Initial coin offerings (ICOs) brought new life into traditional investment methods, giving retail investors a new way to capitalize on innovative blockchain-based projects. The concept of an ICO is simple: a company generates tokens, a form of digital asset, and proceeds to sell these tokens through a crowdsale.
As a result of this groundbreaking fundraising method, cross-border investing became significantly easier as investors around the world could partake in token offerings within previously inaccessible jurisdictions—albeit in a highly unregulated environment.
While the idea of such an unregulated investment opportunity was and continues to be intriguing to many, it also entails a considerable amount of risk. For example, throughout 2017, ICO scams ran rampant. Under-qualified and sometimes ill-intentioned teams were raising millions of dollars without feasible business models, fleecing investors looking to cash in on the next blockchain unicorn project.
Bad actors also uncovered opportunities to reinvest illegally obtained financial instruments and convert them into tokens, thereby circumventing KYC (Know Your Customer) and AML (Anti-Money Laundering) procedures required to legitimately invest in standard securities offerings.
From a need for significant regulation in the crypto industry, the security token offering (STO) was born.
STOs bridge the world between ICOs and IPOs. Put simply, they blend some of the same libertarian benefits of an ICO with the strict regulatory guidelines of an IPO.
If you’re debating whether to pursue an STO to raise capital for your business, here’s what you’ll need to consider for a successful launch:
1. Is an STO the right choice for my venture?
Before getting into any details, you should validate whether an STO is the optimal fundraising method for your business. There are various benefits to conducting an STO over other forms of funding.
Firstly, particularly for startups, an STO is more flexible than traditional venture investment. Although your token holders will expect returns, you’ll retain more control over the decision making process than if a venture fund were to provide an injection of capital.
Moreover, because an STO is regulated, you’ll be able to offer your security tokens to investors across the globe, all while remaining compliant with the relevant regulations.
With that being said, an STO is not necessarily the right choice for fundraising in all cases. Businesses with expectations of low initial growth or revenue will be less likely to attract investment. Therefore, if you have confidence you can achieve a return for your investors within a reasonable time frame, and that your business would be well-suited for a model of transferable and highly liquid shares, then an STO could be the perfect fit.
2. What kind of Security Token do I need?
There are four different categories of security tokens.
1. Debt tokens: This type of token effectively serves as a loan that the business agrees to pay, with interest due to the token holders.
**2. Equity tokens: **These tokens represent shares of the company itself, much like a traditional stock. Equity tokens may involve profit sharing in the form of dividends.
3. Asset-backed tokens: These tokens are issued against an existing asset. So, if a venture is undertaken by an established business that owns an asset such as real estate, the asset can be fractionalized into security tokens and sold off to investors.
4. Utility tokens: These tokens provide a means of accessing future services of the venture itself. A large number of ICOs conducted during 2017 and 2018 were marketed as utility token offerings.
3. Which legal considerations apply?
Legal considerations are a critical aspect of launching an STO, and their implications will depend on where your token sale will occur.
For securities offerings in the US, three relevant regulations apply. Regulation D is the least arduous, requiring a declaration to the SEC that the offering was open only to investors accredited by the SEC. In this case, only those investors above a specific net worth and income threshold are eligible to become accredited, meaning much of the general population is excluded. Regulation A+ allows the offering to solicit non-accredited investors, up to a maximum total value of $50 million. Regulation S is for securities offerings that take place outside of the US. It only requires that the offering is made in compliance with the law of the jurisdiction in which it is based.
In Canada, the laws are generally similar to the US. In Europe, EU legislation requires that any securities offering files a prospectus. However, particular exemptions may apply depending on the number of investors or the amount invested.
As each jurisdiction has its own requirements, then legal compliance is one of the trickiest areas to get right for any STO. Therefore, it makes good business sense to engage a lawyer or legal advisory firm that can help navigate the compliance requirements in the relevant jurisdiction.
4. Which platform should be used?
There are several platforms out there that can help you successfully launch your STO, and they all offer similar benefits. In deciding which platform to utilize, it is critical to consider the following two items. Firstly, to what extent will your chosen platform help you navigate the compliance requirements of your STO launch? For example, platforms like EtherParty’s Rocket 2.0 allow token issuers to connect accredited investors and manage their offering in one single ecosystem.
A further consideration is that your chosen platform must be linked to a compliant exchange. The security token is subject to security legislation throughout its lifetime, not just for the initial offering. Therefore, to be fully compliant, your chosen platform must be linked to a compliant exchange.
Some of the more well-known platforms include Rocket 2.0, Polymath, Securitize, Harbor, and Swarm. You should investigate each one thoroughly, considering your unique needs, before deciding which is best for your token offering.
5. Marketing and Promotion
Finally, once all of the infrastructural matters above are in place, you’ll need effective marketing to launch your STO and get it in front of eligible investors who will be willing to fund your venture. This is a daunting undertaking, so using an agency with the right contacts and experience is often a safer choice.
By making the right decisions at each stage of the process outlined above, your STO stands a greater chance of becoming a success. The best way to achieve this is by leveraging the best practices and know-how of others who have successfully launched STOs before. If you’re looking for support in launching your STO, reach out to Vanbex and we’ll help you out at every step along the way.