Over the last ten years, equity crowdfunding has emerged as one of most innovative ways to raise growth. It has democratised finance, providing opportunities to retail investors which would otherwise be restricted to institutional investors such as venture capital or private equity, and it has provided a fresh way for companies to access growth finance.
That has proved to be a winning formula for two of the biggest crowdfunding sites: between them, Seedrs and Crowdcube have raised hundreds of millions of pounds for hundreds of high-growth companies.
But could we be about to witness the dawn of crowdfunding 2.0?
Late last year, the UK’s primary financial regulation watchdog, the FCA, quietly approved the first STOs or ‘security token offerings’. They’re the new kids on the block that share many of the benefits of crowdfunding – and then some. Experts are already estimating that STOs could boom in 2019, raising billions globally.
What is a security token?
Much like traditional crowdfunding, a company wishing to raise finance to grow its business can sell equity to investors, but rather that selling shares via an inefficient and dated offline process, instead it can sell so-called security tokens. These security tokens offer the same rewards as traditional equity such as ownership, dividend and voting rights. Essentially, they are digital representations of the same financial instruments which investors have been buying and selling for decades.
STOs are regulated by the FCA, so they offer investors protections and safeguards against fraud, theft and abuse of shareholders’ rights. Currently the amount that can be raised via an STO is capped at £1 million but this is expected to rise to around £7 million in due course – no mean sum for an ambitious start-up.
It all sounds very similar to traditional crowdfunding, so what’s the point, you may ask?
What are the advantages of STOs?
STOs have some important advantages which will make a difference to both fundraising entrepreneurs and their investors.
For a start, security tokens are built and managed on blockchain technology. That may put off a lot of investors, as crypto currencies have crashed in the last few months. However, STOs can be priced in fiat currencies such as pounds or dollars, so investors are not exposed to the perils of crypto currency volatility.
The efficiency of blockchain technology means better transparency, a simpler and easier fundraising process, with lower administration and management costs for both companies and investors. Entrepreneurs can also reach a wider universe of international investors.
Those investors have greater access to investment opportunities that, up to now, have been the preserve of VC funds only. STOs, you could say, will help to democratise finance.
How do investors make money from STOs?
Further, the ongoing development of a real, cross-border, 24/7 secondary market will offer real liquidity for both investors and companies raising money. Greater liquidity is one of the major problems facing angel and seed investors with the average lock-up time for investment being between eight and nine years. Greater liquidity also supports higher valuations as creating a bigger market draws in more investors.
For those early investors, a properly functioning secondary market means they won’t have to keep their money trapped in companies for years on end; it also means efficient price discovery enabling easier, more transparent valuation of investments.
STOs vs initial coin offerings
STOs build on the advantages and excitement of so-called ICOs or initial coin offerings. ICOs also involve the sale of tokens built and managed on blockchain technology, but ICOs are not regulated and therefore offer investors fewer protections and rights. Nevertheless, they have proved to be an enormous success, raising more than $6 billion from investors worldwide in 2017 – that’s equivalent to ten per cent of all global venture funding. STOs will seek to build on this success, offering investors better regulation and protection.
There are already many STOs in the pipeline for 2019 with companies looking to raise growth finance. These include companies with “real economy” applications such as DOVU which aims to revolutionise the world of transport by encouraging drivers and commuters to share their travel data. This data is shared between car hire companies, manufacturers, insurers and others, while participants are rewarded with monetisable tokens.
Jaguar Land Rover’s ventures arm has backed DOVU, as has government investment fund Creative England. DOVU, which has already signed partnerships with one of Britain’s largest travel groups as well as leading car makers, is now launching an STO to diversify its funding base.
Is my start-up suitable for an STO?
However, it is important to note that STOs are open to any company, not just blockchain-based business models, making them a viable alternative to crowdfunding, and offering real advantages over VC funding, bank loans or IPOs. Importantly, tokenisation is not just restricted to equity sales – just about any asset or revenue stream can now be tokenised using blockchain technology – from a factory, to a forest, to private debt, to a portfolio of residential properties, even to an art collection.
Suddenly, the value locked up in corporate and personal balance sheets can be cheaply and easily monetised. Indeed, industry experts predict the STO market could grow to $3 billion in 2019.
As we all know, high-growth companies create the most jobs and wealth in the UK and beyond. Their biggest, perennial issue is a lack of access to finance. Often, start-ups do not have assets to offer as collateral for bank loans. VC funds can demand an element of control in a company – through seats on the board. Meanwhile their investors often have no say in where their money is invested – and that money could be locked up in illiquid investments for many years.
STOs are no silver bullet but they do provide many answers to these issues and build on the benefits introduced by traditional equity crowdfunding over the last decade, and ICOs in the last 18 months.
For ambitious entrepreneurs and start-ups looking for help to grow their business, STOs now offer yet another method to help them realise their full potential.
Ransu Salovaara is a co-founder and CEO at TokenMarket, an exchange and research company specialising in launching blockchain technology projects