ICOs, Security Tokens and Public Offerings in the European Union

Crypto industry moves so quickly that it seems like years ago when the ICOs were the cool kid on the block. Everybody was talking about or doing something in the ICO space. You had an idea that needed funding — ICO was the answer. This was literally the case less than six months ago. Sure, there were clear signs of cooling off, but still — six months and the market has completely changed.

Now, if someone says they’re going to do an ICO, you can hear the voice in your head going “oh man, it’s not gonna succeed, this train has left the station”. And most likely, this voice is right. ICO project has to be exceptional to gain any interest at all. Forget about raising tens of millions. Funds don’t want to hear anything about ICOs. Retail investors have lost enough and escaped the market. Ideas, that would’ve raised 100m € one year ago, are failing to raise a petty 1 million € today via ICO.

Why? Well, there are many reasons. Scams and weak projects that will never release or never planned to release a product. Or, look at the price action of almost every ICO token. The price peaks during or shortly after the token is listed on an exchange as whales manipulate the price, create the demand by bumping it up, the fomo squad jumps in to get their piece of the gains, as whales exit and register their profits. The fake demand is gone, price plummets — there’s no liquidity, demand, nothing. The retail investor that just got screwed isn’t very smart or just does not understand the game well enough. It’s hard to believe the level of manipulation of the crypto markets, unless you actually have seen it and know it for a fact. We’ve talked to a few post-ICO token price management companies (yes, this is how they call themselves). The so-called whales. The price action described above is how they operate and it’s their whole business model. However, this is not why I made the statement that the retail investor isn’t very smart. They just didn’t know the dynamics of this early and wild ICO market. This statement was made because of the unreal expectations and poor due diligence.

Think about it. It’s unreal to expect to get 10x returns few days after the investment, or in one month, or two months after the investment. What drives that value? Companies issuing the tokens are usually startups, and startups need time to build their products. Building a decentralized product is way harder than building a centralized product, and building a good centralized product is not done in 1–2 months either. Hence, the expectations were unrealistic to start with.

The second problem is the due diligence. Making an investment requires thorough due diligence and understanding of the project. VCs see thousands of projects per year and invest only into a handful. It’s because most projects aren’t worth investing in. As the times were good and crypto prices were rising rapidly, all decisions seemed to be good decisions. Unfortunately, most of the bad decisions are done in good times. Bad investments into poor assets bring economic downturn, and in crypto markets, it just happened quicker than in traditional markets. Difficult times require good decisions and careful analysis of where to deploy capital. Hence, the level of analysis and decision-making has improved. Better projects get funded. This creates a better and more stable crypto market.

Yet, even with a better due diligence and better quality of the projects, ICO as a fundraising method is a lot less interesting for an investor than before. It’s because there’s a new cool kid on the block. And this one is here to stay.

Of course, we’re talking about the security tokens.

Security token offerings will rule the new era of fundraising. Security tokens by nature are a better investment than utility tokens. Security tokens are backed by real assets, and as the security token offerings are regulated, there’s no regulatory uncertainty about them. It also means that the more stable and better quality market participants, such as well established companies, are now jumping into the market. There’s no way they could risk with the regulatory uncertainty of an ICO. STO does not have such risks. STOs also bring better barriers to entry, as it’s not as easy to execute a regulated offering. It’s just a better way to raise capital.

What if the security tokens have the same effect on the financial industry as the introduction of e-mail had to our everyday communication? How much quicker and cheaper e-mail made our lives in workplaces? It revolutionized the communication.

We see the same potential for the security tokens. Less expensive, quicker, easier to manage the investor relationships and create a responsive community, simpler for investors to invest, liquid, and above all — STOs are hot. There’s no better time. There’s a ton of interest by the funds, media, and retail investors.

However, it’s still as relevant to conduct a proper due diligence as with any other investment! Just because it’s a security token does not make it a good investment. At TokenizEU, we definitely see a plethora of companies wanting to do an STO which we have to turn down because the quality of the company or project is not there. If the STO is planned because it’s quite obvious that bank or VCs wouldn’t finance the project, then we will not support bringing such project to the market either. This may mean that we make wrong decisions, but our focus is on improving the quality of the crypto industry, and this means a thorough filtering process. Moreover, as TokenizEU takes 1,5% equity in the form of the issued security tokens, then our interest to hold quality tokens aligns with the interests of the investors on the platform.

Security Token Offering in the European Union

As the TokenizEU platform operates in the European Union, we would like to highlight some of the key elements of conducting a security token offering in the EU.

Usually, when certain thresholds are exceeded, the company issuing the tokens has to register a prospectus which complies with the EU Prospectus Directive. The Prospectus Directive is a framework directive made under the Financial Services Action Plan. It provides for a single regime throughout the EU governing the requirement for a prospectus and its content, format, approval and publication. The EU prospectus regime harmonises requirements when securities are offered to the public or admitted to trading on a regulated market in an EU Member State.

Here’s a quote from the ESMA website that highlights the goal of the Prospectus Directive:

“The regime is designed to reinforce investor protection by ensuring that all prospectuses, wherever issued in the EU, provide clear and comprehensive information while at the same time making it easier for companies to raise capital throughout the EU on the basis of approval from a single competent authority.

Within these objectives, ESMA’s work in the prospectus area aims to: 1) promote a practical and efficient implementation of the prospectus regime; 2) contribute to a consistent application of the regime across the EU by building a common supervisory culture among competent authorities; and 3) ensure an adequate balance between an investor’s need for information and burdens on issuers to provide such information.”

And this is a good thing, as it means that public offering done in one jurisdiction can be easily extended to all other EU Member States. The conclusion of the prospectus has to be translated to each official language, but this is a small burden to bear. In some cases, the offering of security tokens is not a public offering at all, but a private placement. The Member States may have slightly different financial exclusions.

Some examples of the exclusions when the prospectus is not required:

• an offer of securities is addressed solely to qualified investors, or
• an offer of securities is addressed to fewer than 150 persons per Contracting State, other than qualified investors, or
• an offer of securities is addressed to investors who acquire securities for a total consideration of at least 100,000 euros per investor, for each separate offer, or
• an offer of securities with the nominal value or book value of at least 100,000 euros per security, or
• an offer of securities with a total consideration of less than 2,500,000 euros (can be a different sum, for example, 5, 000, 000 euros) per all the Contracting States in total calculated in a one-year period of the offer of the securities.

Final words

Whether it’s a public offering or a private placement, security token era has arrived. If you are looking to raise funds in a compliant way in the European Union, get in touch with us and let’s see how we can cooperate.

Written by Mikk Maal (CEO of TokenizEU and Comistar Estonia)
TokenizEU helps companies to tokenize their equity and raise funds in the European Union. TokenizEU is powered by Comistar. Comistar provides business, legal and tax support for e-residency companies. Our core focus is on e-commerce companies, blockchain industry and affiliate marketers. We’ve been operating for 5 years and have helped more than 300 companies to get started with their businesses.