Security tokens have recently been gaining popularity across the financial industry. Instructions added to the token’s code can automate a number of processes, including dividend payments and shareholder voting, leading to a significant reduction in governance and issuance costs. Security token offering is a great alternative to classic fundraising methods, in this article we’ve compared security token offering to crowdinvesting.
Crowdinvesting ≠ Crowdfunding
Before getting deeper into the drawbacks of crowdinvesting and comparing this fundraising method to an STO, we have to point out that the terms crowdinvesting and crowdfunding are often used synonymously. But the truth is that in some aspects those methods differ from one another.
Basically, the term Crowdinvesting consists of equity-based crowdfunding and debt crowdfunding. In the case of equity-based crowdfunding, users invest in a start-up and receive shares in return. Investors become shareholders of the start-up and benefit from the profits of the start-up and from the possible sale of the start-up to a large investor.
In debt-crowdfunding, it’s not “backers” or “donors” who give money, but lenders (sometimes these lenders are called investors). Unlike other forms of crowdfunding, it’s not an exchange for a reward or equity. The investors don’t get a reward and they don’t get a piece of equity in the company, but instead, they make a loan with the expectation to get paid back the principal plus interest.
So it’s a lot like a loan from the bank, but instead of borrowing one larger amount of money from one bank, you borrow smaller amounts of money from multiple people. Debt-crowdfunding can be used to raise money for lots of reasons, like credit card refinancing, debt consolidation, home improvement, a car or other reasons.
There are many different motivations to participate in equity-based crowdfunding. While some people simply want to support a good idea and its implementation, other investors primarily focus on financial aspects, especially participation in the sale of the company.
In a very general sense, it was not possible for private individuals to invest in start-ups in the early stage before equity-based crowdfunding was introduced. Equity-based crowdfunding also enables private individuals to participate in start-ups by means of small (or large) investments.
Drawbacks of Crowdinvesting
Crowdinvesting has been around for a while now, facilitated by the many different platforms that have set up shop on the internet. This method has proven to be a working solution for businesses to raise money, but there are some major drawbacks with crowdinvesting that both businesses and investors need to keep in mind.
High fees: Fees can be charged for both investors and businesses. For businesses, there are two types of fees charged by crowdinvesting platforms. First is a success fee charged by the platform after the funds are raised, the average percentage charged by crowdinvesting platforms in Europe is 7%. Second is an administrative fee which varies greatly from platform to platform. For investors, there is usually a 10% exit fee charged by the platform.
Risks are incredibly high: According to the UK's Financial Conduct Authority (FCA), equity crowdfunding is an extremely risky investment method. “It is very likely that you will lose all your money. Most investments are in shares or debt securities in start-up companies and will result in a 100% loss of capital as most start-up businesses fail. There is also the risk that your initial investment could be heavily diluted if the company issues lots of new shares in subsequent rounds of fundraising.”
Investors are powerless: The whole process of collecting funds is centralized and raises a number of concerns. All funds from investors collected by shell companies (SPV, syndicates) led by Lead Investor (or fund manager). After shell company collects funds and transfers them to the project, it retains all shares. Meaning that investors don’t have any voting rights and can’t influence the future of the company in any way. Instead of a share or stock, investors receive a certificate with the right of claim and income, but voting rights and control over the shares remains with the platform or SPV.
Lack of secondary market: This issue is heavily tied with high risks. In most cases, Investor won’t be able to sell their assets. Shares in unlisted companies are not traded on a stock or any other secondary market so there is no pool of potential buyers to call upon.
There are two projects on the European market that have a secondary market. Seeds and Funderbeam, but the process is time-consuming and legally complicated. A secondary market for both platforms works on the principle of transferring rights within an SPV from one investor to another. Each transaction requires an agreement to transfer directly between the buyer and the seller, after which the payment will be processed and a new registration for ownership of shares will occur.
We believe that a security token offering is a solution to most of the problems of crowdinvesting for both investors and businesses.
Secondary market: We’ve created a single financial ecosystem covering all the needs of projects and investors by combining the best elements of blockchain and traditional financial markets to ensure access to the secondary market through our platform. Access to the secondary market reduces the risks - users are able to sell their assets at any time. Along with that, it provides liquidity.
Minimal cost: Your expenses are reduced to a minimum. The security token issuance platform on Tokenomica is free of charge. For sure, there are set-up costs, but none of it is collected by Tokenomica.
Investors own their assets: The investing process and all post STO activities are transparent, all necessary documentation is available for an investor at any time. Along with that, we are giving our best effort to eliminate all third-parties from the process. Investors own their security tokens, they are not collected by any other entity and safely stored in users’ wallets. Investors are able to vote from their account from anywhere and take part in companies’ activities.
Access to New Types of Investors: With security token offerings, a business gets access to a pool of investors that are familiar with the industry, who will be willing to invest in security tokens to support technology-based projects all over the world.
Tokenomica's Security Tokens Issuance Platform is working in beta now, you can find out more at sto.tokenomica.com or at tokenomica.com/products/STIP. If you have any questions, feel free to join our Telegram chat, we are always happy to help.