Despite the bearish crypto markets in 2022, web3 brands have managed to raise over $30.3 billion in only the first half of the year. Experienced investors are looking to pour more funds into promising startups in the coming year, with reasons for this action captured in quotes suggesting "the bear market is the best time to build and invest."
But why is funding important for web3 projects?
Fundraising plays a critical role when companies are looking to scale operations. For startups, funding provides the rocket fuel to fast-track operations and move on with their roadmaps. However, the process is often challenging, considering investors have to invest time and resources without any guarantee of receiving adequate funding in return.
Many innovative projects with groundbreaking features have faded into obscurity after several failed funding attempts. As a result, founders often approach funding with the fear of failure.
However, the structure of web3 introduces new funding techniques that startups can leverage to scale quickly. While these new funding methods are highly beneficial, start-ups may eventually have to integrate them with some traditional funding processes to get better results.
Most web3 funding methods introduce a new funding scheme where startups don't necessarily need to have built a product before they can receive large-size funding. A project with a whitepaper and a small budding community can attract millions via a tokenised crowdfunding campaign. Investors are, in the real sense placing a bet on the community or track record of the founder/team.
Additionally, web3 funding processes may not necessarily require startups to go through legal systems of registering with regulators or other government institutions.
While these methods are more open, investors are often sceptical because of the several scams that abound in an unregulated environment. Hence, some investors would only want to invest in projects with smart contracts that have undergone several audits from reputable developers or auditory firms. Others prefer investing in projects that have regulatory compliance and legal backing.
Traditional methods, on the other hand, stress the need for startups to follow the fundamentals by building viable products that address some market problems, bring at least a small revenue stream and a go-to-market strategy that will see the startup scale. While these may appear as high barriers for startups, they often help to filter projects that won't stand the test of time or founders that aren't ready to work hard for their startups' growth.
In the following section, we outlined some of the best funding practices in web3 - traditional and decentralised - and how projects are utilising them.
Grants are helpful to founders at the beginning stage of building since they don't need to refund the money or give up a stake in their startups. To a large extent, they have served as the base ignitor for several web3 projects that have gone on to make waves in the market. While grants may appear like charities in a basic sense, blockchain networks use them to empower startups in a bid to grow their ecosystem and boost on-chain activities. And these types of grants often require startups to build on the said blockchain network or tilt their project to address some specific use case.
Gitcoin is a more popular grant provider for web3 projects and has a low barrier of entry compared to some other grant methods. Rather than a central entity providing your project with a grant, Gitcoin employs a decentralised process that allows several users to provide early-stage projects with funding.
Additionally, traditional organisations that want to test the web3 waters offer grants to innovative projects. However, such grants often come with certain obligations that a start-up must fulfil. For example, grants of this type may require a founder or team to build with ESG compliance, contribute a portion of the cost of building a prototype or attend to specific use cases.
For founders that have already scaled to some extent, grants may not provide the needed funding. As a result, it's more beneficial to consider exploring this route if you're looking to get your project idea off the ground.
You can find a host of blockchain grants here.
Many founders find it difficult to attract funding for their projects because they lack the experience to create pitches or business plans that can convince investors. And since web3 is relatively new, founders who employ traditional tactics may not get the desired results from their efforts. As a result, new founders in web3 need to leverage accelerator and incubator programs that provide training, resources and guidance specific to the space.
Although incubators don't necessarily provide funding, the experience they impart prepares founders for future stages of raising funds for their projects, coupled with marketing and leadership skills. Founders that effectively leverage accelerators can navigate the fundraising roadblocks most start-ups face along the way and scale their projects. Some popular web3 accelerators and incubator programs include SIGNVM, Alliance DAO, R3 venture development, Klaytn incubation program, dlab INCUBATE, Outlier Ventures' Base Camp, Startup with Chainlink, Tachyon and Orange DAO.
Seed funding is quite similar across web2 and web3 as investors - venture capitalists, institutions, angel investors, crowd funders, etc. - provide you with money in exchange for equity in your start-up. Most startups use this money to rent office space, purchase hardware and hire human resources. In web3, equity is the native token behind the project and the unique utilities and experiences attached to it. Investors can cash out their initial investments anytime the token's value rises to a point where they can comfortably take profit.
While the barriers to raising seed are low in web3, startups need to meet some basic requirements if they want to see any success. This includes having a well-structured whitepaper, clear tokenomics, realistic roadmap, vibrant community, reliable code base, go-to-market strategy, etc. In the following web3 seed funding methods, we explored how these different requirements play out in the process:
ICO - Initial Coin Offering is a method of publicly funding crypto start-ups through a crowdfunding-like process. Early-stage projects mint new tokens and sell them to investors in exchange for other popular cryptocurrencies like Ether (ETH) or bitcoin (BTC). And the structure of web3 smart contracts creates an automated and transparent on-chain process that automatically calculates total sales and distributes tokens to investors.
Considering startups may not necessarily need the permission of regulatory bodies before conducting ICOs, it serves as a quick way to raise funds without the bottlenecks in traditional IPOs. Projects that employ good marketing and PR approaches combined with a detailed whitepaper can stretch the boundaries of their ICOs to raise funds that can sustain their growth in the long term.
However, the unregulated nature of ICOs has seen their usage diminish over time as they have attracted harsh criticism from regulatory bodies. For example, several half-baked and fraudulent projects have conducted token sales that resulted in huge losses for investors, with notable events happening in the 2017 ICO boom. It's essential to consider the legal status of ICOs in a country before conducting token sales, as many countries have outrightly banned them within their borders.
Additionally, your project may need to employ standards that prevent sell-offs which usually accompany tokens listed on exchanges. These massive sell-offs can deter growth and dwarf the results of all investments to grow your project.
Venture Capitalists - Generally, venture capitalists buy a stake in your startup and help nurture it for some time with the aim of profiting when the project goes public or is sold to a corporation. Since success in most web3 brands is majorly tied to their tokenomics, VCs receive a portion of their tokens as equity.
NB: A general rule of thumb in token seed funding with VCs is to choose investors with the prerequisite experience to guide your startup through bullish and bearish markets. The role of token governance makes your decision even more critical, as you don't want inexperienced investors deciding the future trajectory of your project.
However, it's important to ensure no single entity holds a large portion of tokens that can give them outsized control over your project. This can discourage the larger community whose belief in your project can spur growth.
Some popular VCs funding web3 include a16z crypto, Pantera Capital, Coinbase Ventures, Alchemy ventures, Paradigm, Polychain Capital, Defiance Capital, DragonFly, etc.
DAO Funding - DAO funding allows web3 founders to avoid the gatekeeping and demands of VCs by relying on decentralised funding. A group of investors with diverse experience can congregate online and pool funds to invest in your project. This enables your project to run with the community ethos of web3, as the equity you release in exchange wouldn't lie in the hands of a single individual.
While DAO funding fits the web3 vision, most of them may not provide you with the requisite experience you will get from professional VCs. Hence, you should conduct critical research about any DAO that shows interest in your startup. Ask questions like:
How many successful projects have the DAO funded?
Does it offer the right level of support to projects? How does its governance model work? etc.
Some popular investment DAOs include OrangeDAO, MetaCartel, SyndicateDAO, and PlsrDAO.
IDOs - Many founders consider IDOs as an advanced and efficient alternative to ICOs, considering a large percentage of the process happens on-chain. Funding through IDOs is a more straightforward process, as founders can quickly list their tokens on DEXs without seeking approval from anyone. Investors can, in turn, easily purchase these tokens and receive them in their wallets. The whole process, from sale to distribution, is automated via smart contracts.
Unlike ICOs, the government can do little to place limits on token sales and distribution. While founders can leverage IDOs to raise funds easily, the money raised from the process is often small compared to other forms of seed funding.
Additionally, raising funds via IDOs automatically signifies actively trading your tokens. This can lead to a rapid growth or crash of the token's value in the market. Such speculation can prove detrimental to your project, considering it's only a young start-up yet to gain a foothold in the market. Funding via IDOs is best for projects that believe in their community's strength to raise funds needed to build and scale to a top level.
Most web3 brands follow the different fundraising methods we explored above. Considering the challenges and opportunities in the process, you can choose the ones that align most with your project's goals. And although the nature of web3 somewhat changes how funding works in startups through newer funding models, experienced investors will always require the basic requirements that precede all funding - strategic go-to-market approach, robust product, realistic roadmap and trustworthy founder/leadership.
Giving all said, the fundraising process isn't an easy code for founders to crack only with their product teams. Hence, it's essential to seek guidance from experienced players that help web3 startups with fundraising resources and advice.
At SIGNVM, we have gone the extra mile to pull together strategic connections of experienced VCs, investors and resources that can help you land the funding and experience to take your web3 startup to the next level. Contact us here.