With traditional fundraising methods becoming more difficult to access, we discuss how the STO framework has the possibility to become the norm for growing businesses looking to raise funds.
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After the Initial Coin Offering (ICO) boom of 2017, many businesses began looking towards blockchain technology to raise funds. Utilising blockchain, growing businesses were able to access a wider investor base and create a sense of community within the project itself.
The Security Token Offering (STO) framework has been making noise since late 2018 and, much like the ICO space, has been met with both scepticism and acceptance. There is no denying the level of opportunity that the STO market has. Analysts have predicted the STO could capitalise on a $10 trillion market.
In this article, we discuss how the STO could soon become the norm for a business looking to raise funds. We will delve into the history of the STO, how it could allow SMEs to thrive and, in the long run, create a new ecosystem of investors with benefits.
If you are new to the world of security tokens, we recommend reading our CTO’s article What are Securities and Security Tokens.
Crowdfunding on Steroids
To understand how the STO model works, it’s important to understand how the principle of crowdfunding works. Whilst crowdfunding in itself is not a new idea, with the first crowdfund dating back to the 1700s by the Irish Loan Fund, what it has been able to create since its mass adoption in the 2000s is nothing short of remarkable.
Platforms such as Crowdcube, Indiegogo, Kickstarter and Seedrs have all enabled growing consumer-based businesses to thrive. Crowdfunding has managed to create a global $34 billion market and in doing so, enabled the next generation of startups to thrive. Crowdfunding is not without its investor drawbacks, many of which have held up the mass adoption.
With the influx of the ICO in 2017, many businesses utilised blockchain technology bring early-stage access to potential investors. In doing so, they issued utility tokens to those investors to access the platform, which was blockchain-based. This funding model is not without mixed emotions. On the one hand, traditional financial entities and regulatory bodies perceived the ICO space like the "wild west". A lack of regulation was one of the biggest concerns, with the SEC Chairman Jay Clayton announcing that “every ICO I have seen is a security.”
Many investors and businesses found that the ICO space allowed their business to grow, bringing a shift in the world of project fundraising. Crowdfunding had met blockchain and, for the most part, many people were pleased the ICO revolution had begun. It allowed many businesses to thrive, as well as investors to gain ground floor access to a business that they believe in.
STOs will be a mature step in the world of blockchain and fundraising. In the ICO space, building a platform with no regulatory oversight caused some issues. As a STO is a security, the regulatory oversight applied to all securities will immediately be in place, meaning the business and its investors are more secure. For the business, it will give them the option to use a much safer and transparent version of crowdfunding, whilst also being at the forefront of new fundraising technology.
Greater Control for Owners
Control is vital for any growing business to have. The founders and C-suite officers need to be able to decide what is best for the project as a whole. Yet, this can prove difficult when it comes to receiving funding from a venture capital (VC) firm.
VCs have a very important part to play when it comes to a growing business. They can, in some sense, make or break a business and decide whether it will succeed or not. The average VC will also request things that the business may not want or be able to offer. VC firms are able to ask for a discount ranging from 40.6%-70.0% to consider funding the business.
After the business has experienced a large enough period of growth, they can choose to list on a market. Yet, going to the public stage can also limit the investors that are able to come in and, this, in turn, means giving away more shares in the business which they might not want to do.
STOs, though not combatting all these issues, are able to help the founders with a cheaper alternative to traditional VC funding and IPOs. It gives them a wider opportunity to look at jurisdictions which work best for them instead of whichever the VC or underwriter wants them too.
Global Investor Base
Picking a market to sell shares can also have its issues. Whilst STOs are not able to combat the jurisdictional issues that will arise, they can help to give the business access to a global investor base. With the traditional IPO route, but, the fees for investors are not small.
IPOs need investors to hire a broker who can buy and sell the respective stocks for them. Hiring a full-service broker will likely cost the investor $150 per transaction. Whilst this is much cheaper than it has been in the past, this is still very expensive for the average investor.
The ICO boom saw an influx of investors from all over the world. We alone saw participants from 153 different countries enter our client's token sales. The ICO framework started a fire in the financial industry and saw some remarkable businesses succeed using the model. In doing so, it created a new form of global investor class; digital asset holders who wanted the ability to trade 24/7 around the globe, creating faster and a more immediate level of liquidity.
Building upon the ICO foundation, STOs will be able to open up the entire globe when it comes to accessing investors. Whilst countries like the USA and China are still wary of tokenisation, many countries around the world are welcoming the technology. For a business, this means that they have a much wider pool to choose from, opening up a larger demographic that they go out to.
If a business does make it to the public stage, after making sure that it has an estimated $100 million worth and turned a profit for the previous three years, then it can look at issuing shares to the public through an IPO. Of course, this is not a cheap and quick process. By choosing to conduct a STO, the business and founders will be paying a fraction of what an IPO costs.
The average cost of going public on the New York Stock Exchange (NYSE) is quite high, though this depends on the size of the business. Businesses can look at paying anywhere from $3 - $4.2 million for one-off costs, then an estimated $1 - $1.9 million a year in fees associated with the IPO. In total, for a business with a revenue range of less than $100 million, they are looking at paying an average of $10.1 million for their IPO.
An STO gives a much-needed alternative to the IPO. It has a far greater reduced cost to entry and, providing you find a good service provider, will also have fewer fees than a traditional IPO or crowdfunding campaign. Crowdcube, for example, charge a 7% fee if your raise is successful and then a 0.75%-1.25% completion fee. This does also not cater to the third party card fees which are applied to the raise, which vary from 0.47%-2.9% depending on how your users pay.
By providing a business with a more affordable alternative to traditional models, STOs have the potential to give a growing business an easier path at a fraction of the price of the current models in place.
Immediate Liquidity for Investors
For many investors, their investment is locked up until the business decides to go public, allowing them to sell their shares. One of the most notable crowdfunding campaigns is Brewdog and it’s “Equity for Punks.” The business itself only allows shareholders to sell their shares , meaning that they cannot sell them publically. They are also unable to sell as and when they want as there is only one day a year in which they can do so.
ICOs came under fire from traditional investors when it came to the level of liquidity. A business could distribute its tokens at 12pm and by 12:15pm have the token itself trading at four or five times the initial sale price. Jay Clayton, Chairman of the SEC, said that “every ICO I have seen is a security.” What individuals from a traditional market did not understand, but, was that ICOs were about creating a fairer route for both investor and business. This is what the STO framework has the capability to enact.
STOs give the business a much-needed update in the world of crowdfunding. It marks a well needed maturing of the tokenisation space. For the business, it will allow them to have instant liquidity of their equity, much like the IPO sale allows, but at a much earlier stage. The average VC wait to gain access to liquidity takes 8.2 years, a figure that is only expected to continue to grow.
The STO model gives the business complete transparency of shareholders, meaning that it knows exactly who has invested, how much and when. Using blockchain technology, this process is then tracked, logged and recorded all on an immutable database. The business can focus on the most important part of its work: developing the idea and technology.
STOs are picking up momentum in the financial world. Facebook's Libra Association created an investment token to pay dividends to backers recently. This shows that the STO is already receiving third party validation.
Revolutions in the financial world are few and far between. Paper shares were only eradicated within the past decade, even in a time where technology is so prevalent in everyday life. For growing businesses, the STO framework could become a much more likely prospect than methods already in place. Only time will tell, but we at TokenMarket are confident that more exciting businesses will use the technology.