This article is an addendum to the Official Guide to the Security Token Ecosystem.
Disclaimer: This article does not constitute legal guidance or legal opinion of the author or any entity associated with the author. This article is published to serve as a summary guide of the information currently available to the public. Anyone seeking to issue a token should retain legal advice for the most up to date legal developments.
As the crypto markets continue to contemplate tokenized securities as a tool with the potential to disrupt the $1.6 trillion private placement market, agile entrepreneurs and organizations are working on novel solutions to translate existing financial structures onto the blockchain.
Consolidating fundraising activities and eliminating (or at least decreasing) the role of middlemen, is a great concept in theory. Issuers, however, are running out of steam figuring out how to structure these complex and highly regulated issuances, spending $400k+ on legal fees, frequently switching legal teams two to three times.
In the spirit of efficiency (because after all, isn’t that the point of the blockchain revolution?), the following are four of the most common security token structures available to issuers.
1. Tokenized VC Funds
A tokenized VC fund provides token holders with a claim to a share of a fund. Each token is a unit that represents a fixed amount of investor rights. Profits can be shared back with investors through several strategies, including direct or indirect token buyback architectures following exits or other liquidity events. Tokens are tradable, and liquid. Unlike traditional VC funds that lock in investors’ capital for a period of 7 to 10 years, tokenized funds provide investors with immediate liquidity opportunities (12 months in the U.S.).
Additional benefits for investors include capital allocation flexibility, as capital can be dispersed more easily across funds, and smaller capital commitments. Tokenized funds are subject to the Investment Company Act, which limits the funds to 99 U.S. investors, and 2000 investors globally. Tokenized VC funds are commonly issued under Reg D and Reg S, but we can expect Reg A+ issuances to become more mainstream over the next few years.
Note: The Dodd-Frank Rollback Bill signed by President Trump last week, in theory, increases the number of American investors from 99 to 250.
2. Share-Like Tokens
What if you could issue stocks on the blockchain? This question is less theoretical than it may seem. Share-like tokens can have features such as ownership stake in an entity, LP shares, voting rights, dividends, profit shares, or some interest in the success of a future entity. Benefits of going through the tokenization process in this context include fractionalization of ownership, increased liquidity, automated compliance, after-hours operations, layered share rights and overall greater flexibility.
A subset of these are ‘Revenue-Share’ tokens. Rev-share tokens are neither debt nor equity, and entitle the holder to a percentage of gross revenues from the company.
3. Asset-Backed Tokens
Asset-backed tokens constitute an economic right to a real-world asset, such as art, commodities, or even power plants. This model is most commonly used in real estate and infrastructure projects. Asset-backed tokens can be used for fungible or non-fungible assets, in which case assets may require an abstraction layer. This layer takes distinctly different assets and bundles them together, akin to how mortgages might be grouped together to create securities.
Some of the benefits of asset-backed tokens is the ability to subdivide larger assets into smaller units and to create unique and diversified products. Think derivatives, but more transparent!
While there aren’t many tokenized debt instruments currently available, there are a handful in the works. Debt tokens, can act as bonds, constituting a fixed claim on future streams of income. Some questions in regards to tokenized debt are still open, such as whether a token can maintain a seniority claim over equity in repayment, or whether it can change accreditation requirements.
Benefits of using the crypto bond structure include the elimination of middlemen and registries, reduction in settlement time and decrease in operational risks. Tokenized debt can offer favourable tax treatment to the issuer and is not subject to the public issuance investor limit of 2000.
The Best Legal Minds to work on Your Security Token
If you are wondering where to turn to for help, here is a list of some of the top lawyers to work on your security token structure:
James G. Gatto, Sheppard, Mullin, Richter & Hampton LLP
James A. Mercer III, Sheppard Mullin, Richter & Hampton LLP
James J. Thompson, Sheppard Mullin, Richter & Hampton LLP
Deborah S. Thoren-Peden, Pillsbury Winthrop Shaw Pittman LLP
Curtis L. Mo, DLA Piper
Margaret N. Rosenfeld, Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, LLP
Heyward D. Armstrong, Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, LLP
Grant P. Fondo, Goodwin Procter LLP
Richard B. Levin, Polsinelli LLP
Charles A. Gelinas, Dentons
J. Dax Hansen, Perkins Coie LLP
Kyle Wood, Perkins Coie LLP
Robert H. Rosenblum, Wilson Sonsini Goodrich & Rosati
Patrick Murck, Cooley LLP
Michael McGrail, Cooley LLP
Adam T. Ettinger, FisherBroyles LLP
Marc Boiron, FisherBroyles LLP
Pratin Vallabhaneni, White & Case LLP