Tokenize This: Week 9 ~ Tokenized Client Contracts
Bootstrap startups with their own revenues. Keep it all in the family.
Little known fact, some companies actually sell their assets off as a key part of the business plan. You’d think companies want to retain as much of their assets as possible, right? Yet here some firms willingly sell assets off at a DISCOUNT, just to ensure current revenue. Don’t believe me?
Look at alternative lending firms. Let’s say they lend capital to the owners of a commercial real estate complex at 7% interest. Rather than sitting tight and waiting for that loan to be fully repaid, the lender will actually sell off a decent portion of that loan to another buyer (usually a bank) at a lesser rate — let’s say 4%.
In this scenario, the bank takes over this loan liability at a rate equivalent to 4%, but receives the repayments from the CRE owners at 7%. Arbitrage opportunity of 3%, solely for assuming the risk and trusting that the CRE firm will fulfill its end.
Why would the original lender accept 4% up front rather than sticking it out for the 7%? Well, they must deem that present 4% to be more valuable than the longer-term 7%.
Let’s take a look at how this practice of “selling off” assets can benefit firms of all types — especially startups that are still itching for their growth spurts.
Value Adds
Startups/Companies (Token Issuer)
- Avoid having to exchange equity ownership at every fundraising level
- Gain access to more frequent capital injections, which may relieve pain points during critical growth cycles inherent in startups
- Further insight into which types of contracts are in high demand via token prices in the secondary markets; gives the company a stronger pulse on the on the market in which they operate and better pricing insight
Contract Buyers (Tokenholders)
- Predictable ROI opportunities for various lengths of time (months, quarters, years)
- Direct investment access to some of the most desired assets and clients
- Alternative investment strategy that should ultimately have limited correlation to legacy markets; the investment value is solely dependent on the fulfillment of the underlying contract
A main struggle surrounding the vast majority of startups lies within fundraising, working capital, run rates, burn rates & runway, and expansion rates. Those factors all go hand-in-hand: if the fundraising is weak, the team may have to “lean out,” have a shorter runway, and experience hardships with essential operations.
On the flip side, strong fundraising equates to greater flexibility, possible team expansion, and a longer runway to bring the company to fruition. This, in turn, results in a better shot at higher run rates and scalability.
The Funding question typically revolves around the founders’ preferences and equity desires. Most struggle to part with equity in their own firms in exchange for fundraising. This is very understandable — it’s difficult to part with your creation…
Which means there is an enormous Total Addressable Market for alternative funding strategies that could lessen the equity loss for founders and early employees (employee option pool is also very significant to ensure early team members are fully aligned with the startup — things can get bumpy, after all).
We previously discussed an Income Share concept in Week 7 with a focus on College Students and tuition costs. Taking that to the next level brings us into the corporate world.
What if startups can use all of their dearest KPIs and metrics to float themselves through times of trouble? If you’re following and can connect the dots from the intro, I’m suggesting startups sell off portions of their future revenues & contracts in exchange for present fundraising.
Alternative lenders can lend at 7%, and sell a portion off at 4%. They capture a quick 4% and move on to the next opportunity.
Why can’t startups sell off the rights to a $15 million revenue package over the course of 2 years for $10 million in cash now?
Not a bad return for the investor: ($15 — $10) / $10 = 50% gain in 2 years.
And if the startup has pertinent needs and uses for that $10 million now rather than $15 million in 2 years (which is likely the case), then they would be wise to take the “investment” and continue to build.
Utilizing security token capabilities to “digitally wrap” future revenues would enable these packages to trade on exchanges. The most feasible structure would involve well-defined client contracts, as shown below.
***
Client A agrees to a 3-year subscription with Firm 1, for a total contract value of $5 million.
This contract is represented by a security token called REV5. There are 35,000 REV5 tokens worth $100 each, for an aggregate value of $3.5 million.
REV5 is launched on a compliant security token exchange and is available for purchase by any verified and able exchange users.
Owners of REV5 may participate in the rewards as the contract ages to maturity, proportionate to the amount of tokens owned.
***
As we can see, conditional on all 35,000 REV5 tokens selling, Firm 1 gains an upfront $3.5 million on a product that would yield $5 million over the course of 3 years. This serves Firm 1 so long as there is a beneficial use of the $3.5 million that will (ideally) result in collective gains > $5 million over the next few years. As long as that final value is greater than the contract value, this is a worthwhile decision — the means justify the ends in this scenario.
As for the tokenholders, the simplest token structure would be one where no value/distributions are made until the REV5 contract “matures,” which is after 3 years per the subscription terms.
The secondary trading value of these tokens may actually increase as time goes on, since the light at the end of the tunnel (aka “contract maturity”) will be in plain sight. This gives early tokenholders the potential for capital gains if they wish to resell before maturity, and later-stage investors with a more predictable ROI. As with most of our Tokenize This concepts, tokens can be structured in various ways, however, and there is no one-size-fits all in this regards.
Lastly, the risk of a contract falling through or being breached by the client is something that would need to be addressed and monitored prior to and during the investment period. Nothing is guaranteed, and downside potential still exists for tokenholders in the event of a “contract default.”
Partnership Potential: Pipe.com
Pipe is a #MiamiTech startup that is currently running a successful operation on this concept, sans security token implementation. With the mission of empowering SaaS companies, Pipe has impressively jumped from a $6 million Seed raise to a $60 million Seed extension in June 2020.
The firm lives by the following:
Stop pushing your customers into discounted annual subscriptions. Your subscriptions are an asset, trade them like one.
Based on this, it seems that Pipe is focused on shortening the lulls between subscriptions and increasing the cash flow frequency associated with underlying contracts. Co-Founder Harry Hurst stated in a recent podcast that Pipe is managing contracts that currently trade for around 95 cents on the dollar. Very impressive numbers, and he’s maintaining the ultimate goal of pushing that number as close to “a dollar on the dollar” as he and the team can. It’s possible that future implementation of security tokens or simply blockchain technology can improve efficiency and transparency throughout the life cycle of each contract, and push the team closer to their goal!
New Edition coming next Wednesday 3/17/21!
Disclaimer: This is not financial or investment advice and should not be interpreted as such. Please do your own research on investments and financial decisions before partaking in any ideas or ventures depicted in this publication.
