Science Blockchain Incubator – The Juice isn’t worth the Squeeze

Science Blockchain Incubator (“SBI”) – The Juice isn’t worth the Squeeze

Perspective is being written from a US based accredited investor

Executive Summary

The Science Blockchain Initial Coin offerings (“ICO”) and Science Blockchain Incubator (“SBI”) are set to launch on October 2nd, 2017 with a goal of raising $100M to incubate the next generation of crypto companies.  Investors have been clamoring over the ICO market in 2017 and the Science ICO offers a unique opportunity for investors to buy into future companies vs. pure currencies (i.e. – selling the pitchforks to the goldminers).  

In this post, we dig into why the SBI opportunity, while attractive, is NOT the correct investment for someone looking to enter the crypto-world.  We will dive into how investors would get paid as well as discuss the potential and risk of the SBI in particular.  This post assumes at least a basic understanding of crypto-currencies and investing in general.  

SBI at its core is a fantastic idea, allowing investors to directly participate in funding companies that have the goal of riding the “third wave of innovation” of the internet – the Blockchain.  Investors who aren’t comfortable investing in currencies can not invest in hard assets or teams of people building products and companies.  

However in my opinion, the SBI will not be the last ICO opportunity focused on building companies and I am comfortable waiting for a different investment opportunity due to specific SBI risks.  The primary concerns, detailed later in this post, include the Science team’s lack of successful exits in crypto, the investment return dynamics of funding an incubator on top of the GP token carry percentage and the limited liquidity available vs. existing crypto options.  

But first a primer on the structure and characteristics of the SBI ICO

Key groups at the SBI Party (See Diagram)

The SBI will require numerous parties to be successful and it is important to understand the motivations and identity of each group.  The leader of this forway into blockchain is Science Inc. , a LA based Venture Capital firm (“Incubator equity”, “Science”.  The 4 person team has a solid track record of identifying and exitting Consumer and Media investments, including Dollar Shave Club and Hello Society (per CrunchBase).  Per the Offering Memo, Science has committed to buying 30% of the tokens or $30M.  That is the definition of strong alignment of interest.  

The Science Business Incubator is the vessel that receives the cash from the ICO and ultimately chooses and invests in the blockchain portfolio companies.

Science Blockchain Token Holders are the investors (including you if you choose this adventure) contributing the bulk of the ICO’s funds in exchange for tokens and will be selected from professional and accredited investors in the US and overseas.  I would expect limited information on who is ultimately investing, until the closing of the ICO (and potentially forever).  An important note – Token holders have no voting rights and virtually zero control over the actions of the Incubator (similar to traditional VC fund structure)

And finally the raison d’etre for this ICO, the Portfolio companies.  Science has sole discretion to select the companies / teams they wish to invest in and token holders are along for the ride.  While the memo lists investment guidelines, I would expect Science to take a wide approach – targeting anything that sniffs at the blockchain / cryptocurrency

 

How do I make money?

With the rampant investment community and media craze around cryptocurrency riches, the SBI stands out for taking a longer term approach by building and supporting companies that will utilize blockchain.  However, for investors that means that there are significant limitations on how you can make money from your investment.  

Investors have two primary ways to generate returns, 1) investors can sell their tokens on an exchange to another investor or 2) token holders will receive cash distributions or token distributions generated by the Incubator’s portfolio companies.  

      1. Door number one is the simplest and one of the most attractive options for investors, providing a substantial advantage vs. the typical venture capital investment.  However, the trading value of the token is derived from three main data points; – the Net Asset Value (“NAV”) of the portfolio companies / assets, the actual trading of the SBI token on exchanges and the external environment for ethereum and the cryptocurrency markets.  The NAV will be updated quarterly by Science based on various valuation methodologies (note – the art of valuing blockchain companies is very much in the early stages – expect future developments here as investors gain more experience) , however in a dynamic where profit generating companies are rare, expect the NAV to fluctuate quite a bit.  However it would be foolish to assume that the NAV of the portfolio will drive the value of the token daily trading price.  Many ICO’s are correlated to the values of their underlying cryptocurrency, in this case ethereum.  Subsequently, if the ethereum market experiences continued high volatility, expect wide swings in the prices for the SBI token – assuming transactions do occur and set daily prices.
      2. Cash distributions to token holders or Door number two, will take take longer (up to 10 years), but potentially prove substantially more lucrative to token holders.  As the incubator receives 25% of the portfolio companies equity, any major acquisition or ICO of a portfolio company will provide cash back to the investors.  This is the “must believe” aspect of the SBI  – that the companies and technologies here will prove attractive to outside buyers resulting in a large windfall to equity holders.  
        1. Note there is limited historical precedent or history with portfolio company ICO distributions to investors, adding another element of risk and dilution depending on the structure of the portfolio company ICO.  

 

The Upside – SBI Investment

With the ICO and cryptocurrency market white hot, why invest some of your beloved capital in SBI?  First rule of investing – diversification.  By buying into the ICO, you are given the opportunity to “invest” in multiple, potentially industry disrupting start-ups.  This approach requires the belief that the crypto-boom is here to stay and will ultimately generate substantial opportunities.  With a wide mandate, Science can pick and choose potential home-runs that will utilize blockchain – regardless of industry focus.  As one of the first incubators fully devoted to promoting blockchain companies, SBI will hopefully have its pick of the litter.  Assessing the quality of these companies is the Science team, which has successfully picked the winners in the challenging consumer products and media industries.  

A second investment consideration is the opportunity to invest in the blockchain category utilizing “Operating Companies” that hopefully will not undergo the volatility of the currently traded cryptocurrencies (potentially).  Investing in companies that are trying to create value (i.e. revenue, products) is a very different opportunity vs. investing in cryptocurrencies – i.e. – stores of value

Finally, (and the investment attribute I personally value) by entering the crypto investing arena through SBI, token holders will have a front row seat to potentially game changing technology and products, providing the education and network to expand their knowledge of the crypto-world.  

The Dirt – SBI Investment

A fundamental concern on the economics – giving up 30% to the GP is a hefty take for a team with an unproven model resulting in portfolio math that requires substantial out-performance to generate market beating returns. A typical VC fund looks at 2%/20% Carry with newer funds typically taking a discount.  A second economic concern is the Incubator Evergreen Fund that requires a minimum of $20M or 20% of the funds generated.  While the language isn’t clear, that money is assumed to stay invested within the Incubator and not available to token holders.  The combination of the 30% carry plus funding the Evergreen fund produces a substantial hurdle for the portfolio returns to overcome.

As with any VC investment, the results are unpredictable and the chances of success are slim, however there are several risks unique to ICO’s and specifically the SBI ICO.  First off, the limited monetization options and liquidity should force potential investors to take a long-look at their strategy and goals for this investment.  Tokens are locked up for a year with significant restrictions on their ability to be sold over exchanges after the one-year lockup.  Prices for any transaction will be influenced by some ratio of NAV, cryptocurrency values and overall cryptocurrency risk, resulting in an investment that may not be tied to the performance of the underlying portfolio companies in either the short- or long-term.

Outside of the general ICO risks, the SBI ICO in particular has some unique concerns.  While the Science team has shown strong results in building successful businesses in consumer, crypto-success may be tied to a team that has stronger background in cryptography or algo-heavy companies.  

Finally a SBI specific risk, will be Selection bias, where the top level crypto-companies choose to raise funds through more established VC channels, leaving second tier firms to reach out to the incubator.  However, depending on the success of the first few companies, SBI has the opportunity to become a “Y-Combinator” of Crypto companies.  

Leave a Reply