more money into the hands of consumers and in turn back into the economy. Pathfinder Equity Systems 3

6 Reverse ICOs could be the answer. These coins and tokens don t have a limit to how small a trade can be, inviting participation from smaller companies that are typically locked out of the process. Cryptocurrency investors hold massive amounts of un-invested tech-savvy capital. Investor Profile The cryptocurrency investor is different from the traditional investor. They re often young, computer savvy, and prefer to stay anonymous. These investors form the basis of the cryptocurrency economy. Many have accumulated their wealth by mining for new coins. Their investment strategy can be summed up by this quote from an anonymous crypto investor: Even if the ICO fails, it will gain more eyeballs for Bitcoin. More eyeballs for Bitcoin means another 5% value increase, and my core holdings will increase more than my ICO loss. I can t lose. They ll buy other cryptocurrencies, and buy into ICOs. Dropping a million on an ICO in minutes is not a big deal, and they are less worried about risk. With a higher risk tolerance than most and significant liquid funds of money, these new investors will invest more on average than a traditional investor. These cryptocurrency investors might not care as much about the SEC or Sarbanes-Oxley, but they do care about technology and ecosystems. Reverse ICOs Comply with SEC Regulations As we explained earlier, reverse ICOs are treated like securities, and follow the same regulatory and ethical practices that any traditional capital raising would. Specifically, there are four types the reverse ICO is compatible with: Full IPO Reg. A+ Reg. D 506c Significant disclosure, intended for all investment types Similar to IPO, intended for smaller companies with less disclosure requirements. $50 million limit on securities in a 12-month period No limits on amount that company can raise, little disclosure but only for accredited investors Crowdfunding efforts Traditional methods of disclosure such as prospectuses, financial audits and the like may be required as per SEC standards. Pathfinder Equity Systems 4

7 Advantages of an ICO Over an IPO While there are similarities between an ICO and an IPO, the ICO offers key advantages. The first and most important is the large pool of untapped money and investors in the cryptocurrency market, filled with less price-sensitive investors. This has a lot to do with the dramatic increases in cryptocurrency valuation, which in turn allows these investors to take risk on ICOs. This leads to higher valuations than most IPOs would offer. ICOs are inherently technical, so companies gain access to more technically sophisticated investors. The more efficient nature of the cryptocurrency markets allows for faster funding than companies may have been able to do otherwise. Using tokens as equity can be a way to crowdsource new customers and users, and create new business models. These crypto-investors actively participate in growing the product market, much as customers in the past referred friends to a network. Companies gain the perception of being forwardthinking, something that is important in the tech sector. The Best Candidates for Reverse ICOs Traditional ICOs were intended for startups, used in place of venture capital seed or Series A funding. Reverse ICOs are instead aimed at successful midsize or large companies with a stable business model and solid revenue stream. Specifically, the best qualified candidates for a reverse ICO offering are companies with at least $20 million in revenue, in business for at least five years, and with a solid customer base. There are a large number of companies especially in the tech sector that fit these criteria but can t do an IPO. We see reverse ICOs as especially useful within venture capital portfolios. The average market capitalization of a company using the traditional IPO process was roughly $16 million in the 1980s. Today, that s more than $100 million, a six-fold increase. This creates a problem for VC portfolios where as much as a half of those portfolios contain so-called middle performers that are successful but unlikely to be acquired or be able to go public because of these increased market cap requirements. Using the ICO, VCs have a new tool in the toolbox to exit these companies and create value. Top Recent ICOs $35 million Founded by former Mozilla CEO, an open-source browser that pays users to view ads, using tokens as micropayments. $257 million Amazon Web Services competitor. Uses tokens as equity and for payment of services. It was the first USbased ICO to be compliant with securities law. $150 million (expected) Successful messaging app. Its cryptocurrency will be used as a currency on the platform in the future. $232 million Tezos is supported by venture capitalist Tim Draper. Aims to build a decentralized blockchain capable of governing itself. Pathfinder Equity Systems 5

8 How ICOs Increase Company Valuation In this white paper, a substantial amount of time was spent on how ICOs increase corporate valuation. But how does this work? Based on discussions with investors, Pathfinder believes there are three categories of value boost. ICOs generate higher valuations during the sale process, gain business model advantages, and provide fuel to accelerate firms to the next wave of web technology. Here s what we see as the key drivers in increasing valuation: Higher valuation during sale Large pool of eager investors who are hot money They re primarily interested in proving that bitcoin is mainstream They re less price sensitive (much less concerned with your financial statements) They re willing to accept higher than normal valuations Token economics improve business models Accelerates you into the next wave of web technology Token align incentives between interested parties Can become part of your payment structure (pay for services, pay customers for content or actions) Creates a perception of advanced technology in your user base It s exciting for your employees, and will help you attract higher quality talent Not only is it perception, but it is reality. Cryptocurrency is creating waves of change It should be noted that these are potential valuation boosts only. These are our best guesses based on discussions with investors. No player in this market has enough experience to make any guarantees; we are showing this list so you can make your own judgements on the odds of success. Pathfinder Equity Systems 6

9 Don t Be the Next Tandem For any technology entrepreneur, the greatest concern is to miss to be caught on the wrong side of a technology wave and see your company eclipsed by the next big thing. The second biggest fear is to miss out on some crucial change in the way that technology is funded. When those two things happen together, it creates a perfect storm of change that could destroy established businesses almost overnight, while creating a whole new generation of winners. The dot-com bubble is a great example. Cryptocurrency and token economics aren t easy to understand. Even highly technical web technologists can struggle to understand what this technology means. Sure, it could all be a scam, but the same thing was said about browser-based software, the Internet (Bill Gates himself was skeptical!), and mobile apps. Blockchain, crypto, and decentralized enthusiasts are building an entirely alternative technology universe which taps into the internet s inherent power in ways that are unpredictable and powerful. ICOs and cryptocurrencies might be a bubble, but more likely they portend major changes in web technologies. The ICO Process Earlier on in this white paper, the similarities and differences between an IPO and ICO were listed. To better illustrate the process, the chart below compares the typical IPO process with two reverse ICO processes, complete with action items. Remember, with the ICO process, several of the middlemen banks and brokers are removed. These sales occur instead directly from the company website, and on your terms. The result is a quicker process. IPO KEY STEPS Reg A+ ICO KEY STEPS Reg D ICO KEY STEPS Key advisor agreements Key advisor agreements Key advisor agreements Letter of Intent from Investment Engage investment bank Engage investment bank Bank Engage registered transfer agent. Choice of stock exchange Choice of stock/token exchange Choice of token exchange Identify compliance issues Identify compliance issues Identify compliance issues Liquidity analysis Liquidity analysis Liquidity analysis Preparation Preparation Preparation Due diligence Due diligence Due diligence Prospectus Offering statement Offering Memorandum Valuation Target investor lists Target investor list Roadshow Prep (consumers, institutions) No underwriters Research Reports No underwriters Appoint co-leads, underwriters Test the waters (if desired) Pathfinder Equity Systems 7

10 SEC Filings Complete Registration Request Offer Structure Completion Finalize underwriting terms Secondary shares Lock-up periods defined Marketing Phase Draft preliminary prospectus Roadshow Pricing Allocation Book building, or Auction Process Transaction Closing / Trading Start Final Prospectus Final legal docs Final underwriting agreement Aftermarket Price stabilization Market making Analyst coverage SEC filings File offering statement Marketing Phase Market to consumers through online platforms (Krowdster) Work with investment bank on institutional orders Allocation Fill early (testing the waters) orders Fill consumer orders Downselect from IOI pool for institutions Transaction Closing / Trading Start Final legal docs Final agreement with token exchange SEC filings File form D Offer Structure Completion Lock-up periods defined Marketing Phase Work with investment bank on reaching institutions to get IOIs Allocation Downselect from IOI pool to fill with preferred bidder(s) Transaction Closing Final legal docs It is important to mention that so-called Know Your Customer practices still apply to ICOs. While cryptocurrency investors prefer anonymity, a company offering an ICO without KYC sets itself up for trouble. KYC is designed to shield from criminal activity, and ensures all money raised is done so from those who ve obtained the funds legally. At the moment, while regulations do exist for securities, there still are questions on how to handle foreign investment in an ICO. Some ICO strategies may prohibit foreign investment. There s a variety of ways to handle this: companies worried about these issues might want to consider a Reg. D ICO. Doing so could limit your funding potential, but that s not always the case. Filecoin was able to raise $257 million using a Reg. D-based ICO (we caution that might be the exception rather than a rule). Other companies have either launched their ICOs in another country or limited their sale. Tezos, a generic and self-amending crypto-ledger, launched their ICO out of Switzerland, while messaging service Kik blocked U.S. and Canadian investors to avoid compliance issues with either countries securities law. Pathfinder Systems believes the best way is to launch an ICO using the appropriate regulatory channels: this way there is no question over the ethics or legality. There is still widespread confusion as to how this is legal: following established regulations is the prudent path. Pathfinder Equity Systems 8

11 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Billions $USD White Paper: ICOs For Mid-Size Tech Firms 90 Total Bitcoin Market Capitalization Data: Blockchain.info Data from October 1, 2015 September 23, See current data here. Risks and Concerns ICO 2017 class is full of junk. But they will evolve and ICOs 2020 and later will liberate fundraising from Wall Street and Silicon Valley." -- Naval Ravikant, CEO of AngelList Reverse ICOs are brand new, and as with anything new, there are inherent risks. Valuation Risks: Pathfinder proposes well-designed ICO events that yield an optimal capitalization. Ultimately however, investor demand will determine the value for a company s tokens and the amount of capital raised during the ICO. Pathfinder addresses this risk by developing effective marketing strategies for all ICOs. Security Risks: Pathfinder assists clients in planning and executing an ICOs that minimizes security risk, both to the Company and its investors. As largely an online event, an ICO is exposed to risks in the form of data breaches, hacks, and other Pathfinder Equity Systems 9

12 intrusions. Pathfinder helps to minimize these problems by identifying reputable technology partners that provide world-class support. Risks to investors are addressed by use of escrow agents and third party, verifiable audits of all sale activity. In addition, since the ICO sale event is conducted on the blockchain, all transactions may be verified, recorded, and permanently archived. Regulatory Risks: Today, ICOs are conducted in an evolving regulatory environment, including variances by jurisdiction. Pathfinder recognizes this reality, and proposes ICO strategies that meet compliance requirements in effect today, and anticipated in the future. Pathfinder also identifies expert legal advice to assist in managing this risk. It is our opinion that the capital raising potential of reverse ICOs far outweigh any potential risks, and those that get in on the ground floor stand to gain the most. There s a vast untapped market of less risk-adverse investors in cryptocurrency, and an equally large number of successful mid-range companies that could benefit from higher valuations in the early phases. In some cases, it might be a perfectly appropriate to wait for the dust to settle. However for some waiting it out might be disadvantageous. This is especially true in technology. Companies that don t stay on top of innovation in this sector run the risk of falling behind in what may potentially be a game-changing shift. The purpose of this white paper is to provide the information that company executives and venture investors need to make their decision. About Pathfinder Equity Systems Pathfinder Equity Systems is your one stop vendor for reverse ICOs. We have the biggest list of investors and the best process for managing and launching SEC compliant cryptocurrency offerings. We've set up a stellar team of analysts and technology--including the Pathfinder Crypto Economic Graph, a database of ICO statistics, cryptocurrency investors, and economic trends, coupled with deep learning, network graph analysis, and scenario evaluation tools. Pathfinder was founded by Tom Benson, a Silicon Valley software CEO, Paul Beckman, professor of information science at SF State University, and has advisors from investment banking, capital markets, venture investing, and crypto technology. Pathfinder Equity Systems info@icopathfinder.com (650) Not Legal or Financial Advice. Pathfinder Systems is not an accounting or law firm. This white paper is for information purposes only and should not be used for legal or investment purposes. Consult qualified legal and financial advisors before making any decisions. Pathfinder Equity Systems 10