Have you ever wondered why so few companies go public? According to the World Bank, there are more than 100 million companies worldwide but less than 1% are listed on stock exchanges.
If you want to allow investors around the world to buy and trade your shares, you need to conduct an IPO (initial public offering) on the stock exchange. And the reason for such a small number of public companies is precisely the IPO and its cost. For example, the price of a small IPO in the US could be worth $2.6-13.3 million, according to PwC. And it’s without taking into account the annual costs of complying with the various requirements that may reach millions of dollars. Although the cost of going public may differ depending on the country and company, the IPO process is still quite expensive and time-consuming. So many companies, especially small and medium-sized businesses, remain private.
But if the company is not public, then this greatly limits investment potential. Most people do not have open access to investments in such companies; instead, only high-net-worth individuals and institutions invest in them. Limited access to capital quite often forces the owners of non-public companies to accept unfavorable terms offered by banks and individual investors.
One of the possible solutions is business tokenization that became possible with the advent of blockchain technology and the evolution of the cryptocurrency industry. Here’s what you need to know about business tokenization and what to look out for before using this fundraising method.
Tokenization is a method of converting assets like real estate, stocks, art, and so on into a digital token. Tokens are created and stored on the blockchain and can act as a digital counterpart to real-world assets.
With tokenization, you can attract new audiences and store the asset in a safe and secure environment. If you want to tokenize a business, then you can tokenize company shares to increase liquidity, transparency, and availability for international investors. Additionally, blockchain-based shares provide opportunities for the formation of a traceable secondary market.
However, asset tokenization still has several restrictions in certain countries due to the lack of regulated rules and the recognition of tokenized assets as the equivalent of real assets. Therefore, it is recommended to get legal advice before conducting business tokenization in your country.
Preliminary analysis is one of the most important steps for business tokenization. You need to assess the financial needs of the company and determine why you need tokenization — for IPO replacement, to promote a certain product or service, to sell an asset, etc. After that, it is worth identifying your target audience, as well as analyzing the market and competitive offers to assess the prospects for your solution.
The next step is the token economy formation and its technical implementation. A token means that a unit of an asset exists on another blockchain and is created using smart contracts. So you need to choose which blockchain to use for token creation.
At the moment, the top network for smart contracts is Ethereum, one of the advantages of which is the versatile standardization of tokens. For example, you can create ERC-20 tokens that are fungible and do not differ in any way from each other, or ERC-1400 tokens where each token is unique and has its own serial number.
Also, determine the advantage of buying tokens for investors, how tokens can be used, the issuance rules, and the number of tokens. Keep in mind that not all types of tokens may be suitable for creating regulated securities. For example, regulators may need to have proper AML/KYC procedures in place to accept tokens as counterparts of shares.
An important issue in business tokenization is the choice of the legal form of issuing tokens. While the company’s shares are traditionally listed on the stock exchange, the crypto market offers a lot of different ways to distribute tokens.
An ICO (initial coin offering) is a lot like crowdfunding and can be suitable for a startup or new project funding. ICO tokens can be purchased anonymously but they do not guarantee any ownership rights to the token owner. It means ICO investors may be more interested in the benefits of the token utility and more motivated in further token trading.
Although ICO creates a big room for attracting investors, you will most likely have to deal with its promotion yourself and may face some regulatory restrictions.
IEO (initial exchange offering) and IDO (initial DEX offering) are a kind of cryptocurrency analog of the IPO. IEO means that tokens first become available for purchase on a certain centralized cryptocurrency exchange, such as CEX.IO. IDO means the issuance of tokens on a decentralized exchange.
Although IEO and IDO help the project to attract a primary audience through the audience of the exchange, the overall potential for creating own community may be limited because not everyone can use the services of certain platforms.
STO (security token offering) and ETO (equity token offering) are special types of ICOs that represent a share in the company and give token holders the right to receive dividends and vote. That is, these types of tokens are the closest to the traditional shares of the company.
Many countries have specific regulatory institutions for securities and they can check issued tokens for compliance. STOs and ETOs are subject to the scrutiny of these institutions that distinguishes them from other ICOs and provides greater protection to investors.
While STO and ETO are subject to similar regulatory scrutiny, there are some differences between them. For example, equities have some unique regulatory nuances like token ownership in the name of a physical person or other legal entity, not in the name of a cryptocurrency wallet. It means equity token offerings have to collect investors’ personal data for AML/KYC requirements.
Business tokenization is an effective way to raise funds and attract new investors but this method is still in the early stages of regulation. Aside from STO and ETO, the status of most tokens is still uncertain, meaning tokenization could pose regulatory and legal challenges. However, business tokenization is becoming more and more popular since tokenization recognition as real asset equivalents grows every day.