Money makes the world go round, as the old adage says. Whether pre-revenue or listed, all companies require cash to operate. However, the way this cash is sourced generally changes over a company’s life cycle. Where later stage companies can self-sustain from revenue, early-stage, high-growth companies do not usually have these revenue streams in place and therefore need to source external financing to function and grow.
In the first quarter of 2023, global funding for businesses was around $76 billion; it is an integral cog in the corporate machine. The funding path for early-stage, high-growth companies is well trodden, and the same players are almost always involved. However, the emergence of blockchain technology has created a new corporate funding vehicle in the form of decentralised autonomous organisations (DAOs), that have the potential to really shake up the status quo.
DAOs are a relatively new structure on the blockchain, but their number and popularity have exploded in recent years. From 2019 to 2020 the number of DAOs grew by 660% and the total number of DAO governance token holders in April 2023 was 6.9 million.
This article will discuss funding DAOs and how they are impacting the landscape of early-stage, high-growth investment. For a more detailed overview of DAOs, please see here.
To grasp the impact of DAOs on the current funding landscape, it is important to understand how it is traditionally done. Typically, early-stage, high-growth businesses will have the following funding stages:
Every company’s funding journey will be different, but in general each will have a funding cycle that follows the stages above. Stages 1 and 2 are generally for smaller, pre-revenue companies and stages 3 and 4 are for more established, revenue generating businesses.
Venture capital is a form of private equity focused on supporting early-stage, high-growth businesses with substantial or accelerated growth potential. VCs raise capital from limited partners, which can be a mixture of private wealth, financial institutions, and investment banks. This capital is then invested at the VCs’ discretion under a general industry focus or published theses.
VCs are an important part of the funding ecosystem and can invest at all growth stages, but they tend to get involved a bit later in the cycle (ie stage 3) and the investments are usually larger in nature than those in stages 1 and 2 from angel or private investors. Many VCs will also provide additional value to help accelerate the investee company’s growth through mentoring/networking services and having a presence on the board.
However, venture money is not designed to be long-term. The goal for VCs is to grow the business in an accelerated timeframe (ie five years), so that it can either IPO/ICO, or be sold to a PE house for a profit, which is not always in the best interests of the investee company.
Funding cycles are relatively formulaic and there is seldom much variation. New modes of financing occasionally break into the market (such as equity crowdfunding), but they are yet to significantly disrupt the status quo.
Could DAOs finally be the vehicle to change that? Here are some of the ways in which DAOs have been and are currently being used for funding:
All of the DAOs listed above are funding vehicles in their own way, each with their own purpose and governance structures. However, the vehicle relevant to this article is a sub-category of investment DAOs, which are known as venture DAOs. This type of DAO operates by members pooling capital together, typically to invest in early-stage Web 3.0 start-ups, protocols and off-chain investments.
Venture DAOs function very much in the same way as other DAOs (ie running on smart contracts). Its members (ie token-holders) pool capital, and the smart contracts will then invest the monies in ventures on either a pre-determined basis, or by a consensus. The returns on investment are then automatically distributed under pre-established governance terms in the smart contracts.
Venture DAOs are typically set up using a token-based system, with voting rights on a one-token one-vote basis. This can vary depending on how each DAO is set up. Alternatively, venture DAOs can be set up so that governance decisions are made by user reputation, based on on-chain data, which shows their versatility to suit both the needs of the investor and the investee.
Some real-world examples of venture DAOs are MetaCartel, SeedClub and DAO VC. MetaCartel was the first venture DAO and was founded in 2018. Its community consists of crypto-native founders, builders, engineers and investors, which provide capital, open-source tooling and apps to help support the growth of the DAO ecosystem.
The main difference between venture DAOs and VCs are its modes of governance. A VC’s direction and sector focus are determined by its leadership or management group. Venture DAOs, however, offer a more democratic approach, with decisions generally made on a majority consensus.
Unlike traditional VCs, venture DAOs provide greater access for investors, allowing members to find potential investments and even contribute to the due diligence process. There is also shared upside, whereby all members can benefit from the success of investments, not just a small number of partners.
Also, it has been argued that VCs focus on distributing their capital in a narrow range of sectors, resulting in an entrenchment of views and less innovation across the market. This is potentially the most important use case of DAOs, as they can liberalise early-stage, high-growth funding and arguably provide a plethora of new ventures access to vital funding.
DAOs should not be seen as a revolutionary competitor to VCs in terms of the equity investment market, and there is a limit to the level of disruption that they can cause. Venture DAOs should instead be seen as a participant in a different market, rather than a disruptive new player in early-stage, high-growth funding.
However, with the growth in Web 3.0 initiatives and projects in the metaverse, the number and variety of applications of DAOs will continue to rise. Any VCs that want to operate in the Web 3.0 space will be forced to adapt and branch out into these fields, or they will quickly get left behind.
There are also some concerns about how venture DAOs are to be regulated by the FCA, including anti-money laundering measures and whether they conduct regulated activities, but this is outside the scope of this article.
In summary, venture DAOs provide a new and exciting mode of funding in the market, but their impact will be very much limited to the sphere in which they operate, and they are unlikely to significantly shake up the current early-stage, high-growth funding landscape.