Security Token Offerings (STO) VS Initial Public Offerings (IPO)
During our sales meetings, we sometimes spend the first ten minutes explaining to our clients the differences between the ICOs and STOs. While it’s easy to differentiate ICOs from STOs, the main question that constantly comes up instead is how the STO differs from the IPO?
If security token offerings are regulated public offerings, then what’s the difference and is there any good reasons for doing an STO instead of an IPO? IPO as a financing model has been around for a long time — the first IPO was conducted 400 years ago, in 1602! Today, many industry insiders believe that STOs will disrupt the IPO markets. As always with such statements, it’s wise to research and make your own conclusion. Though we believe this will happen, we do not think it will happen as quickly as some people expect. As STOs and security tokens are regulated, providing any necessary infrastructure and services which are required for the market to function properly, are generally licensed activities. Licensing and compliance take time and capital. Hence, the barrier of entry is bigger, which makes everything slower, yet provides the much-needed certainty and quality, which has been clearly lacking in the ICO markets.
What advantages IPOs have?
As IPOs have been around for a long time, it means it’s the go-to option for established companies to raise capital. By established companies, we refer to companies that have a working product and viable economic results or at least supporting growth metrics (by growth we refer to IPOs that are generally done by unicorn startups which require capital to fuel their immense growth). Unicorn startups do not need new financing model, as they have plenty of interest from the VCs and the public. Yet, these are the companies and use cases that STO market needs in order to attract investors and capital. The incumbents of the financial markets, the institutional capital, won’t invest into STOs if the quality of the companies isn’t there. So, IPO has a certainty as a fundraising method (not saying that IPOs don’t fail) which is proven itself through times. Certainty is a big factor, especially if big money is on the line. Imagine a CFO pushing for an STO and failing. It’s likely that this person will lose the job. Now, imagine a CFO going for the traditional IPO route and failing. Most likely, the person won’t get fired (at least not for this decision), as he or she just did what everyone expected. People are risk-averse, hence such psychological factors have to be considered when it comes to faster adoption of security token offerings. Perhaps soon, as STOs push themselves to the podium, and we have more successful use cases, then this won’t be a problem anymore.
Currently, traditional stock markets have lots of liquidity. Security token exchanges are just launching, and it’s not clear yet whether these exchanges will build great products and attract enough liquidity to provide a viable secondary market for the tokens. And it’s not clear when it will happen. Our assumption is that there will be plenty of options, just like with traditional stock exchanges. Already today, traditional stock exchanges are building their capabilities to facilitate the security token trading. For example, several crypto exchanges (Binance, OKEX, etc) are working with the Malta Stock Exchange to jointly launch trading platforms for security tokens. You can find similar initiatives elsewhere in Europe, Asia and in the US. Australian Securities Exchange, London Stock Exchange, Templum, Open Finance and tZero are some of the notable samples. The biggest crypto exchanges reached heights no one ever thought they would. Same will happen to the security token exchanges. The only question is when.
Benefits of STOs?
Lower barrier of entry.
It may sound a bit controversial, as STOs are regulated offerings, just like IPOs. Meaning, the issuer has to comply with the legal framework of conducting public offerings, which in turn means including lawyers and advisors — just like with IPOs. This costs money. Yet, the fees are far less than paying the investment banks and brokers. Also, platforms such as TokenizEU have their worked-in legal structures of conducting the offerings. This helps to bring down the cost. Post-offering administration is way cheaper with STOs compared to IPOs. Plus, STOs should potentially provide a more direct and transparent access to the investor base and lower brokerage fees compared to traditional investment banks.
While unicorn startups won’t need a new model for financing, it doesn’t apply to most companies. And there are plenty of quality companies that wouldn’t do an ICO due to uncertainty, and neither would they do an IPO due to the complexity and the cost. STO has the potential to unlock liquidity for these companies, and bring a plethora of new investment opportunities for the seekers of a steady return.
Not tied to any one country.
This is a big one. For example, if we think about doing an IPO in the European Union and how fractioned Europe is, then it’s not common that a Swede would invest into an IPO conducted in Spain. Very often it’s not even possible if you don’t have an investment account with the broker bank of the country where the IPO is done. Hence, the IPOs are usually carried out only in the jurisdictions where the company operates in, or perhaps some neighbouring countries as well if the company doing an IPO has some presence there and the broker bank provides this possibility. With STOs, there’s no such problem. You only need to have an account on the STO platform to participate. It doesn’t mean it’s automatically a global public offering. The issuer can set restrictions to the offering, i.e the offering is limited to the jurisdictions where the STO is registered and compliant (for example, European Union). STOs are not local, and this is a huge benefit in increasing the investor pool. Due to the nature of the STOs, the offering isn’t perceived to be tied to any one country. It’s usually seen as Company X is launching an offering on the Platform Y. With IPOs, it’s Company X is doing an IPO in Poland (or any other country).
The issued token is also not tied to any one exchange and does not depend on the quarterly expectations of analysts. It’s a well-understood fact that pushing for quarterly results harms companies and the quality of the decision-making.
Compliance is programmable.
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.
Cryptocurrencies and ICOs swept through the financial markets like no-one ever expected, with an exception of the hardcore fans and crypto-believers. Get rich quick promise and ease of getting involved created a huge community of people that were introduced to investing, who got their taste of making a profit, and unfortunately, also losing money. This new investor community is looking for better and safer investments. The investor profile may be a bit different (STO investor and ICO investor), but the interest in STOs is already huge, and the door is wide open for these new investors. Especially the younger generations, they are gladly adopting token investments instead of opening investment accounts in traditional banks. These are people that have never invested in traditional stock markets, and probably never will. As for the more experienced investors that have been investing in traditional stock markets until now, they will continue to do so, together with investing in the security tokens.
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.
What do you think, did we miss something? What are some of the differences between IPOs and STOs that we did not mention?
In our next blog post, we will analyse the prospectus requirements in the European Union.
Written by Mikk Maal (CEO of TokenizEU and Comistar Estonia).
TokenizEU is a security token issuance platform. We help to structure security token offerings and comply with the regulations in the European Union, as well as issue tokens and enable investors to participate in the offerings. To enable non-EU residents to participate in the offerings, we support creating SPVs (special purpose vehicle) in the European Union through Estonian e-residency program.