DLT Capital: Raising Funds with a Security Token Offering

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This article is written by Stefan Perlebach

We are pleased having Maunel Müller from DLT Capital as our interview guest who answered our questions in collaboration with Scott McKenzie, who is the legal advisor of DLT Capital GmbH.

DLT Capital is supporting startups throughout the whole process of raising capital and consults them on how to use an of Security Token Offerings as a means to raise funds.

Which problem is DLT Capital trying to solve?

Many blockchain startups need help making their plans come to reality — marketing, business consulting, financial, and legal. One of the main areas we help with is finding the funding. This includes traditional seed rounds for equity to ICOs, ETOs, crowd investing, or other alternative financial methods. We are excited that so many projects have been coming to us in the last year asking about STO’s — and we are happy to help them put it all together.

Out of your experience, what is the biggest misconception people have about Security Tokens?

I think we should differentiate between Security Tokens and STOs.

Let’s have a look at Security Tokens first. The biggest misconception in this area , I think, is that they should or will replace utility tokens. Utilitiy tokens still have their use cases, but they are not qualified to be a fundraise vehicle — in most cases it’s better to separate fundraising from the utility of the solution. As a result you will be able to “customize” your investor offer and optimize the functions of your solution more precisely by programming the security token accordingly. It is rather the case that utility tokens belong to the basics and security tokens are a supplement.

With regard to STOs, I often hear that it is “easy money”. But, STOs will be subject to much stricter legal requirements, e.g. in terms of prospectus requirements, than unregulated ICOs — this will increase the legal costs in particular, from which law firms will benefit. The current market situation, “Cryptowinter”, leads to a consolidation by decreasing liquidity and therefore it is associated with a professionalisation of the projects (“survival of the fittest”), these things raise the bar for financing even higher. It is expensive and time-consuming to carry out an STO. However, prices will fall as standardisation and regulation evolve and the number of service providers rises in the long run. We already know platforms that will make this possible. In this context, it is important to emphasize the lack of experience, because nobody has a glass ball — only once we have seen numerous public STOs a valid assessment will become possible.

Why should I tokenize my company shares?

Already today your company shares are traded digitally on a stock exchange, but in Germany you still need a signed certificate which must be deposited as a security. Now it is possible to go the next step in the digitization of assets and its trading processes like Neufund, Börse Stuttgart or Stokera are doing. Tokenization now enables each company to digitize its shares and provide them with various options that can be individually tailored to the relevant investor groups (tokenomics). Liquidity is no longer reserved for listed companies. Basically, companies gain access to quickly available capital and investors get a liquid asset. However, investments in young companies remain highly risky and the future will show whether the market is ready.

The benefits could be that every company is able to tokenize their shares and trade them fast and easy with lean processes. Furthermore, companies are able to configure the properties more easy and individually, for instance with or without voting rights. The investors get a more liquid asset and companies getting access to (big) money in less time, compared with an IPO.

Where do you see the biggest pros and cons doing an STO as a means to raise funds?

As already mentioned, this type of liquidity was previously reserved only for listed companies with a revenue in the double-digit millions at least and a market-ready product/service, and there was certainly a reason for this (risk assessment, investor protection, etc.). But Crowdinvesting shows that such a concept can work and it is time to take the next step.

A clear advantage is certainly the low entry barrier on the technical side and of course the liquidity on the investor side. In addition, the company gains access to investors worldwide and has to invest less time compared to an IPO.

At the moment, however, there is still uncertainty about the legal framework for practical implementation. In addition, there is the global inconsistency of local regulation, which can be attributed to a lack of agreement and communication I think. In addition, we are in a very young market with an immature infrastructure — we will see a lot of progress in this area in 2019! The market is therefore very volatile and very speculative. There are many hidden costs that can be more clearly estimated as the market matures.

At this point I would like to add a legal perspective. I assume that we in Germany will see a much more practicable and simpler regulation for STOs this year — the competition for the blockchain capital is strong and I hope and think Germany can still score here.

How expensive and time consuming is it to do an STO?

It depends on the project. DLT Capital provides an individual estimation sheet with time and cost estimations (including savings from our exclusive partner deals), so the companies get a quick overview of the effort of their STO / Fundraising.

Where do you see the biggest challenges doing an STO in these days?

I think finding the right partners e.g. for fundraising, listing, prospect writing (in case of public sale) etc. is key in this market! The token issuance in particular is difficult. In Europe there is still no platform that is allowed to issue security tokens for a public sale in accordance with the law. Another obvious challenge is the public sale in the bear market, which is admittedly not STO specific. Furthermore, setting up clean processes and being compliant with the relevant legislation can also be challenging these days — This essentially concerns the obligation to publish a prospectus.

What would you recommend to projects considering doing an STO?

I can only repeat myself at this point — Find the right partner is key! Your partners are giving you guidance to make the right steps at the right time under these special and fast changing market conditions. Projects should also consider other alternative financial options — we are consulting them too.

Many people see a big advantage of tokenizing Venture Capital — thereby bringing more liquidity into the market. Can you explain to us how Security Tokens are enabling this?

Basically, the tokenization of venture capital and the associated “disruption” of the market are strictly speaking ICOs and not necessarily security tokens. Since only accredited investors operate in the VC business, this is a different legal basis with significantly reduced requirements. In a nutshell, this means that the investor offers, which is represented by the security token, can be completely individually adapted, while in the public sale according to today’s law one has some more restrictions, especially in terms of prospectus, and has to make the same offer to everyone. Nevertheless, there are of course legal regulations that need to be observed when digitizing VC with security tokens, which Stokera and Ashurst are currently working on. The mechanism of getting more liquidity into the market through the digitization of VC is quite simply explained by the existence of the crypto market. The crypto market generates liquidity by bringing together buyers and sellers of tokens and thus giving an investor the opportunity to sell his shares. It does not matter whether the token is a security or a utility so far. The difference is in the properties that the token represents, which could be equity, shares, turnover share, voting rights etc.. I am curious to see how the market for security tokens will develop and what effects this may have on the crypto market. I think we will see much better regulatory frameworks, like prospectus “light version”, and a major advance in financial infrastructure in 2019.

But in general, tokenization raises of course the value of securities and its underlying assets to investors through increased liquidity, so the value of tokenized securities should also rise in the market. On the other hand I could imagine that the higher level on liquidity lowers the returns of investors in the long run, cause it is not longer needed to compensate them for taking the risk of low liquidity and high barriers. Additionally I would like to mention some more benefits of tokenization of assets. Let me briefly summarize it for Brokerage firms. They can reduce internal costs, develop new products (tokenized assets of everything, ETFs etc), enter new markets (EM, new investors…), and increase value for existing shareholders. In conclusion to this, the fund industry has fantastic use cases for Blockchain.

One often mentioned advantage of Security Tokens is that of fractional ownership? Can you explain to us, why this was not possible before Blockchain technology came along?

Fractional ownership applies to the trend of tokenization of assets or tokenization of everything and means that several unrelated parties can share ownership of a high-value tangible asset, like real estate, to mitigate the risk of the investment. But it is not new, just digitized by the blockchain cause all use cases including registry, like a cadastre, works well with blockchain. And one can automate the process and reduce costs and more people get access to some investment classes plus one can create new investment classes.

One of the main motivators for a fractional purchase is the ability to share the costs of maintaining an asset that will not be used full-time by one owner, like a yard, or to make bigger investments to get more return, like crowdinvesting.

What was the best learning you made during the last year?

Good question! I had assumed that we would see much more progress in regulation, cause the legal basis is given in most jurisdictions — I’m just not a lawyer. Instead, implementation of global standards/regulation turned out as very difficult with slow progress. The next problem is that we are going to define local rules for global markets and processes — we need more communication & collaboration on this topics. A lot of laws will be launched in 2019 and we at DLT Capital believe that 2019 will be the year of Security Token and building financial infrastructure — regulators facing the old problem of how to reframe the changing environment, driven by the accelerated technological progress, to protect the people (retail investors) and not stall the innovation. With regard to the obligation to publish a prospectus, I see the challenges in finding the appropriate effort for young companies to meet the protection obligations of retail investors while at the same time not standing in the way of progress. But we don’t know how the market will react on the change, cause it is still an high risk investment in early stage companies and the previous legislation was not without reason in the EU — or it will “just” bring the digitization of IPOs and assets, at the end (?).

Thank you for the interview.

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