Can Blockchain Help Underfunded Startups Make It Past Infancy?

By Tudor Vrabie, Co-founder and CTO of SeedOn

You don’t need to be a successful entrepreneur to know how hard it is to fundraise for a startup. Though it’s entertaining to watch business owners vie for investments on ABC’s Shark Tank, dealing with competition and investor uncertainty is hardly much fun for those on the other side of the screen. Startups are statistically likely to face rejection after rejection, with VC firm Andreessen Horowitz only investing in a mere 0.7 percent of startups approaching it annually. Without the evolution of fundraising tactics, infant companies will have nothing to rely on other than fancy pitches to VCs and a cameo on ABC.

Struggling to obtain the financial lifeline

Early-stage funding is a major headache for hopeful startup founders, especially considering its potential for long-lasting effects on their business long after it is secured. Twenty percent of small businesses fail within their first year, most commonly due to a lack of capital or funding. Companies without early-stage VC backing take on additional risks, causing them to fail more frequently and four times faster than their venture-backed counterparts.

Funding is an obvious necessity for both short- and long-term success, but the current array of options aside from VC backing are also hard to secure for most startups. Startups can seek to crowd-fund their rise, but there are a few limitations here, too. Entrepreneurs face a catch-22: They need to secure funding to build a respected business from investors who want to see existing credibility in the first place. If prospective investors don’t trust a business, a founder can say goodbye to any chance of winning their backing. There is also no shortage of fraudulent crowdfunding campaigns, which further contribute to investor uncertainty and mistrust.

Initial public offerings (IPOs) can hypothetically be practical for smaller companies, but the expensive and time-consuming process only diverts founders’ attention away from the main business objectives. The associated costs and lost time can total up to an overall loss surpassing the value of the obtained capital. IPOs are also relatively limited in reach, as they are typically restricted to a select set of institutional investors, who may not be too impressed by what the startup has to offer. 

Initial coin offerings (ICOs) emerged as a new way of funding startups in the blockchain boom era, embracing the accessibility of digital assets. However, they lost momentum early on due to an abundance of scams, with a whopping eight out of ten ICOs in 2017 classified as fraudulent.

Taking a page out of blockchain’s book

Startups are struggling to draw seed investments, and the current options are clearly ineffective or simply inaccessible for the majority of early entrepreneurs.

While ICOs did not last as a viable option for startups, digital assets’ strengths can fill in where traditional funding methods fall short in the startup world. Blockchain technologies have been praised for decentralizing processes in a myriad of industries. Blockchain-based funding has already proven to be effective for films, replacing an antiquated funding system in the entertainment industry. Film producer Niels Juul recently founded production company NFT Studios, which sells NFTs to public and institutional investors. These profits then fund smaller productions that often struggle for recognition from Hollywood’s powerhouse production companies.

Decentralization of early-stage funding can expande entrepreneurs’ outreach because of blockchains’ global accessibility. This opens the door for anyone to get a stake in a project, regardless of its size or location. On the other side of it, startups can raise money quickly, with a clear record of fund exchanges on the blockchain. 

Smart contracts offer investors some peace of mind by ensuring funds are secure throughout the process. This removes the guessing game of what money is used for and removes the risk of funds being preemptively used before the project reaches its fundraising goal. This security can boost investor confidence, incentivising them to be less conservative. 

However, the ICO scam saga points at a need for a certain degree of centralization in blockchain fundraising. Smart contracts are not enough to ensure security throughout the entire crowdfunding process. Oversight is still necessary to guarantee investments are legitimate and secure. 

Know-your-customer (KYC) verification and background checks will prevent another iteration of the 2017 ICO bubble by ensuring the credibility of investors. Someone has to conduct them, though. A centralized platform or a DAO, through its expert members, would be ideal to moderate blockchain crowdfunding. Some kind of general supervision will ensure blockchain crowdfunding can offer decentralized solutions without being an unrestricted free for all. Finding this balance from the beginning is crucial to prevent bad players from making everyone skeptical of decentralized fundraising’s capabilities. 

The implementation of these security features and counterbalance of decentralization and oversight can open the door of blockchain fundraising to beginner entrepreneurs. Early-stage startups can raise funds, while also verifying investor intentions and identities. 

Businesses are evolving, and the processes integral to their conception, like funding, must grow accordingly. The blockchain has the potential to radically change the fundraising process for infant businesses, but it must walk the line between centralization and decentralization to avoid repeating its own past errors—or those of its more centralized counterparts.