What token launches need to learn from IPOs
Token launches have a lot to learn from the IPO process. Companies have been listing their ‘tokens’ (i.e shares) on public exchanges since the Dutch East India trading company created the first secondary stock market in 1611. Ever since investment bankers have been fine tuning their IPO skills.
What is an IPO & why do we care
An initial public offering (IPO) refers to the process of offering shares of a private corporation
So why hire an investment bank like Goldman Sachs for the IPO process? Because it’s complicated. An IPO process has many steps, all to ensure that when a company sells shares to the public everybody wins: the company raises capital, early investors get to cash out on illiquid shares, institutional investors get to buy shares at a reasonable price with future upside potential and retail investors get to purchase shares in the public market. Not everyone gets an equal part of the win (Bill Gurley is a well known VC investor who speaks out against the traditional IPO model), but the idea is to optimize the process as much as possible.
The challenge is taking an illiquid asset, private company shares, and selling them to the investing public, whom all have different valuation methods. Matching supply and demand for shares with a fluctuating price is the challenge.
It’s this challenge that causes private companies to hire investment bankers to assist them in their process. To help:
- Communicate their story to a new class of investors
- Gauge market interest
- Price shares
Pricing tokens has many of the same challenges, so what can we learn from how investment banks run an IPO process that’s applicable to token launches?
The best IPOs do this…
A good IPO process covers these bases.
- Investor relations & communication: Dealing with the current investor base and their expectations to reach liquidity. Finding a new investor base who are willing to purchase shares upon the initial offering from the underwriter. Crucially, it’s help tailoring the communications to the different investor groups. This includes writing the S-1, helping company management prepare investor presentations and arrange a roadshow where the company meets investors.The best IPO processes tailor their pitch to their new investor base. They set expectations with their incoming investors to make sure there is an alignment of interest. They do this by over communicating and a lot of regulated disclosures.
- Gauging market interest and setting share price: Investment bankers serve as the middle men for many similar transactions. This gives them the rolodex of investors to call, to check in with and see if they’re interested in participating in the IPO. More importantly it lets them gauge interest for how many shares investors want to buy and matching their desire to different price models. Investment bankers (not the same ones who run the IPO process) also develop the financial models for valuing a company once it’s gone public. Together these factors go into a model for how many investors are interested in buying shares in a company on its IPO.The best IPOs are ones that are oversubscribed by a factor of 5, 10 or even higher. That means that for every share that’s being sold there are 5 or more buyers interested in buying it.
- Manage the liquidity of shares on the day of offering and thereafter until the lockup of shares expires: The day of the IPO is messy. Shares trade in a volatile fashion as the market struggles to find equilibrium between price, supply and demand. Managing the initial offering of shares to the public through the stock exchange and coming up, in advance, with the mechanism for evaluating future demand for the stock and managing the supply in light of the evaluation is also the job of good investment bankers.The best IPOs manage to create a pop in the stock price on the first day that’s beneficial to both new and existing investors. If the price soars too much on the first day, early investors can feel taken advantage of, as the newer investors enjoy a large one day gain. Essentially the miss pricing of the stock by the investment bankers. They also manage liquidity, supply and demand so that the stocks price doesn’t drop below the IPO price for the first 60–90 days. Usually until the company reports its first quarterly financial results as a public company, at which point management takes center stage in managing the public narrative.
To recap, a successful IPO does five things:
- Create more demand for shares than supply.
- Achieve a premium share price that leaves everybody happy.
- Create good stock price performance on the day of IPO and first 90 days following. Including setting up management for under promising and over delivering (UPOD)
- Build an investor base that’s aligned with the company profile, size, vision and management.
- Causes a positive brand image.
The way to do this is by running a proper IPO process that includes expertise, connections and standards.
What token launches need to learn from IPOs
Based on these five things that IPOs do well, here’s what token launches and the web3 industry as a whole need to learn how to do better for their launches.
Set a standard for when a token gets launched publicly
Yes, this sounds a lot like regulation, but it should be a self imposed industry one. The NYSE imposes requirements on companies that want to list. So does the NASDAQ. Setting standards help create a more level playing field and avoid the worst scams and flops.
Standards for a token launch don’t have to be as stringent as for a company going public, but we need to coalesce around one. For example IPOs are for relatively mature companies whereas one of the use cases around tokens is to help bootstrap a community launch. A standard needs to fits the differences between web3 projects, DAOs and tokens and startups. Which are many.
Clear, in depth, communication with investors
IPOs have clear standards for documentation. The S-1 is a massive document that covers a company thoroughly and reviews financials, risks, disclosures and equity and compensation structure. Management teams of pre-IPO companies do roadshows where they meet and engage with hundreds of investors who get to ask them questions and investigate their company.While web3 have a good start with a whitepaper and Github culture, there isn’t any standard around what’s disclosed, too who and how much in depth.
Good communication with the public is about over communicating. It’s about not obfuscating the facts and putting the important details of a project out there for all to see in a clear and succinct manner. Token launches need to disclose a lot more than they currently do and work on making it clear and accessible to the investors they’re approaching. A Medium post just isn’t enough.
Find the right investor base
Who you communicate to is just as important as what you’re communicating. Finding the right investor base is critical for long term projects and tokens. An important part of an investment bankers job during an IPO roadshow is to find and match investors who have a similar mindset and ethos as the company. A high growth SaaS company trading at high revenue multiples makes sense for a growth, tech or momentum investor. Not to a value investor. To avoid flipping the stock on the IPO day (which is a lose - lose proposition for most of the stakeholders) you want to find the right investors.
Some web3 projects have started doing this when they do an airdrop (Optimism, for example, tried to use on chain and community data to drop tokens to active participants they assumed would have aligned interest with them). Most though don’t pay enough attention to who their token holders are going to be, what their incentives are, how long they’ve held onto other tokens and whether they’re fair weather investors or not. The story of the Flow blockchain and their investors A16Z is a good example of having strong backers.
Smart token launches will work hard on finding the right investors with aligned long term mindsets.
UPOD: Under promise, over deliver
Establishing trust between management and token holders is important. The best projects should under promise and under hype what they’re building instead of the latter. I know, I know — crazy. But still, you can set a vision that’s audacious and cool without over hyping the journey, the time it will take to get there and the road blocks along the way.
UPOD is part of communicating with the market and investors properly — it’s about setting expectations and managing those expectations along the way.
Managing token liquidity is the trickiest part since most token launches are early in a projects life cycle. There’s no mature business model which helps to forecast supply and demand. Crypto bull and bear markets wreak havoc on tokens: there’s never enough supply in a bull market and too much in a bear. Liquidity is mismanaged in most token launches for several reasons:
- The web3 industry still has not recognized that tokens and startup equity are vastly different. They need to have different liquidity unlock profiles from the get go.
2. Web3 projects mismanage their vesting schedules, lockups and how much circulating supply of their token is available on the market. More careful attention needs to be paid to how many tokens are unlocked and when.
3. Tokens launch without enough demand. Token utility is usually not high enough to justify the market cap and there’s no long term aligned token holders. Without the communication and road show, it’s tough to find these people.
Together these factors make it hard to manage the liquidity of a token launch — from its launch day through its first 18 months as a publicly available token. This causes volatility and too many bag holders and supply overhangs.
Learning from the IPO process
Company’s have been selling their shares to the public for hundreds of years. There’re many ‘lessons learned’ from these centuries in today’s IPO process. Things that web3 should learn as well:
- Set standards for when a token can launch publicly.
- Communicate clearly and honestly with investors. Over communicate. Aim for the level of a S-1. Do a roadshow.
- Find the right investor base for your project.
- UPOD: Under promise. Over deliver.
- Manage liquidity maniacally. Don’t unlock supply prematurely. Don’t launch without demand for your token.
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Designing Tokenomics by Yosh Zlotogorski