Although it may seem like something that is decades away, it is not. Blockchain and tokenization are going to create (very soon) conditions for investors worldwide to securely buy assets anywhere. It is known as the “democratization of investing”. It is already estimated that STOs or secure token offerings (described below) will generate more than $5 Trillion (with a “T”) in capital from now to 2025 (that’s in the next 6 years only). Let that sink in . . .
STO with SPAC-like Structure
The proposal described herein relates to structuring a “secure token offering” or an “STO”, that contains certain features of a SPAC (Special Purpose Acquisition Company), also known as a “blank check company”. The special purpose acquisition company is a type of investment fund that allows public stock market investors to invest in private equity type transactions, particularly leveraged buyouts. SPACs are shell or blank-check companies that have no operations but go public with the intention of merging with or acquiring a company with the proceeds of the SPAC’s initial public offering (IPO). Most SPACs list on NASDAQ, and over the past few years, the capital raised though SPACs was $10B in 2017 and $14B in 2018. This sort of STO offering eliminates the onerous reporting and filing requirement associated with a traditional SPAC.
The following is a succinct summary of the SPAC structure from an Ernst & Young LLP publication, “Technical Line – Navigating the requirements for merging with a special purpose acquisition company” published May 16, 2019:
Upon formation, a SPAC is initially capitalized by sponsors, who contribute nominal capital or fund formation and offering costs in exchange for founder shares that typically make up 20% of the shares of the company after the IPO, assuming the underwriters don’t exercise an overallotment option. The SPAC then files an initial registration statement on Form S-1 with the Securities and Exchange Commission (SEC) to conduct its IPO. The SEC usually declares a SPAC IPO registration statement effective more quickly than a traditional IPO registration statement because the SPAC registration statement is simpler than that of an operating company. A SPAC’s balance sheet usually presents only deferred offering costs, the statement of operations presents nominal operating expenses consisting of organizational and startup expenses, and the statements of shareholders’ equity and cash flows reflect the issuance of founder shares to the sponsors. Because they typically qualify as emerging growth companies (EGCs), SPACs may elect to provide reduced disclosures. A SPAC’s IPO registration statement also doesn’t have to include any financial statements of businesses to be acquired under Rule 3-05 of Regulation S-X because it hasn’t yet begun its search for a potential target. As a result, the SEC staff usually issues fewer comments on a SPAC’s IPO registration statement, and those comments are easier to resolve than those on IPOs of more complex entities. After the IPO, a SPAC must promptly file an audited balance sheet under Item 8.01 of Form 8-K showing at least $5 million in net tangible assets to avoid classification as a blank-check company subject to the requirements of Rule 419 of Regulation C, which, among other things, restricts trading of a blank-check company’s securities. A SPAC must also comply with normal public company periodic Exchange Act reporting obligations. The equity sold in a SPAC IPO consists of units, each typically comprising one share of common stock and a warrant to purchase one-half of one share of common stock in the future. The warrants, which become exercisable shortly after the SPAC acquires an operating company, are issued with a strike price that is out of the money (usually 115% of the price per unit in the IPO). They are intended to compensate holders for investing their capital in the SPAC before it acquires an operating company. Proceeds from the IPO are placed in a trust account for use in an acquisition. The SPAC then identifies one or more operating company targets for acquisition. These operating companies are usually privately held companies that use the SPAC merger to become publicly traded companies. A SPAC generally has 18 to 24 months from the date of its IPO to acquire a target, depending on the provisions of its charter documents. If an acquisition is not consummated during that period, the SPAC dissolves, and the IPO proceeds that are held in trust are returned to investors. SPACs sometimes seek approval from their shareholders to amend their charter documents to extend the acquisition deadline. When a SPAC proposes to acquire a specific target company, public shareholders have the right to redeem their shares for a pro rata portion of the proceeds held in the trust account (usually an amount equal to their original investment, plus nominal interest) if they do not wish to invest in the proposed target. The warrants received as part of each SPAC unit in the IPO remain outstanding even if a shareholder elects to redeem its shares.
The afore referenced is a description of the traditional SPAC IPO that launches on a public stock exchange such as NASDAQ. The proposed structure herein seeks to utilize the basic idea of the SPAC but formulate and enhance the capital raising feature through the STO. The Secure Token Offering is an investment offering of securities that has a tangible asset-backed value attached to it. The “asset” can be real estate or other “thing” of value, or profits derived from revenues, and includes actual legal rights such as voting or revenue distribution. The STO differs from a conventional security in that it confirms ownership through blockchain transactions. The STO must adhere to the regulatory restrictions in the jurisdiction where it is located. The advantages to the STO when compared to the traditional securities offering, private or public, are numerous: 1- lower underwriting expenses; 2- the offered security can be fractionalized; 3- the tokenization has greater flexibility due to the manner in which it is presented on the blockchain, i.e., the coded “smart contract” can be adapted so that it performs exactly according to the issuers desired offering, 4- the incidence of fraud is eliminated; 5- the purchaser can access greater liquidity through the exchange where the token is stored; 6- creates access to assets that were traditionally available only to institutional investors by allowing for fractionalization of the offered asset; and 7- Security tokens tend to enjoy high levels of liquidity as they are eligible for trading globally (24/7), allowing for anyone around the world to access them.
The Proposed STO Structure
The STO issuer entity will be registered in a non-US jurisdiction such as Liechtenstein or Malta. The offering should still strive to comply with an offering that is exempt from SEC registration and structure itself as Reg D and Reg S compliant. Reg D being an offering that is for accredited investors and Reg S for non-US investors. Further analysis of the SEC perspective (given the asset is US based and some of the founders are US citizens) is required.
The prospectus will describe the industry target with the following as an example: “acquire existing operating assets that consist of Manhattan-based commercial real estate with existing rental income, and which present opportunities for ongoing cash flow during renovation or repositioning of the asset.” The STO establishes a token price multiplied by the total number of available tokens in the offering and relates the token to a particular asset benefit such as “1 token equals 1 membership unit in the operating entity with limited voting rights”. In real numbers this might be “2,000,000 tokens offered at $500 per token” in order to raise $1 billion in capital.
Like the SPAC, the issuer management team needs to be top notch and consist of an industry specific leader, an experienced tokenization manager, sophisticated financial managers, all jointly as a combination providing superior credibility and expertise. The smart contract will essentially mimic the SPAC process, in the sense that the token buyer will make the token purchase with the understanding that the purchase price will be held for a period of time (12 months for example) so that the issuer can enter into the appropriate transaction with the target asset by way of merger, straight forward acquisition or the like. The transaction letter of intent will be presented to the token buyer who will have thirty days to either confirm the transaction or elect to withdraw. If the token buyer elects to withdraw, the transaction is reversed, and the buyer is refunded his purchase price with a pro-rata amount of interest. If the token buyer elects to confirm the transaction the purchase is concluded, and the token is transferred to the buyers designated wallet and the purchase price is released to the issuer. The issuer has the opportunity, via the platform and the website (the medium that is being used to communicate with the token buyers or interested parties) to inform them of these developments, which also serves to generate further interest in the STO and if necessary will act as a source to replace any buyers who decide to nullify the transaction by withdrawing.
The STO can engage underwriters to assist in i) the organization and ii) the promotion of the STO to ensure that it achieves maximum exposure. The underwriting costs related to i) and ii) are expected to be greatly reduced when compared to the traditional SPAC costs.
It has been reported that STO’s are expected to generate $5 trillion in capital from now through 2025. The industry is actually refining itself in real time, and therefore presents opportunities for capital raising which exists due to the public’s appetite and appreciation for the perceived advantages. I foresee multiple opportunities that can be leveraged from the SPAC structure, in this case, channeled through the emerging STO vehicle.