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How asset tokenization brings liquidity to equity crowdfunding

Learn how to enhance liquidity by making the private company's shares traded from day one without the high compliance costs of an IPO
25 MAY, 2021
Capital Raising
Did you know that only 0.4% of all shares in the world have a chance to be traded? According to the World Bank, there are 150 million companies worldwide, of which only 600,000 are listed on the stock exchanges. Let's talk about why so few companies trade their stocks.

What is the pre-IPO?

Pre-IPO is a late-stage for a private firm to collect capital before its stock market listing. In current history, a number of startups have been successful in obtaining capital by using this fundraising method, and as a result, their value has increased prior to their IPO. This gave companies a chance to mature and properly plan for an IPO by collecting additional funds.
During the pre-IPO stage, people invest money in private companies several months or years prior to their listing, "freezing" their investments in the hope of acquiring high-quality assets. Then, when the firm goes public or is acquired by a strategic partner, an investor can leave a pre-IPO deal.

Why most shares cannot be traded now?

There's a rather straightforward reason why it's hard to make the shares traded — the cost. To allow investors to sell your stocks, you have to conduct an IPO on a stock exchange. The cost of going public varies on a case-by-case basis and depends on the country. According to the PwC research, the price of a small IPO in the US is $7.3 million. This figure does not include annual compliance costs, which can also reach millions of dollars. This is why it's no surprise that most companies avoid going to the stock market.
The reason why the IPO costs are so high lies in the legal requirements of going public. The necessary procedures include:
  • Preparing and registering a long and complicated document called a prospectus;
  • Undergoing audits;
  • Paying investment bank fees for underwriting, which is required by most stock exchanges.

Furthermore, as a public company you need to file annual reports and have a more extensive legal and compliance staff, which makes the cost even more significant.

The impact of companies not going public is that only high-net-worth individuals and institutions can invest in most businesses. Therefore, most people don't have access to some of the most lucrative and profitable deals, and business owners have limited access to capital and often have to accept unfavorable terms offered by banks and investment firms.

How to get liquidity from day 1 using asset tokenization?

The solution to getting liquidity is decentralization. Instead of going to the stock exchange, you can leverage new technologies that allow you to create the so-called liquidity pool that will enable trading of your shares. There are a few steps required to implement such a solution.

The first step is tokenizing your shares. This is the process implying your shares should exist in the form of tokens on a blockchain. The technology of decentralized trading was first introduced for cryptocurrencies, and currently, it supports the trading of assets that exist in the form of tokens on a blockchain.

The tokenization of securities has become quite popular in the last few years. It has been implemented by such reputable institutions like the World Bank, Austrian Government, HSBC, and a few other large investment banks. It is accessible for smaller companies as well, and we at Stobox provide the technology and consulting necessary to tokenize shares or other securities.

Notice that not all types of tokens suit regulated securities. For example, Bitcoin can be traded and held by anybody, which, from the legal point of view, isn't something that can be done with shares that require proper KYC and AML procedures. Therefore, it is crucial to choose the right technology stack. Stobox provides a protocol for tokens that includes all the necessary features needed to regulate securities.

What Is The Liquidity Pool?

After the shares of your company have been tokenized, it is time to create a liquidity pool. You can think about it as a space where you have your shares and some other currency that can be traded, like dollars or euros. To create a liquidity pool, you have to put a certain number of shares and a certain amount of currency into the pool. For instance, if you put a hundred thousand shares and a hundred thousand dollars in the pool, the price for your share will be $1.

Imagine that somebody buys ten thousand shares. Now there are ninety thousand shares and a hundred and ten thousand dollars in the pool, which brings the price for your share to $1.22. This way, the liquidity pool and the DS Swap technology enable any private company at any stage to allow their stocks to be traded so that they could attract more investors and more funding.
Stobox DS Swap is a decentralized solution to unlock secondary trading for security tokens. Investors can sell their security tokens or buy more using an automated liquidity pool. Learn more

How it works from a legal perspective, and what are the potential pitfalls

The question you're undoubtedly asking at this point is what are tokenization legal issues, and how this decentralized trading is possible from a legal standpoint, provided that allowing customers to exchange stock normally necessitates going through complicated and onerous procedures. The answer is that regulation creates complex processes specifically for centralized trading venues, where there is an operator that makes all of the exchange decisions and must be certified to ensure the market's integrity and safety. The regulator then states that if you wish your stock to be traded on a centralized venue, you must go through these complicated and time-consuming processes.

The legislation does not limit private transactions. That is, if two investors have privately negotiated a trade without going to the Stock Exchange, this is not heavily regulated.

In this case, the liquidity pool is not the exchange with many securities and a central operator, but a transaction between the issuer, that is, you as a company, and your investor, which you conduct using the liquidity pool as a technical solution. The provider of such technology is not an exchange or a regulated venue. Only the technology is provided, but you operate a liquidity pool and are responsible for everything that happens there, so the technology provider does not make any decisions that require it to be regulated. Therefore, when you have a liquidity pool, decentralized trading of securities is not regulated by the legislation of stock exchanges, so you don't need to become a public company and go through all that complex compliance procedures to enable such trading of your shares.

What benefit do you receive from creating liquidity for your shares

There are three essential advantages of creating a liquidity pool:

  1. You'll be able to attract more money and reach out to smaller investors rather than just banks and hedge funds. You are also going to have a chance to raise funds from individuals willing to contribute as little as $500;
  2. A liquidity pool allows you to sell your shares as a company owner and do a partial exit to benefit from the growth of your business;
  3. As you're getting more people trading your stocks and looking for your company, you achieve higher exposure. This process brings a community that can help you move your business forward, distribute your posts on social media, and become your brand evangelists.

Conclusion

Asset and stock tokenization is not yet unusual but already an extremely efficient tool that will provide your business with perks like a green light to trading stocks, enhanced liquidity and growth of your community. If you feel like you would love to expand your knowledge about the benefits of tokenizing your assets, feel free to request a free 30-minute consultation with Stobox specialists.
25 MAY, 2021
Capital Raising
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