How tokenisation as a method of funding could help technology companies
Tokenisation
By Emily Pavlou, OneCycle
Tokenisation of assets refers to the process of issuing a blockchain token (specifically a security token) that digitally represents a tradable asset. These security tokens can be traded on a secondary market.
The tokens act in the same way as any other traditional security or investment contract, and are subject to the same rules and regulations.
The way we invest is changing
Security Token Offerings to account for 32% of early-stage funding by 2022 ( Opimas Consulting)…
The way we invest in assets has begun to fundamentally change since the arrival of tokenisation, with rapid disrupting in the technology sector.
There are many reasons for this. Predominately, benefits to both the investor and the start-up (or seller/issuer of the tokens).
Tokenisation Example : OneCycle Limited
A sustainable and green company, OneCycle decided to maximise the benefits of a token fundraise.
OneCycle is a Green NanoTech, that extracts magnesium directly from the sea in a sustainable and carbon neutral way. They are transforming how we produce nano-particle sized magnesium, known as MgO Nano. After thorough consultation and liaising with key stakeholders, they began fundraising through a FCA compliant security class asset/security token offering, backed by the physical magnesium or nano-particles produced.
Fundraising for this build has begun via a tokenised asset – the Magno token – attracting both traditional and the new breed of investor through the global nature of blockchain. Key benefits of this tokenised offering so far, are asset liquidity, and a less expensive source of growth capital – both a priority for a company like OneCycle that plans to grow at a high rate. The MagNo token is currently issued at less 50% of underlying realisable products market value.
What do technology start ups need?
Asset liquidity and a low cost source of growth are key, but there are so many other key benefits to companies like OneCycle and the investor with tokenisation.
Greater Liquidity
By tokenising assets, tech companies benefit from increased liquidity, so in the example of OneCycle, each MagNo Token is backed by the real world asset magnesium oxide nano-particles ( MgO Nano).
The tokens can be traded on a secondary market, where there is a broader range of traders, increasing liquidity further. This benefits investors as they act as direct counter parties rather than to have to place an order with an administrator or broker. And benefits sellers/issuers like OneCycle, whom benefit from greater liquidity, lower processing/ admin costs. This is all due to the automation and digital record keeping that does away with costly intermediaries.
Equity investments in technology can sometimes be illiquid for a longer period. Security tokens become liquid much faster, in some cases immediately, allowing for faster returns, greater ease of rebalancing an illiquid portfolio, and the potential ability to realise returns at any time.
Faster and cheaper transactions
Tokens are completed with smart contracts, so faster deals and lower transactions cost, and tokenisation reduces risk from data breaches.
Criminals target businesses that accept credit and debit cards because there’s a wealth of intelligence in payment information. Hackers target insecure systems that contain this intelligence, and sell the stolen data or use it themselves to make fraudulent purchases.
The costs to businesses are all too familiar. Ponemon Institute’s 2018 Cost of a Data Breach study pegged the average data breach at $3.86 million. Ponemon’s estimate for each lost or stolen record containing confidential information now stands at $148.
Tokenisation helps protect business from the negative financial impacts of a data theft. Even in the case of breach, valuable personal data simply isn’t there to steal. Tokenisation can’t protect your business from a data breach – but it can reduce the financial fallout from any potential breach.
Getting the investment : STO v IPO
If you invest in a company, and you get a token instead of a share certificate (digital or printed). The token has coded restrictions on transfer and sale that are agreed upon at the time of investment. Security tokens make life simpler, faster, and easier than shares because tokens are digital (accountable, trackable, and impossible to counterfeit).
Transaction costs are lower (close to zero). Tokens enable fractional ownership with no overhead.
Security token offerings (STOs) may only require limited disclosures relative to IPOs or other traditional offerings, which would reduce the costs of the token issuing companies/ the tech start-up.
Advantages of tokenisation compared to loans
The crucial advantage of tokenisation compared to loans is that it’s significantly more accessible. For projects without hard assets that can serve as collateral or in the case of raising capital for a new project or a newly incorporated special purpose vehicle, you may not be eligible for a loan at all. And even if you are eligible, the interest rate may be too high and make the business less attractive overall, because the cost of capital is too high.
Another advantage is that tokenisation provides a better ‘loan-to-value’ (LTV) ratio. If you offer tokenised debt securities, you can get any LTV as far as you can find investors for whom such an offer would be compelling.
Difference from the institutional private placement
Private placements are fundraising rounds that suggest getting capital from large institutional investors, like venture funds or private equity funds.
The problem with institutional capital is that big investors have a high bargaining power due to their size. It means that they can demand better terms, such as a higher equity stake, a place on the board of directors, and other conditions. These conditions often may be highly unfavourable for your business. For example, due to the so-called “liquidation preference”, you as a founder may not get anything at all at an exit unless the company hits the big growth targets.
With tokenisation, the choice of investors is flexible, which allows you to set your own terms and generally get higher bargaining power. Additionally, as tokenisation enables trading even without an IPO, investors get higher flexibility for a cash-out, which means they now do not have to make the company chase ridiculous growth targets.
Tokenised securities and equity crowdfunding
Equity crowd funding emerged and has grown in popularity in the recent decade as an alternative to banks and institutional financing. Even though it has been first introduced for startups, it has spread to other industries as well, such as real estate. Still, equity crowdfunding has several severe limitations.
The first problem is that shares sold by doing crowdfunding cannot be traded. This is a massive handicap because most investors are used to investing in highly liquid assets like Tesla or Bitcoin, and they are not ready to get only dividends or wait for years for a chance to get a return on their investment. Investors for whom this is a good deal are, first of all, institutional ones, as mentioned above. Unlike shares sold on crowdfunding campaigns, tokenised securities can be traded, which makes them much more attractive.
Another problem with crowdfunding platforms is the fact that they are geographically limited to a single country or region. This is because such platforms require a license, which is valid only in a single country where it has been granted. Such a pattern is especially problematic for developing economies with limited local capital markets.
Difference between tokenisation and public offering
As something that provides access to investors and trading, tokenization seems to be similar to a conventional public offering. From a legal perspective, a security token offering may be conducted in different ways, using the regulation either for public offerings or private placements. But usually, tokenised securities are not listed on traditional stock exchanges and are not regulated as fully public offerings.
IPO has a very significant implication for cost, as it’s very expensive. According to the PwC, the average price of a small IPO in the US is $7.3 million. This number doesn’t take into account the additional annual reporting burden for public companies. Security token offering may cost ten to a hundred times cheaper depending on the size and other factors.
The drawback, however, is that stock exchanges usually provide better access to investors, and trading there is easier. With security token offering, you need to put in additional efforts to find investors, and trading is limited compared to stock exchanges, even though still much better than in the case of equity crowd funding and private placements.
Conclusion
OneCycle used as a perfect example of tokenisation, have definitely benefited from the advantages outlined in the article above, they are currently still open for funding with their Security Class Token, and then it will be available on the Archax digital exchange for trading.
Using tokenisation as a fundraise will leave more money for other areas of the business essential for success.
There are some obstacles in the way of widespread adoption of tokenisation, but education, and piggybacking the success already in the marketplace, means that this is being overcome rapidly.
“Only institutions that engage with the technology (tokenisation), plan for the future, and adopt to the realisations of it, will thrive”
Deloitte