#22 StartUp: Unlock Ownership - The Rise of Tokenized Shares

Why on the hearth Startup (or other companies) should think of raising money not just from equity selling but as well from tokens?

Answer: Give more people the opportunity to make money from your multi-trillion company!

Let's dig deep! Shall we?

Starting point

In recent years, the world of finance has witnessed a transformative shift with the emergence of blockchain technology.

One of the most exciting applications of blockchain is the tokenization of assets (ScanSan Properties tokenise properties in the smartest way possible, have a look and make money), including shares of companies.

Tokenization of shares refers to the process of representing traditional ownership shares as digital tokens on a blockchain.

This blog post explores the concept of tokenization of shares, its benefits, and the potential impact it can have on ownership and investment.

Below few questions that I've asked myself.

First of all: What is the Tokenization of Shares?

Tokenization of shares involves converting company ownership shares into digital tokens recorded on a blockchain. These tokens, typically utilizing smart contracts, represent ownership rights and can be transferred peer-to-peer without intermediaries. Each token represents a fraction of the underlying asset, allowing for fractional ownership and easier divisibility.

Why is so impactful?

Streamlined Capital Raising: For companies seeking capital, tokenization provides an alternative to traditional funding methods. Initial Token Offerings (ITOs) or Security Token Offerings (STOs) enable companies to raise funds by issuing tokenized shares directly to investors. This process can streamline the fundraising process, reduce costs, and expand the pool of potential investors. Remember, these are two different ways of raising capital, therefore, need to be treated differently and create different documents for it to be applicable. You will find more info below.

What we should be aware of?

Regulatory Considerations: Tokenization of shares operates within existing regulatory frameworks, necessitating compliance with securities laws and investor protection regulations. Companies and investors must be mindful of jurisdiction-specific requirements and engage legal counsel to navigate the regulatory landscape effectively.

What are the advantages?

Advantages of Tokenization of Shares:

• Increased Liquidity: By tokenizing shares, previously illiquid assets can be traded on secondary markets with greater ease and efficiency. Investors gain access to a global marketplace, enhancing liquidity and potentially unlocking new sources of capital.

• Fractional Ownership: Tokenization enables fractional ownership, allowing investors to purchase smaller portions of high-value assets. This democratizes investment opportunities, making traditionally exclusive assets accessible to a broader range of investors.

• Transparency and Security: Blockchain technology provides an immutable and transparent record of ownership. Every transaction is recorded on the blockchain, reducing the risk of fraud and enhancing the overall security of the ownership ecosystem.

• Automated Compliance: Tokenized shares can be programmed with smart contracts that automate compliance requirements, such as investor accreditation or regulatory restrictions. This streamlines compliance processes, reducing administrative burdens and ensuring adherence to relevant regulations.

• Unlocking New Investment Opportunities: Tokenizing shares open up new investment opportunities across various sectors. It allows for the fractional ownership of real estate, venture capital investments, fine art, intellectual property rights, and more. Investors gain access to a wider range of assets, diversifying their portfolios and potentially generating higher returns.

Documents

If you decide to conduct Security Token Offerings (STOs) for your company, you will generally need to create a different set of documents compared to those required for traditional equity investments. The documents for STOs are designed to comply with securities regulations and ensure transparency and investor protection in the digital asset space.

Here are some key documents commonly associated with STOs:

1. Offering Memorandum (OM) or Prospectus: This document provides detailed information about your company, the tokenized securities being offered, associated risks, use of proceeds, financial statements, and other relevant disclosures. The OM or prospectus is crucial for investors to make informed decisions and is typically prepared in accordance with applicable securities laws.

2. Token Purchase Agreement (TPA): The TPA outlines the terms and conditions of the token sale, including the number of tokens being sold, the purchase price, any lock-up periods, transfer restrictions, and investor representations and warranties. It serves as the contractual agreement between the issuer and the investor.

3. Subscription Agreement: This document is signed by investors to indicate their intent to purchase the tokenized securities. It includes information about the investor, the number of tokens being purchased, the purchase price, payment terms, and representations and warranties.

4. Token Governance and Rights: As part of the STO, you may need to outline the governance structure and token holder rights. This may include details on voting rights, dividend distribution mechanisms, redemption rights, or any other rights and privileges associated with the tokenized securities.

5. Token Issuance and Token Holder Agreement: These agreements outline the terms and conditions governing the issuance and transfer of the tokenized securities, including the procedures for token creation, token distribution, token transfers, and any associated fees or restrictions.

6. Legal Opinions and Compliance Documents: Depending on the jurisdiction and regulatory requirements, you may need legal opinions from qualified legal professionals attesting to the compliance of your STO with relevant securities laws. Additionally, you may need to file certain disclosure documents or reports with regulatory authorities.

Bear in mind you can do both at the same time but you have to be careful

Dilution Traps

It can happen that an investor purchases tokens using the equity path and this can potentially lead to diluting the value or ownership of token holders who have participated in an STO. This scenario can arise if there is an overlap in the ownership structure or if there are different classes of shares or tokens involved (of course you don't want this to happen because as a Founder this will just give you a headache).

Below few factors to consider:

1. Ownership Structure: If your company has multiple classes of shares or tokens, it is essential to clearly define the rights and privileges associated with each class. This differentiation helps ensure that the rights and ownership of STO participants are protected from potential dilution caused by equity investors.

2. Dilution Protection: Implementing mechanisms like anti-dilution provisions can help protect the value of token holders in an STO. These provisions can be designed to adjust the number or value of tokens issued in the event of new equity investments or share issuances, reducing the risk of dilution.

3. Voting Rights: Depending on the governance structure of your company, different classes of shares or tokens may have varying voting rights. It is crucial to clearly define the voting rights of token holders in an STO to safeguard their influence and decision-making power within the company.

4. Investor Protection Measures: When conducting an STO, you must adhere to securities regulations and provide appropriate investor protection measures. These measures may include disclosure requirements, transparency, and ensuring that STO participants have a clear understanding of their rights, risks, and any potential dilution risks associated with other investor classes.

Let's wrap it up

I know this article wasn't easy to digest but those are all things that I believe founders should be aware of before jumping into the STO world.

To navigate the complexities of investor dilution and to protect the interests of both STO participants and equity investors, it is advisable to consult with legal professionals experienced in securities law and corporate governance. They will help you to create the right structure you want to offer and create appropriate agreements to mitigate potential conflicts or dilution issues between the two investor paths (very important to think about the future and how you want your company to be in the future)

It's important to note that the specific documentation requirements for an STO can vary based on the jurisdiction, the nature of the tokenized securities, and applicable securities regulations. Engaging legal counsel experienced in securities law and digital asset offerings can help ensure that you create the necessary documents that comply with the relevant regulations in your jurisdiction.

And at the end, we can say that the tokenization of shares represents a paradigm shift in ownership and investment. By leveraging blockchain technology, this innovative approach offers increased liquidity, fractional ownership, transparency, and automation of compliance processes. It unlocks new investment opportunities and streamlines capital raising for companies. While regulatory considerations remain, the potential benefits and impact of the tokenization of shares make it a powerful tool for shaping the future of finance and democratizing access to investment opportunities.

Be smart and most important avoid being greedy, everything should be done at the right time.

Thanks

Alessio