In the article you will find a comprehensive description of the STO launch process in terms of US legislation – from preparing startup documentation and registration with the SEC to choosing a blockchain platform and starting token sales.
The DAO case report, which the US Securities and Exchange Commission (SEC) published in 2017, found that the “new digital economy” must take into account the laws and rights of investors, since the tokens implemented during the ICO are mostly “digital” securities – security-tokens.
Consequently, all crowdsales who sold security tokens to investors can be considered illegal, since they have not been registered with the SEC. To the “security” American regulator includes all tokens that passed the Howey Test and several alternative tests. Howey Test is a four-question questionnaire that was formulated by the Supreme Court in the SEC vs W. J. Howey Co case in the 1940s.
The questions in the howey test are:
1. Is the fact of investment funds confirmed?
2. Do investors expect to receive income from investments?
3. Is money invested in a common enterprise?
4. Is profit generated by actions of promoters or third parties?
If the answer to all questions is “Yes” – tokens are securities.
In addition, tokens will be considered security if alternative tests are passed:
1. Reves’s Family Resemblance Test. If the issuer and / or his representatives manipulated investment expectations during the issue, sale or promotion of tokens (RRC20), such tokens will be considered security. The term “manipulation”, according to the law, can be interpreted as you please.
2. Risk Capital Test. If a token can be called a risky asset, it is a security. Under the “risk” law implies the likelihood of not receiving the benefits for which the investor invested money in an asset.
The initial offer of tokens, which, according to the listed tests, can be considered security, should be carried out according to slightly different rules than the usual ICO: more openness, regulation and responsibility. This form of crowdsale is called Security Token Offering (STO). The STO and ICO startup algorithm includes registration with the SEC and the crowdsale itself.
Step 1: Project preparation
Preparing to launch STO usually consists of several key points:
1. Forming the backbone of the project team: management, developers, marketers and advisors. The names of the key players need to be announced in advance, because it is investors who look at them first – the idea of the project is secondary.
2. Selection of the type of token and its functions: dividend payments, ownership of the asset, company share, access to the blockchain functionality, and the like.
3. Calculation of the amount needed to finance the project, that is, you need to decide on the soft cap and hard cap. This will affect whether it is necessary to register the issue of security tokens with the SEC and how exactly to do it.
4. Development of a marketing campaign and promotion methods.
5. Website development and formation of technical documentation.
6. Company registration and offer compilation.
In addition, it is also desirable to take the first steps in the development – to create a MVP. Its presence is important for large investors, since they will see what they are investing in.
This increases the credibility of the project.
If there is no MVP, you need a project concept: a screen map, an algorithm for interacting with users, design patterns, and the like. Investors will not invest in “words”.
Step 2: Registration STO in SEC
At the time of this writing this article (November 2018), the SEC does not have separate rules and laws to regulate the cryptocurrency market and the blockchain. The prescriptions of the regulator describe the general rules for the market as a whole and the primary proposals, the tokens of which, according to Howey Test, fall into the category of security, must comply with them.
Thus, the fifth section of the Securities Act of 1933 obliges issuers of securities to register with the SEC. An application for registration must be submitted before STO is launched. Initial placement can be carried out only after confirmation of the validity of the application.
The form of registration statement is divided into two parts:
1. Prospectus – a document with data on STO, which must be provided to everyone who buys or plans to buy a security token. It is necessary to indicate the key information about the issuer: field of activity, economic condition, management structure, financial results and risks. The prospectus must contain real financial statements.
2. Additional data to be transferred to the SEC without their announcement to market participants, intermediaries and potential investors.
Sample form S-1 can be used by all STO initiators. For information on how to enter financial data, see SX posture. The introduction of non-financial information is described in the SK posture. In addition to these data, the STO initiator is obliged to provide all the information that is needed so that information about the issuer and its offer “does not mislead” the regulator and potential investors.
SEC rules allow developing and some small public companies to disclose information according to simplified rules, which are spelled out in Art. №8 of S-X posture and part (a)(19) Securities Act of 1933. Small public companies are companies with annual revenues not exceeding $50 million, most of whose shares are owned by “ordinary” investors: not insiders, not management, not shareholders, whose share exceeds 5%.
Application for registration in SEC is submitted through EDGAR. To use this system of the issuer, you must have a central index key (CIK) with access codes – login and passwords. They are obtained after entering key data on the issuer on a special page and submitting identification data: a notarized printout of the ID form. This document can be sent to SEC as a PDF file via the Internet.
Exceptions to the rules
In some cases, STO initiators have the right to full or partial exemption from the need to register the issue of security tokens. This is possible if the issuer is subject to the rules indicated in the following documents.
1. FIrst level to raise amounts up to $20 million;
2. Second level to raise amounts up to $50 million.
Common to both levels are the requirements for data disclosure and compliance with the offering memorandum. An additional requirement for the second level is an independent financial audit and the provision of periodic SEC reporting. Non-accredited investors can invest a maximum of 10% of their annual income in such projects. Crowdsale initiators who need up to $ 20 million are entitled to use any level of Table A+.
Table D. In this case, rules No. 504 and No. 506 are used. According to rule No. 504, the STO initiator can submit an application to the SEC using Form В if he plans to raise up to $5 million, provided that the tokens are “frozen” within a year after the end of the crowdsale.
Rule No. 506 is divided into two sublevels:
1. №506(b) — a ban on advertising and promotion of a crowdsale among a wide audience in exchange for the opportunity to participate in financing up to 35 “complex” and unlimited number of accredited. The issuer is obliged to disclose information about his condition, management and provide risk analysis.
2. №506(c) — advertising is allowed, but only accredited investors can participate.
Start-ups that choose registration under the norms of Table D do not pass registration, but they must notify the SEC of the issue of securities using Form D. This must be done within 15 days after the conclusion of the first investment transaction for the purchase of tokens.
Crowdfunding (CF). Applicable with the participation of business angels – investors who invest in the project in exchange for the company’s share. According to this rule, both accredited and non-accredited investors can participate.
Rules to follow when registering by CF Table:
1. Amount attracted – up to 1,070,000 dollars per year.
2. All transactions go through an SEC online intermediary.
3. Capital that a private investor can invest in a project is limited by the size of its assets and income.
4. It is necessary to disclose information about the issuer to potential investors and the regulator.
5. Purchased tokens must be “frozen” during the year.
Information disclosure takes place through the filing of a Form C in the SEC instance through EDGAR. This includes information such as company name and address, type of tokens and size of the issue, date of completion of the crowdsale and the amount you plan to raise with STO.
Table S. It is used to protect investors from the United States who invest in overseas projects. This application provides the following requirements for STO:
1. The sale of tokens is carried out within the framework of an “offshore” contract: the seller has the prerequisites to believe that the counterparty is outside the United States or the transaction is concluded on an offshore trading platform, for example, on the Eurobond market and a number of foreign offshore exchanges. Which exchange is offshore, and which is not – decides the SEC.
2. The issuer, the seller and their representatives do not carry out targeted actions to sell tokens in the United States, which also means a total ban on STO advertising targeted at investors from the United States.
The model of the investment agreement Simple Agreement for Future Tokens (SAFT) at the end of 2017 was described by lawyer Marco Santori and the Protocol team. In their opinion, SAFT is not something new, but a little-known model of crowdsale, which has been used in the market for a long time. The financing mechanism for startups through SAFT is:
1. The company enters into a contract with investors, under which the latter finance the project in exchange for the right to receive a certain number of tokens after completion of the development. At this stage, tokens are not emitted, which does not relieve the developer from the obligation to register with the SEC.
2. Developers use investment capital to create a blockchain, application, or other software product. This may take months and years of development. Tokens are still not emitted.
3. Upon the completion of the development, the issue of securuty or utillity tokens is initiated, which arrive in the wallets of investors and the development team. Investors can use tokens to access the blockchain functionality or simply dump them to the exchange for financial gain.
4. The development team can also use tokens at their discretion.
The SAFT contract is considered closed after investors have received the agreed number of tokens. How much they turned out to be profitable or in demand – it does not matter, unless it is agreed in advance.
Step 3: Platform Selection
For launching STO is needed an infrastructure that ensures the safety of emissions and complies with legal regulations at times that concern openness of information and verification of investors through KYC / AML procedures. Such a platform can be created by yourself, but it is easier and cheaper to use ready-made solutions:
1. The platform uses ST-20 standard tokens for securitization of bonds, assets or shares on the blockchain. Polymath serves as a hub that connects KYC / AML developers, investors and suppliers.
2. Platform for launching STO based on the Ethereum blockchain. It is based on an adjustable system token (R-token), which allows you to tokenize any business after passing the On-chain Regulator Service.
3. Blockchain platform for STO, issuing and managing security tokens throughout their life, as well as for keeping one-on-one developers with investors through smart contracts.
The presented platforms are not the best or most reliable. These are just examples of where you can initiate STO launch in the same way as on Ethereum, EOS, Neo and other platforms that provide opportunities to launch ICO.
Step 4: Pre-announcement
The team begins to promote the project, telling the public about their idea with the help of white paper, yellow paper and road map. These documents describe what developers want to achieve, how it will be done and what benefits users and potential investors will receive.
At this stage, STO initiators are looking for opportunities to promote the project in the profile press, as well as on those sites that are popular with major investors and prominent economists: Forbes, The Economist, The Financial Times, Business Week and others.
In addition, during the pre-announcement, a white list is created – a list of investors who indicated their readiness to participate in the project. They have the highest priority when selling tokens with big discounts during the following stages. The white list is needed to give the tokens a halo of exclusivity and is guaranteed to sell them to selected investors who helped the project from the very beginning (if any).
Step 5: Private Sale
Closed sale of a limited number of tokens to investors from the white list with a substantial discount is from 30%. In some cases, the discount reaches 100% and more. Private Sale is carried out a few months before the start of the main stage of primary placement. The project team uses the collected funds for further promotion and the creation of MVP.
Even at the stage of Private Sale, the project team expands its membership and is looking for partners with big names who are given an even greater discount on tokens, so long as their name is visible on the website and in the press release. This will help attract even more investors.
Step 6: Pre-Sale
Another sale of a limited number of tokens to investors from the white list, but this time the number of coins is more, and the discounts are much lower (although they are still quite substantial). The money collected during the pre-sale is directed to the development and marketing campaign.
As a rule, Pre-Sale takes place in several stages – the earlier investors invested, the greater the discount. If the tokens released during Pre-Sale are not sold out, the team removes the participation limit only by writing to the white list.
Step 7: Main Sale
Sale of the remaining part of tokens allocated for STO, with a minimum discount of 5–10% or without it. The money collected at this stage is spent on the development, the salary of the team and the deployment of the project. All investors are allowed to participate, however, if it is obvious that demand exceeds supply, the team returns to the practice of sales through the white list.
After the completion of Main Sale, the tokens fall on cryptocurrency exchanges, unless restrictions are imposed on their resale for a certain amount of time. Restrictions are imposed if they want to avoid the collapse of the course due to speculators who buy coins with large discounts during STO, and then sell them at face value immediately after the crowdsale.