The shift from IPO to STO…a new missed opportunity for the legal profession…
Is the legal profession missing out because they do not see the potential of the tokenisation process to create a Secuity Token Offerings. Although recently we have had an influx of corporate lawyers approaching us with companies that have postponed their IPO and others with Holding Group clients that want to raise new capital to tidy the ‘cap table’ and inject new money into their children.
One or two of our clients are raising $100m+ and as we take them through the tokenisation process discover the native properties of Blockchain as a legitimate cost out and efficiency play, that directly boosts business performance and therefore exit values. And so the attention immediately moves to how to apply Blockchain to unlock operating models and how to raise more efficient capital.
It was around 2016 when I noticed more and more law firms showing interest in Blockchain and the ICO madness that followed. Some firms jumping straight in while others watched from the sidelines.
Well the ICO madness is over.
STO’s (Security Token Offerings) is an entirely different process and something more familiar to corporate lawyers who assist clients with raising capital, with M&A transactions and less so these days IPO’s (see my previous STO articles). Falling within current regulations and Securities Laws, STOs are safe ground for the legal profession without the areas of grey. They are by default the digitisation of financial instruments, although not quite the democratisation of capital, does improve on the current process.
But why do one…an STO that is…
With Banks not lending at sensible terms, Venture Capital remains costly and management teams refuse the level of dilution expected. More established companies with scaling revenues and valuations over $50m have few options other than to consider IPO which has turned out for many a costly ‘road to nowhere’.
IPO-land proves difficult
Let’s face it an Initial Public Offering is really for established businesses with some scale that can afford in both time and cost, to jump through the various expensive hoops to sell their instruments on public exchanges, and be subject to the scrutiny that goes with it. The process is beyond the reach of 99% of companies, and those smaller businesses that go public on the minor league exchanges often dilute their equity beyond what is reasonable, remain short of capital and in a zombie state.
The recent story of IPO’s is also worth noting with many businesses preparing for listing only to decide, based on market conditions to delay or cancel, leaving both cash and fees on the table, and the reward for those involved locked up.
Decimated during 2018
In Europe alone 41 deals were pulled in 2018, including Aston Martin and Funding Circle. The primary reasons given was market and political uncertainty, and of course BREXIT. Many exchanges around Europe destined to list new companies also missed out, the London Stock Exchange and the Italian exchanges in particular, as volumes of new public security globally continually falls. A consequence of prefering to stay private or because the process remains to hard, costly and takes too long.
Deal flow across the board has dropped, and we are now in a phase where there are more ETFs than there are stocks? A telling data point about the state of affairs.
The efficiency of STOs outperform other types of fund raising…
It is child play!
A company issues digital tokens that represent a financial instrument, equity, a debt instrument or hybrid which companies like ours, designs, engineers and mint. Often preceded by a convertible note round placed privately, converting to a security token or not.
The tokens are purchased by accredited and or sophisticated investors, unless the issuing company prepares a Prospectus and want to issue to a retail audience. Every transaction is recorded on the Blockchain, confirming the ownership of the tokens, a transparent record of shareholders or bonds holders.
The Issuer with our help, often where the directors hire an advisory firm or platform company, will programme the smart contract logic to exercise the rights of the token holder, to receive a dividend, interest and or allow the holder to trade the instrument on an exchange. A somewhat more complex consideration most Issuers fail to grasp, and one that advisory firms also do not understand.
The genius of the tokenisation process allows new hybrid instruments to be created that change state to influnece investor behaviours pulling them in, to keep them in the game with incentives and discounted future rounds with the reward a future IPO or liquditation event, when prevailing conditions are right. STOs if structured right offers a continual path for capital raising. Remembering these are digital manifestations of paper shares, bond documents and other loans where the terms are reflected as software code that automatically execute, delivering certainty for the holder and reducing complexity, a service workload often carried by lawyers a ting on behalf of the client.
The Issuer, if they know what they are doing, has an obligation to engineer the commercial rules into the instrument that influence the rules and behaviour of the asset on exchanges, maybe after an initial hold period, which is where the STO process can get complex.
The secondary trading aspects relating to how the new asset will be traded have to be considered at the outset. Choosing the wrong token protocol may isolate the token with no place to list, keeping in mind there are no global stabdards yet. With ERC20 the predominant choice of many, the path remains uncertain, as this protocol lacks core functions that are expected by regulators globally. Functions that enforce token holder rights and where the KYC data follows the current holder.
Why? Because ERC20 is based on Ethereum which is a ledger based protocol that doesnt offer the ability to track and trace assets, there is no password reset if keys are lost, and no assets maybe stranded. But most of all the current owner of the token, their KYC must be known, as the exchange regulatory reporting requires this.
STO Costs and requisite assets
In many ways the preparation of an STO mirrors an IPO in terms of the documents that need to be created. An Information Memorandum, Investor Pitch Deck and Term Sheets and Sales Agreements to name a few, leading to a data room for a much deeper dive.
This is where Advisory Firms often start to fall foul of Financial Promotion Rules getting involved in pushing the STO, of worse paid to rate the STOs for a fee (see other recent article).
Investors and Family Offices are looking for Diversification
STOs have come at a good time for our investor community who cotinually look for diversification as global recession approaches. They already sit on enough land and real estate assets in a market that is overpriced and where supply has peaked. Teetering on the brinked of a 40% correction.
Within our Family Office community many have already pivoted towards a technology bias from more traditional asset classes. Others are avoiding the 7 to 10 year lock in of VC and other Funds, mooting they require much more flexibility as markets move much faster driven by short term algo trading and profit taking strategies.
Tokenising holding company structures we have found can be a great way to diversify investments, as the operating companies represent a different industry and regional focus, a mix where some are recession proof, in many ways a hedge against broader volatility that hs been associated with a tokenised economy. And of course everything is subject to sufficient market liqudity which the smarter exchanges understand, linking accredited investors and institution money into their eco system.
STOs are the future as every asset will be tokenised delivering truth, transparency and the ability to execute of promises made. A $4tn market approaches as momemtum is building and new infrastructure is being rolled out.
Author. Nick Ayton is CEO and Co-Founder of Chainstarter Group that has built a Crypto Capital Markets infrastructure from Primary Issuance, two regulated Secondary Trading Exchanges, and work with more than 100 Family Offcies globally.