How to Raise Capital using Crypto

The year 1602 — 30 years prior to the construction of the Taj Mahal, 60 years prior to Blaise Pascal’s invention of a horse-drawn public bus which has a regular route, schedule, and fare system, 80 years before Louie XIV, the Sun King moves his residency to Chateau de Versailles and 90 years before the Salem witch trials in Massachusetts — Amsterdam Stock Exchange is founded, the first Stock Exchange in the world.

That happened 419 years ago, almost half a millennium has passed since!

Fast forward to today. There is a new cool kid in town. And he’s called Tokenization. Before explaining what Tokenization means, let us take a quick detour and explore the traditional means for raising of capital.

If you’re not interested in traditional raise of capital , you can just skip this section.

Raise of capital in traditional practices

The different methods by which publicly-traded companies raise money to fund expansion include the use of bank debt or the sale of new shares. The three main ways in which companies can raise capital on the financial markets are share placings, open offers or rights issues.

What are the advantages of traditional raise of capital?

The listing on a major exchange (i.e. NYSE, Nasdaq) has considerable benefits, most important being intrinsic marketing potential and trustworthiness:

  • A value for securities can be established;
  • Increased access to capital-raising opportunities (both public and private financings) and expansion of investor base;
  • Liquidity for investors is enhanced since securities can be traded through a public market;
  • Publicly traded securities are attractive for certain other purposes (as transaction currency or executive and employee compensation, for example);
  • Credibility and visibility with the public is enhanced, as is the corporate image;
  • Lower cost of capital relative to debt financing.

Now, all of this sound great. The problem is, most of us can’t list a company on a major traditional stock exchange. The quote ”You have to spend money to make money” comes to mind. It’s an old saying — historians say the phrase could date back as far as 1500 BC when ancient Egyptians used hieroglyphics on their tombs which translated into “I have not been made without work” — but nonetheless true.

Although there are many benefits, the costs of going public are considerable. The requirements are even greater. Let’s take Nasdaq for example:

Nasdaq listing costs

  • $25,000 application fee;
  • between $150,000 and $295,000 in entry fees;
  • Upfront costs of an IPO can be significant. Underwriters’ commissions are typically 4%–7% of the proceeds of an IPO; their expenses are additional. A company will also incur other offering expenses, including legal, accounting, printing and filing fees, and will be subject to ongoing costs associated with public company compliance obligations.

Minimum requirements

  • >$4.00*1,250,000 (shares) + owner’s equity market cap;
  • minimum of 450 round lot shareholders (100 shares or more) or 2,200 total shareholders or 550 total shareholders with 1.1 million average trading volume over the past 12 months;
  • minimum of 3 market makers;
  • $25,000 application fee;
  • meet all the criteria of at least one standard as defined by Nasdaq:

Standard №1: Earnings

The company must have aggregate pre-tax earnings in the prior three years of at least $11 million, in the previous two years at least $2.2 million, and no single year in the prior three years can have a net loss.

Standard №2: Capitalization With Cash Flow

The company must have a minimum aggregate cash flow of at least $27.5 million for the past three fiscal years, with no negative cash flow in any of those three years. Also, its average market capitalization over the prior 12 months must be at least $550 million, and revenues in the previous fiscal year must be $110 million, minimum.

Standard №3: Capitalization With Revenue

Companies can be removed from the cash flow requirement of the second standard if its average market capitalization over the past 12 months is at least $850 million and revenues over the prior fiscal year are at least $90 million.

Standard №4: Assets With Equity

Companies can eliminate the cash flow and revenue requirements, and decrease their marketing capitalization requirements to $160 million if their total assets total at least $80 million and their stockholders’ equity is at least $55 million.

What Is Tokenized Equity?

Tokenized equity refers to the creation and issuance of digital tokens or “coins” that represent equity shares in a corporation or organization.

A share represents ownership in a company and the associated social (voting) and patrimonial (dividend) rights. These rights are typically represented by a physical certificate or by an entry in a centralized record.

With tokenization, the blockchain becomes the record. Shares are incorporated in ERC-20 tokens, which provide direct share ownership to their holders in the sense of local law.

If you are unfamiliar with crypto tokens (digital tokens) or feel the immediate urge to create one but have no technical skills feel free to check out our tutorial — How to Create Crypto Tokens Without Coding. We promise it’s very easy to follow.

What are the advantages of stock tokenization?

Shareholders of non-listed companies are typically locked in their investment. Through equity tokenization, they can transfer their digital shares at any time and resell their investment without having to wait for the company’s exit (next round, Mergers and Acquisitions), which can take years.

  • There is no need for a public listing of a company in order to sell shares;
  • This method opens up the opportunity to raise money from multiple investor types at once, globally;
  • It is geographically irrelevant;
  • It is not an exclusive form of capital raising; the company can also issue traditional stock options, providing diversification;
  • By using a web application, the investors are directly connected to the corporate actions, contingent on the smart contract (voting, dividend transactions, updates);
  • Compliance can be enforced by code. Transfer restrictions, geographical boundaries, lock-up period etc. — all legal requirements can be programmed into the token. That’s important, as it will make the offering and the post-offering administration easier and cheaper;
  • Tokens allow fractional ownership, which means that the security/asset can be fractionalized into smaller units. This makes investing more affordable for investors with a limited budget;
  • Overwhelmingly lower cost and requirements.

What are the disadvantages of stock tokenization?

Where there is an up there must also be a down. This are the cons of stock tokenization.

  • Investors aren’t actually buying ownership in the underlying company. When they purchase a tokenized stock, they aren’t buying ownership in that company. Instead, They are buying a derivative that tracks the performance of a particular stock. They don’t have any of the rights of being a shareholder, such as voting rights, unless stated otherwise through the smart contract;
  • The regulation is unclear. It’s still not entirely clear how tokenized stocks and the exchanges that sell them are regulated. In fact, there seems to be some disagreement between the exchanges and the regulating agencies themselves;
  • There may be a lack of understanding. Investors who are new to tokenized stocks may not entirely understand what they’re getting themselves into. This could lead to individuals losing money;
  • Tokenized stocks may have more risk. A tokenized stock is designed to track the performance of an underlying security. But they are a relatively new concept with little track record or regulation. As a result, there’s no guarantee they will track well.

What are the costs associated with the tokenization process of a company?

Like the Nasdaq one, this is just a random example of a tokenization service for price comparison. In this case, the company offering the services is based in Switzerland and only deals with local companies.

CHF 11,990 (~$13,100 or ~11.000 EUR as of the date of this article) for the creation of a new tokenized Swiss company including:

  • SA/AG/Ltd legal form
  • Articles of association prepared for shares tokenization
  • Board of directors’ resolution for articles of association approval
  • Issuance of share-tokens
  • Preparation of incorporation documents
  • Notarial fees
  • Registry of commerce’s registration fees

Conclusion

Although tokenization offers a much more cost effective and easy to execute and operate solution, there are multiple negative aspects which may deter institutional investors from investing. A modern and appealing strategy would be to offer both methods in parallel, thus having access to global investing. Unfortunately, this is the most expensive option, with the greatest level of complexity pushing up the operational expenses. Everything considered, tokenized equity is a great way for smaller companies to raise capital from retail investors, regardless of their net worth and geographical boundaries.

Here are some resources we used for writing this article for further study:

https://www.investopedia.com/terms/t/tokenized-equity.asp

https://www.mtpelerin.com/equity-tokenization

https://www.torys.com/pages/trends/the-benefits-and-costs-of-going-public

https://www.investopedia.com/ask/answers/nasdaq-listing-requirements/

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