A Clearer Funding Path for Security Tokens
Two interesting trends are happening in the world of finance that are set to collide: massive companies are staying private much longer, and early stage startups are raising money from the “crowd” via token offerings. There are now hundreds of companies valued at more than $1B that are avoiding selling shares to the general public. At the same time, thousands of companies raised billions of dollars from the global public in a completely unregulated manner, outside of the confines of traditional capital markets last year via ICOs. Here at Omnicor, we believe these two trends are about to collide, and we’re going to see a completely new type of fundraising emerge, on the blockchain, that is both regulated, tradable, and accessible to retail investors.
In this article, we’re going to look at why companies are staying private longer, how that’s negatively impacting the average American, and how regulation around crypto is going to open up a new wave of investing and fundraising that is going to completely change the way the US and the world operates in the “public” markets.
According to the US Chamber of commerce, over the past 20 years, the number of public companies traded on the stock market has been cut in half. There are hundreds of companies valued above $1B that your average investor cannot purchase shares in. We now see companies like Uber, with it’s $48B valuation, still inaccessible to the non-accredited, non-institutional investor. That means if you’re not already connected or managing vast sums of money, good luck investing in companies like Uber.
The US Chamber of commerce patently says this is hurting average Americans. A young, somewhat financially savvy person with a bit of savings can’t buy the next Amazon and watch a $100 investment balloon to over $100,000 because companies like Amazon just aren’t going public. Why? A multitude of reasons: regulatory complexity, fees and reporting associated with going public, and a massive surplus in private capital availability for companies all add up to the fact that companies don’t need to go public. PWC Estimates that an IPO can take 18–27 months of planning and cost $4.2M and 4–7% of the proceeds from the sale.
Today, the crypto market is a convoluted mess. If you would have asked someone a few years ago whom was holding an obscene amount of BTC what the future would look like — the answer would have been clear: blockchain is going to change the world. Amongst believers today, that much is clear. But as skepticism has poured in from outside sources, the community has divided across projects, stacks, and ideologies, and no one knows precisely what the future might hold.
I’d wager to guess that at the very least it will look quite different than it does today. It usually does. We can’t be sure what exactly will be decentralized. This interesting TED talk from a new blockchain initiative talks about decentralizing human rights. And while I hope the trend to move away from centralized structures of power and finance continues, there is a very clear path emerging as to how companies can tokenize, raise money with a stamp of approval from the SEC, and still offer regular investors a liquid financial product with the opportunity to participate in a company’s growth.
In recent months, there has been a lot of conversation and discussion around how the JOBS Act is going to pave the way for the future of ICOs in the US. Some are calling this new wave of ICOs ICO2.0 or STOs (Security Token Offerings), and I’m sure we’ll see plenty of other acronyms and terms for these offerings.
The JOBS Act (“Jumpstart Our Business Startups) was passed in 2012 as a direct result of the fact that fewer and fewer private companies were offering shares to the general public. It was designed specifically to encourage funding for small businesses in the US, and to ease US securities laws which previously made fundraising from a larger investor base prohibitive to small companies without the time and resources available to go down the traditional path of a public offering.
As such, we’ve seen companies like StartEngine, WeFunder, AngelList, and countless others emerge to try and both help investors find more interesting startups to invest in, and to provide startups who could not secure traditional early stage venture capital a way to fundraise effectively and legally.
David Weild IV is often referred to as “the father of the JOBS act”, and he is asking for a JOBS Act 2.0 built on the blockchain. The former Vice President of the NASDAQ is working with two blockchain startups to try and help them raise capital using regulations outlined in the JOBS act. He claims he doesn’t like the title “father” as it wasn’t his pen that wrote the act, and it’s not spurred the growth in IPOs he would have hoped, but the blockchain might.
So what does the JOBS Act say exactly, and how might we see it playing out in the future of crypto. First off, it’s important to briefly discuss the difference between a Utility Token and a Security Token. I won’t jump too deeply into this debate, but we see a security token as any token in which an investor buys a token and believes it could increase in value. This is the definition as outlined by the SEC in the Howey test. Straight and clear.
A utility token is ONLY a utility — meaning the only reason someone would buy it is because it acts as the key to a product or service, just like tokens at an arcade. They do not think they can go up in value. An important distinction to make here is that Security tokens can have utility, BUT Utility tokens cannot be sold as a Security in the US unless they follow the regulations for such sales. I’ve heard many prominent people with far deeper knowledge than myself say “even if you don’t say your token will go up in value, if an investor believes it might, you are selling a security.”
With that definition laid out, and when this path becomes clearer to the crypto community, I think we will see projects shifting the way they think about their tokens: many will sell securities that have some utility. At the same time, I think we are going to see a rise in tokenized equity, meaning instead of offering shares in a company via private investment and/or a traditional public offering, companies will sell tokens that offer holders both the opportunity to earn a share of the profits of a company/network and trade their tokens as they increase in value.
Why sell tokenized equity? Because it will cut out the fees and middle men, such as transfer agents, clearing houses, brokerage firms, investment banks, and lawyers associated with a traditional IPO, bringing the cost for companies to fundraise down immensely and allowing a broader pool of investors to participate in early-stage funding rounds of companies that don’t yet look like Uber or Amazon.
So what does the JOBS act actually look like. There are many possible options but three specific paths are most widely taken:
- Regulation D 506(c): only accredited investors can invest, and there are no limits on how much a company can raise. General advertising permitted so companies may advertise via social media, email, or offline, and there is no limit to the number of investors that may participate.
- Regulation Crowdfunding (Reg CF): Both accredited and unaccredited investors can invest, and a company can raise up to $1.07M per year. Limited advertising is permitted, but the issuer does need to be careful. Generally speaking you cannot mention your company’s planned fundraising efforts ahead of time. And once officially engaged in the offering, a company can tell the public the basic facts of the raise and point them to the portal, but would be wise to say as little as possible outside the official fundraising platform.
- Regulation A+: Both accredited and and non-accredited investors can invest, and a company can raise up to $50M. The offering needs to be approved by the SEC, and while there are some expenses, it is significantly cheaper (the costs are only going down as the path for tokens becomes clearer) than and IPO, and we expect many companies to fundraise using this regulation moving forward. With a Regulation A+ offering there are no general solicitation restrictions. Meaning a company may freely advertise and openly discuss the offering. This includes going on television, shouting from a rooftop, and leveraging social media or other digital marketing strategies.
As more companies explore these funding opportunities, expect a growing number of opportunities for unaccredited investors to get involved in fascinating early stage companies. Over the coming years, we may see people buying more tokens than stock. Hopefully with that will come the decentralization of availability: meaning more investors make more money rather than a handful of early stage VCs and finance gurus getting in on the best up and company new enterprises. We’re excited to be a part of that ride and to watch as investing as we know it shifts dramatically.