Running A Compliant Security Token Offering in 2018
The Team, Tools, and Techniques you need for your 2018 Token Offering…
Are much different than what you needed for your 2017 Initial Coin Offering (ICO).
In 2017, hundreds of Crypto Currency and DApp project launched via the ICO crowd fundraising process, most pre-product and certainly most pre-customer, pre-traction and pre-token. Launching an ICO in 2017 required the following 7 elements:
A Website (i.e. www.vertalo.com);
A Whitepaper (i.e. www.vertalo.com/whitepaper);
A ‘countdown clock’ (we don’t have that, but they are useful to create FOMO);
Token Terms (Terms of the pre-sale, and the discount that you get depending on when you buy and how much);
And you probably needed less than $200,000 and three months to get from idea to ‘investment’. Maybe even less if you were smart enough to be able to do all the above with just a couple of smart, experienced people working part-time.
Certainly many teams that raised funds via the ICO method had more substance than this, but it wasn’t really necessary. Many projects also utilized ‘Advisor Networks’ that acted in the role of a broker-dealer, helping the project circle interest faster, earning a performance fee (% of the raise) or discounted tokens or both. Advisor/Marketing platforms even wrote many of the whitepapers, built the websites, manned the social channels, and built the tokens.
In 2018, as the ICO came under intense scrutiny for the SEC and other regulatory bodies in the USA, the ICO model example above started to falter. Issuers (projects that raised funds), investors, and promoters started to receive inquiries from regulatory bodies. Rumors swirled that projects that had used the ‘SAFT’ model were targeted for having potentially violated US Securities law. While there are no statistics for the impact that regulatory attention had on projects, anecdotal evidence points to a steep drop-off of ICOs in the United States, and a migration to jurisdictions such as Malta that have been seen as more ‘crypto-friendly’.
What is driving the move offshore? The SEC is requiring that Crypto Projects that seek to raise funds in the US register their offerings consistent with the way that startups and other businesses have been doing since 1933: A registered offering. Chris Concannon, President and CEO of BATS Global Markets, had this to say.
“The actual party that offered the unregistered coin, they could have been involved in issuing an unregistered security,” Concannon said. “Anyone who sold that off could be deemed an unregistered underwriter.”
What does this mean for you and your crypto project? It means that not only do you need to think about your offering differently, you will need a different team, more structure and a larger budget. If you want to run a crypto fund raise in the US in 2018 and beyond you may be advised to run a ‘Reg D’ compliant fund raise.
Issuing a Security Token is like having a baby.
To issue a Reg D security token (btw, according to William Hinman all tokens issued in the US are considered Security Tokens by the SEC), you’re going to field a team and project that is significantly more experienced, more devoted and expensive than the same project might have cost you in 2017. What does a Reg D security token issuance look like in 2018? What do you need beyond what was required for an ICO?
- Legal. In order to issue a Reg D security token (forget about Reg A/A+ for now) you need a securities law firm to prepare your Private Placement Memorandum (PPM). The Vertalo PPM is 117 pages and took more than 3 months. We had to integrate our whitepaper.
- Legal. That’s right, more legal. You need someone on YOUR team to work with your law firm. Are you a lawyer? If not, you’ll probably need a lawyer to represent you on calls with your team and help you decide what advice and actions to take. If you don’t have a lawyer on your team, you need to hire one. This is not legal advice, it’s just a good idea.
- Tax Advice. Income derived from network (aka Utility) token sales is considered fully taxable, whereas funds gained from an equity raise are not generally taxable. A good tax attorney or accountant is important, and our commentary is not tax advice.
- A Cap Table. ICO issuances, as a rule, sold network tokens (aka ‘utility’ tokens) to ‘contributors’ without any rights to underlying assets. While a network token is STILL a security under Reg D, it doesn’t necessarily confer equity or other rights. However, if you are issuing ANY security under Reg D, you need to register it and its owner. So you will need to place the information about the holder and the date/price paid etc. onto a ledger. The same goes for any Equity Token buyer data. You will need a registry of your stakeholders so you can communicate and establish eligibility for trading and exchanges.
- Restricted Shares. If you sell tokens via Reg D, it is likely that equity token buyers will be subject to a 1 year lockup, so you will have to add that to your list. At this writing, you can’t distribute tokens that are not locked-up and comply with SEC 33.
- Ongoing KYC and Email Addresses. You will need to communicate with your buyers to send them consents, K-1s, 10-Qs, etc. You need to KYC your buyers and you will need ongoing KYC and AML procedures in place.
- A foreign jurisdiction. If you issuing from the US, you may be limited to who you can sell your tokens to. In order to maximize your token sale, you may need to set up a subsidiary in another jurisdiction and file a Form F-1. If you set up in a foreign jurisdiction? That’s a whole other post.
- More Money and More Time. This is the most important distinction. In my estimation, you cannot launch an STO for a software project with less than $1 million, and that may not be enough. Your legal and other costs are that much higher, and you may find it necessary to raise venture capital prior to embarking on an STO.
Things you don’t need and can’t use are important too.
A. You may not be able to advertise your token offering unless you are selling to certain US-only investors according to 506(c). Consult with your attorney. Becuase Vertalo is filing under a combination Reg D and Reg S.
B. You will not get as much benefit from Telegram or Slack, and may not be able to use them as you would with a ICO
C. You need to be very careful about working with advisors who are not a licensed Broker-Dealer. Again consult your attorney.
D. You cannot make forward-looking statements in your whitepaper. This one really hurts some projects.
There are other nuances about what you can and cannot do.
None of this should be construed as legal and tax advice, and I am not a lawyer. However, we have many attorneys and tax advisors associated with the Vertalo project and we learned how different and STO was compared to an ICO over a 9 month process towards our own issuance. Vertalo’s STO journey was very intellectually demanding, but very time-consuming. We learned a ton. Most of what learned about security token issuances we now apply at our parent company SeriesX.
We issued our own Reg D SEC Compliant Security tokens in March of 2018 and it really changed how we see the world. Sure, it’s more complicated than an ICO, and certainly more expensive, but it also gave us some peace of mind.
If you want to learn more about tokenized securities and registries, please visit www.vertalo.com and if you want to reach out to me, email me at firstname.lastname@example.org