For most companies, the cost of compliance and participation in public markets is too high and quarterly earning calls and loss of privacy too much of an irritant. By contrast, private markets have grown in sophistication, depth and international reach. As a result, the number of public companies in the US has halved in the last two decades and the trend continues with more private companies electing to stay private and more public companies electing to become private.
Private markets have their shortcomings though, including lack of secondary market trading and concentrated ownership. Imagine you are an investor with a share in a Private Equity or private Real Estate fund and you want to sell. Good luck! It can take months or years to find a buyer. When you do finally find one, it can still take a couple of weeks of legal back and forth. This could cost $20–40k in legal fees as well as a haircut on the valuation you are able to obtain, on average 40–60%. A triple whammy of time inefficiency, high fees and valuation loss. One of the major use cases coming out of the blockchain hype of the last years addresses exactly this.
Security tokenization is the issuance of a real-world asset on blockchain. In theory, anything can be tokenized but the main use cases today are private real estate funds (REITs), private debt and private equity or VC funds. These asset classes are both regulated, which reduces risk and increases participation and is understood in terms of valuation methodology, which sets them apart from ICO tokens.
Tokenization can reduce time to find a buyer to days or weeks, not months. Instead of paying $40k there is an exchange fee of perhaps a few hundred dollars payable by the buyers. The seller will still have to sell at a discount, but perhaps only 15–20% instead of 40–60%. Once sufficient infrastructure has been built it means 24/7/365 liquidity with no counterparty or settlement risk. In other words, an investor doesn’t have to marry his investment and is free to date instead.
From an issuer’s perspective, it is attractive because the offering can be fractionalized and distributed more widely. Imagine you own a $250m hotel building and you want to raise $100m. In the past, you could either sell the entire building, mortgage it or bring in a minority investor. But what if you want to continue owning your hotel and you don’t want more debt on your books. Where are you going to find an investor with that amount of cash available? Even if you do, the minority shareholder will likely heavily interfere in your managing of the property. By tokenizing the property into a private company or REIT you could bring in hundreds of passive shareholders and sell the same stake at a premium.
The additional shareholders will not increase admin cost as the ownership (cap table) and all transfers are transparently registered on blockchain. No need for a transfer agent recording transactions, cancelling and issuing certificates, processing investor mailings and dealing with lost or stolen certificates. At the same time, the investors’ rights are better secured on blockchain than sitting on an excel at a law firm.
Tokenization is attractive from a marketing perspective as well. Due to the online focus, it can attract broader Investor interest and response, and Investors and supporters can become brand ambassadors. Furthermore, it allows issuers to creatively bundle in all kinds of special benefits or access. The hotel owner could build in rights to use the sports facilities, priority invites to special days etc. A football club could tokenize their shares and build in “meet the players” days, early access to the best season tickets, limited edition signed shirts etc. For clubs, it is not hard to imagine the valuation premium to increase to 50–100% with the right mix of perks bundled in.
The costs of undertaking digitized security offering — more commonly referred to as Securitized Token Offering or STO — are already lower than traditional ways. Not necessarily on day one, but over a five year period, one can conservatively estimate a 40% reduction. Because of wider syndication, an issuance valuation can increase by 5–15% and even more through creative bundling in of additional benefits. A wider investment base generates more liquidity and many startups and traditional firms are currently building the infrastructure for efficient compliance, price discovery, custody and secondary market trading.
The line between public and private securities will begin to blur as technology allows for more efficient and less costly disclosure. The interlinking of centralized venues (traditional exchanges, alternative trading systems and crypto exchanges) will create global liquidity for public and private securities. Issuers now have a new cutting-edge way to structure their capital in a way that is more likely to contribute to their survival and success and investors will have a choice of buying into companies or funds that are transparent to them and whose brand value they can contribute to.
Manuel Rensink is a director at Securrency MENA an Abu Dhabi based subsidiary of Securrency Inc. He works closely with regulators, issuers, and investors on regulatory compliant security tokenization. Previously, he was a director at alternative exchange Lykke, index firm MSCI in Dubai and JPMorgan spin-off RiskMetrics Group in London.