Case Study
Equity-backed Tokenization
A hypothetical case study
ETO vs ICO
The Equity Token Offering (ETO) was an unfamiliar concept this time last year. The Initial Coin Offering (ICO) was king; ranking in projects millions of dollars in the blink of an eye. However, the market has changed, investors become aware utility tokens did not confer much in the way of ownership. Equity tokens solve most of the issues that plague ICOs. Being backed by equity gives investors more security than the vague promise of future utility.
ETO is regulated, protecting investors from bad actors and outright scams. ETO enable access to a global pool of investors without sacrificing control. They are compliant with all securities laws and can offer liquidity to investors. In addition, they greatly reduce operational cost and complexity by paying out distributions and managing cap tables on the blockchain.
The Company
"You have put your faith in us and as a result, our strategic vision is finally becoming a reality. We have said from the beginning that we believe blockchain will disrupt the Capital Markets and with your support that is being achieved. Your capital has provided the company with the fuel that we need to bring blockchain to capital markets"
On August 6, 2018, an e-commerce retail giant blockchain subsidiary raised $134 Million from over 1,000 global investors with fully executed Simple Agreements of Future Equity (SAFE) in an Equity Token Offering (ETO) designed to comply with SEC requirements.
| VC FUNDING | ICO | ETO | |
| Dilution | High | Low | Low |
| Operational Impact | Mid | Low | Low |
| Strategic Impact | High | Low | Low |
| Regulatory Uncertainty | Low | High | Low-Mid |
| Liquidity | Low | High | Low-High |
| Required Track Record | Yes | No | No |
| Only Accredited Invertors? | Yes | No | Yes |
| Programmable? | No | Yes | Yes |
The company was interested in performing General Solicitation but did not want to assume the increased reporting requirements associated with Reg A+. The company filed a confidential private placement offering memorandum under Regulation D and S (U.S citizens must be accredited investors and offshore transactions could not involve U.S. citizens) to the U.S. Securities and Exchange Commission (SEC).
| REGULATION D | REGULATION A+ | REGULATION CF | |||
| 506 B | 506 C | Tier 1 | Tier 2 | Title III | |
| Raise Limits | No Cap | No Cap | <$20MM | <$20-50MM | $1MM |
| General Solicitation | No | Yes | Yes | ||
| Waiting Period | No | 60 Days | No | ||
| Unaccredited Investors | Up to 35 | No | Yes (as long as investment < 10% of net worth) | ||
| Investor Limits | 99 for Funds & 1,999 for Companies | No | |||
| Required Investor Accreditation | Self | Issuer Verified | Self | ||
| State Registration (Blue Sky) | Yes | Sometimes | Yes | No | |
| SEC Registration | Form D Only | Yes | Form D Only | ||
| SEC Review | No | Yes - Several weeks | Yes - 3 Weeks | ||
| Annual Audit | No | Yes | |||
The company plans to use the funds to finalize its blockchain Alternative Trading System (ATS) and build similar platforms in jurisdictions around the world. The platform will purportedly allow traders to exchange tokens in an easy, compliant, and user-friendly manner with features such as risk management software, an order management system, matching engine, and others.
TOKEN GESTURE
Although the company has deployed the token contract and created the tokens on October 12, 2018, holders cannot access them until January 10, 2019. To comply with securities regulations, they must remain in a custodial wallet for 90 days after issuance. Following this three month lock up, the company will allow holders to resell the tokens in a digital securities broker account. Other Accredited Investors may open accounts with peer-to-peer trading only accepted via this platform.
After this period, holders and other accredited investors will be able to trade them on the company’s platform currently developing. Non-accredited investors can join the party by August 6, 2019, through an approved trading platform. The company also plans to register the securities to allow secondary trading on international exchanges.
The benefits of the equity token, particularly when compared to traditional securities:
"... tokens in your personal wallet will not represent merely a contractual claim against someone else’s contractual claim, against some firm you never heard of that actually owns all the stock you think you own (that is to say, “the current National Market System of the United States”). With our technology, 1) you can hold your tokens in your own wallet representing true ownership of the Equity Token, 2) regulators get much greater clarity into the atomic structure of the market, so any mischief is observable by them, and 3) the whole thing is cryptographically protected in ways that make many forms of Wall Street mischief impossible to perform in the first place. In sum, this is the first step in a new and better form of capital market for humanity."
THE EQUITY TOKEN OFFERING
Working with Ohanae, company followed a 3-step process for setting up, executing, and managing its ETO.
In the setup phase, Company focused on structuring the offering creating or changing the required documentation, obtaining legal reviews for the process, and setting up marketing activities.
The ETO itself consists of issuing the tokens, conducting KYC/AML/Accreditation processes for the investors, and managing the flow of capital and tokens between company and investors.
Once the tokens are issued, the investor lifecycle needs to be managed, including investor communications and secondary trading compliance.
Pre-ETO
Company Charter
The issued tokens represents company stock. Company needs to issue sufficient stock to perform the issuance, and define their specific rights such as preferred or ordinary stock, dividends, voting rights.
Pre-ETO
ETO Documents
Company has to define the terms of the offering and reflect those terms in their offering memorandum. This document is substantially less comprehensive that the prospectus, used for public offerings, and includes:
Company Overview, Risk, and Financials.
Offering Details: In this case, the company decided to conduct an ETO under Regulation D, Rule 506 (c), since this allowed them to perform solicitation for their offering.
Minimum Investment Size: This is set to ensure that valuable investor slots are not taken up by small investors (up to 1,999 investors).
Rights: Dividends, voting rights, and standard drag-along rights.
Obligations: Right to buy back the tokens in certain cases.
Transfer Rights: Secondary trading is restricted by the existing securities regulations.
Price: Company to determine a price for each token.
Accepted Currencies: Company to decide using USD, BTC, and ETH.
Cap: The limit of the raise.
Closing Date: The date at which the offering ends.
Use of Proceeds: Company would have the flexibility to change this as it sees fits.
Legal Disclaimers: Company to engage outside counsel to assist with drafting the standard Private Offering legal disclaimers along with some additional disclaimers relating to the token offering.
Subscription Agreement: Investors may be required to sign the Subscription Agreement, which is a separate document that summarizes the terms of the investment and captures the investor consent to those terms.
Pre-ETO Marketing
Since Rule 506 (c) allows for general solicitation, company has created a marketing plan and set aside a budget. Due to the cap on the number of investors, these marketing activities are more focused and cost-effective, than those surrounding an ICO. The company may decide to use a broker dealer. Company to use the white label landing page provided by Ohanae in order to manage investor onboarding.
Issuance
AML/KYC/Accreditation: Under Reg D 506 (C), ETO are limited to Accredited Investors. Company working with Ohanae to seamlessly manage the AML/KYC/Accreditation process and create investor accounts on the Ohanae Asset Tokenization Platform for each investor that cleared the process.
Token Issuance: Company uses Ohanae Equity Token standard smart contract, which include all necessary global compliance requirements, such as limits on investor counts, lock-up period, and flowback restrictions.
Funding: The process of collecting funds from interested investors and distributing the issued token to investors will be handled by Ohanae, in compliance with the requirements defined in the set up phase. In addition, if the company prefers not to hold all the funds collected in BTC and ETH, the issuer may opt to use the 3rd party Custodian service that was offered through the Ohanae platform.
Lifecycle Management
Ongoing Communications: From time to time, company may need to communicate with investors. The details are generally defined in the Offering Memorandum and may include sharing periodic financial reports or certain event-trigged communications, such as those involving buy-backs.
Secondary Trading: Restricted shares have certain limitations on secondary trading such as lock-up periods and caps on investor counts in different geographies. Ohanae Equity Token Smart Contract manages these complexities with bake in secondary trading restrictions.
ETO Process Overview and Timelines
| Estimated Time | Responsible | Ohanae Role | ||
| Pre-ETO | Company Charter | 1 Week | Company, Counsel | Advise / Knowledge Sharing |
| Offering Documents | 1 Month | Company, Counsel | Advise / Knowledge Sharing | |
| Real-Estate Specific Setup | 0-4 Weeks | Company, Counsel, Ohanae Partners | Support | |
| Marketing | 3 Months | Company, Broker-Dealer | None | |
| Issuance | KYC / AML / Accreditation | Ongoing | Ohanae | Lead |
| Token Issuance | 1 Day | Ohanae | Lead | |
| Funding | 1 Day | Ohanae | Lead | |
| Total Time from Kick-Off Until Issuance:2-6 Months | ||||
| Lifecycle Management | Ongoing Communications | Ongoing | Ohanae / Company | Execution |
| Secondary Trading | Ongoing | Ongoing | Lead | |
Conclusion
Although there are currently no operational marketplaces trading in compliant equity tokens, there are several such marketplaces that are expected to go live by the time the lock-up period expires.
| Fundraising Alternative | Pain Points | Ohanae Value Proposition |
| IPO |
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| PRIVATE OFFERING |
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| ICO |
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