What is a Securities Token Offering (STO)?
An STO is just like any other securities offering, only the holder’s ownership rights are provided in token form instead of an electronic certificate or piece of paper.
Should I conduct an STO?
That depends. First, let's review what goes into any standard securities offering.
So, you want to offer securities.
You have some decisions to make...
Will you register your offering or will you use an exemption from registration?
Common exemptions from registration:
- Reg D (Rule 506(c) or 506(b)): Private Placement, generally only accredited investors
- Reg A/A+: Mini-IPO, requires SEC to qualify, limited to $50M if Tier 2
- Reg CF: Regulation Crowdfunding, limited to $1.07M
- Reg S: International investors ONLY
Registration methods:
- S-1 (Equity/Debt): Also known as an "IPO" or Initial Public Offering
- SF-1 (Asset-backed)
- S-11 (REIT)
Will I use a single, or concurrent exemptions, or attempt to qualify or register my offering?
Certain exemptions can only be used alone, others can be combined. It is worth noting that registering or qualifying an offering is an incredibly expensive and time-consuming process, which is why many companies will use a registration exemption, where possible. You should consult your securities counsel before attempting to offer or sell your securities - remember, the SEC has a broad definition of both.
What securities will you offer?
- Will they be equity, debt or hybrid?
- Are they asset-backed?
- Are they convertible? Are they redeemable?
- Do they pay via interest, dividends, revenue share, profit share or royalties?
- What are the rights of the securities holders?
- How will they be issued? As electronic certificates, immediately? As paper certificates, later convertible into electronic ones?
...and some materials to prepare
- Regulatory and legal disclosures
- Subscription agreement fro investors
- Marketing materials, sales strategy
- Regulatory filings
The forms you need to file will depend on the type of offering you've chosen to conduct:
- Reg CF → Form C with the SEC
- Reg A → Form 1-A with the SEC and Form 5110 with FINRA if a broker is involved.
- Reg S → No forms required before initiating the offering.
- Reg D → No forms required before initiating the offering, but Form D due 15 days after first sale.R
- S-1 or SF or 1/S-11 → Forms S-1 with the SEC and down the rabbit hole...
If you're issuing your securities as electronic certificates on a blockchain, you'll also need to create a Smart Contract.
First, decide which blockchain the securities will reside on.
Such as Ethereum, Stellar Lumens or EOS
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Ethereum: Security tokens that want to implement novel or complex governance mechanisms into their security token would benefit from Ethereum's robust developer community and ongoing innovation above the native chain. There is no limit to creativity or complexity in Ethereum's smart contract platform, which is quasi-Turing complete. Several developers are already creating smart contract layers on top of the Ethereum blockchain in an effort to establish standardized creation of security tokens, such as with the ERC-1404 open standard, which was developed under the guidance of securities law firms, major cryptocurrency exchanges, and issuers alike.
Things to consider:- Ethereum requires transaction fees to run smart contracts.
- Notable congestion and slower TPS is concerning for some developers and issuers.
-
EOS: If your security token wants to engage in a high-volume transactional environment (in other words, if throughput and/or secondary market dynamics are inelastically preferred for the security token), EOS is a natural fit. The platform can support whole orders of magnitude more of transactions per second for much cheaper than Ethereum. Things to consider:
- Not many notable STO's have launched on EOS. However, a new Financial Securities Protocol has been announced by Ed Sylantyev, which aids with the standardization of compliant security token creation on the chain.
- One fundamental difference from Ethereum is that running smart contracts requires staking tokens for the smart contract. The idea is that while ethereum charges fees for running a contract, EOS lets you essentially rent some of its computing power to run contracts by staking tokens, which can be retrieved after performing transactions.
Stellar: Smart contracts on the Stellar blockchain are simpler, and non-Turing complete. Security tokens that aim to provide simple revenue sharing, for example, would benefit from Stellar's consequentially faster, more scalable network.
Next, you'll have to:
Incorporate the rights of securities holders onto the digital asset
-
If offering the securities through a registration exemption, create secondary trading restrictions:
- for Reg D → Rule 144
- for Reg S → offshore purchasers only for a time
- for Reg CF → accredited/non-accredited purchasers
Ensure KYC investor data protection
-
Enable mechanisms for:
- Paying dividends, interest, principal, royalties, rents, profit or revenue shares, redemptions
- Sending information and updates to holders
- Reversing transactions if/when necessary
- Handling future corporate transactions
Some things you'll need to consider...
Marketing
- Website for your fundraise with information and appropriate disclosures
- Ability to accept investments online
- Outreach to attract prospective investors
- Leverage an investing platform to aid in your marketing efforts and facilitate your offering (i.e. join Republic!)
Collecting investments
- Collect investor details
- Investor signs agreement, then sends funds
- Perform KYC-AML
Additional steps...
- If 506(c) → verify accreditation status
- If broker-dealer is involved → compliance review (as per Rule 2111), retain data (as per Rules 17(a)(3) and 17(a)(4)
Post-close
- Manage investor communications
- File required regulatory reports
- Maintain a file of all communications with securities holders
- 🎉 Celebrate your successful raise!
- ✋But wait! You aren't done...
How to prepare
- List tokens on one or more digital exchange(s)***
- Engage firms to write research reports
- Initiate investor/market PR strategy
- Create and maintain a webpage with current company information
How to trade
- If Reg D → ensure enforcement of Rule 144
- If Reg CF → ensure enforcement of non-accredited purchaser restrictions
- If Reg S → take reasonable steps during compliance period
- If Reg A/A+ → maintain current information and monitor blue sky law
Back to the basics...
What is a Securities Token Offering?
An STO is just like any other securities offering, only the holder’s ownership rights are provided in token form instead of an electronic certificate or piece of paper.
Should I conduct an STO?
As an initial fundraising method or even a second round of fundraising...probably not. However, there are limited examples where an STO can make sense.
Here are some cases in which an STO does make sense:
In private equity, where investments in PE funds are highly illiquid
When dealing with large pieces of real estate
When dealing with limited blockchain protocol environments
For user engagement efforts...
Stay tuned for more on this from Republic.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.
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