Security Token Offerings (STOs) should have been expected due to the fraud perpetrated by Initial Coin Offerings (ICOs). STOs began to gain a foothold in 2018. A study in 2017 showed more than 80% of ICOs were a fraud.
Instead of ICO fraud leading to the disappearance of the sale of cryptocurrency tokens as an investment vehicle, a new class, version 2.0 (STOs) of token sales emerged. STOs are becoming vogue because they are designed to be “compliant” with security rules and regulations. However, let us face it, ICOs, and now STOs, are more an alternative to raising capital than a network or product enhancement.
ICOs to raise capital for blockchain-based companies were popular because of the significant opportunity to raise capital versus the traditional venture capital (VC). In fact, in 2017, the raise of capital via ICOs surpassed VCs.
There are a number of ways STOs can raise capital that are compliant with SEC rules. The Regulation A class (Reg A and Reg A+) might seem to be the most elegant way to do this. The filing can be made public, adding a layer of transparency to the filing for the public. In order for the SEC to take no action on the filing, the submitters must achieve a significant threshold of disclosure. This high level of disclosure can significantly reduce the risk to the investing public. Further, a Reg A STO would enable the entire public, not just accredited investors, to invest in the offering, making it more democratic. Due to the structure of the Reg A, it is frequently referred to as a mini Initial Public Offering, or “mini-IPO”.
However, this model is extremely expensive. For the vast majority of startups, this model is prohibitively expensive. Both the authors of the article invested over $200,000 USD in their Knowbella Tech submission of a Reg A+. Unfortunately, due to the low prospect of the Company gaining a no-action response within the next year or two from the SEC, it withdrew its Reg A submission.
The next form of filing to raise capital using the STO are the Regulation D (Reg D) class. These are divided into the Rule 504, Rule 506(b), and Reg 506(c).
Due to the seeming unlimited amount of money raised through ICOs, which frequently exceeded $100,000,000.00, filers of Reg D will likely use the 506(b) or 506(c) because it has an unlimited cap on its raise. The choice between 506(b) and 506(c) probably comes down to selecting 506(c) because the filer has the ability to raise capital using general solicitation and advertising of the offering. This ability to market is frequently a critical component.
When combined with the Regulation S filing, a filer is able to raise capital from anyone outside the U.S.
More about the comparison of different U.S. SEC filing types that enable SEC-compliant filings can be found HERE.
It is important to note that raising capital from VCs is extremely difficult. The rate of award is even less for women. With a STO, entrepreneurs who are rejected for funding by VCs can still go about raising capital, and it can be significant amounts of capital as Telegram’s raise of over $1B shows. It is extremely unlikely the Telegram founders would have ever raised VC money, let alone the amount they raised. Because of the ability to circumvent the low VC awarding funding environment, STOs will continue to raise capital at an ever-increasing rate.
STOs are even beginning to gain attention of traditional companies trading on stock exchanges. For example, it is anticipated in February 2019 a NASDAQ-listed biotech company with a market capitalization in excess of $250M will be the first publicly traded company in the U.S. to launch a STO. (Per email received from Darren Marble, Issuance.com)
Companies are working toward productization of blockchain beyond cryptocurrency. On a weekly basis, an author of this article gains an average of 25 pitches per week, and sometimes up to 50, to gain funding. This rate of submissions is ever increasing as mainstream, pre-existing companies are now getting into the action. It seems many companies are developing solutions for problems that do not exists simply to capitalize on the buzz of blockchain. This stampede toward leveraging the buzz to raise capital creates skepticism in STOs.
Those STOs that capture attention are those that using blockchain for more than one application such as Knowbella Tech. Getting back to basics, a STO is a security token offering. That is, the token is a security. Therefore, it should convey return on investment (ROI) opportunities to the investor. For example, a security token should provide the investor voting, economic, and liquidity rights.
Those companies launching blockchain-based solutions beyond the STO offer the investor an opportunity to capitalize on the promise of blockchain. In Knowbella Tech’s case, they are also productizing blockchain applications that solve significant market problems. They have filed patents to manage grants, intellectual properties, and other blockchain applications. Even though they are launching a Helix security token via a Reg D STO that provides significant rights to investors and liquidity on security exchanges at 366 days from issuance, they are using blockchain to solve market problems.
Opposite security tokens are utility tokens. Utility tokens are another blockchain-based cryptocurrency used that do not raise capital. These tokens are frequently used as a reward, an in- and out- network medium of exchange, or other part of the issuer’s product and business model. Utility tokens should not be sold to investors. Unfortunately, most ICOs during the pre-STO era sold utility tokens as securities and the SEC has begun to take steps to correct this problem.
An example of a utility token implementation is Knowbella Tech’s planned issuance of AnthroTokens to the crowdsourcing scientific community. AnthroTokens will enable researchers who collaborate within the Knowbella Platform to earn this cryptocurrency and trade them on the more than 200 utility token exchanges.This could be a very important way for underserved scientists, particularly those in Africa, Asia, and Latin America, to gain value while creating economic development within their societies.
It may be the case that companies using blockchain for security tokens, utility tokens, and products that solve market problems will be the types of companies that could interest VCs and professional investors.
The authors of this article are not lawyers and are not offering legal advice. This article’s perspective is referring to United States (U.S.) Securities Exchange Commission (SEC) rules
Private Equity Partner, Conscious Capitalist, Public Speaker, Venture & PE Adviser
Mark Hamade is a Partner at an 18 year old Private Equity firm Vivaris Capital.
LinkedIn — Mark Hamade
Twitter — Mark Hamade
Jason E. Barkeloo has over thirty-four years of experience as an entrepreneur, researcher, patented inventor, investor, and educator.
He’s alos the Founder & CEO of Knowbella Tech and provides cryptocurrency, AnthroTokens, to researchers who collaborate within its open science collaboration platform — the Knowbella Platform.
Linkedin — Jason E. Barkeloo
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