ETOs: To Become Truths Universally Acknowledged
It is a truth universally acknowledged that an enterprise in possession of a good concept must be in want of funding. The means by which this is accomplished has evolved beyond traditional venture capital fundraising rounds, as entrepreneurs and investors alike seek easier and more accessible methods which do not dilute founder equity. Take-up of blockchain-based solutions has been stratospheric: in 2018 alone there have already been hundreds of initial coin offerings (“ICOs”), together raising over $18bn through the sale of cryptographically-secured tokens.
As advisers and regulators alike scramble to familiarise themselves with ICOs, STOs, ETOs, ITOs and I(don't)NOs, they are reminded that innovation will virtually always outpace regulation. Nowhere is this doctrine more applicable than with the blockchain revolution of the past few years – the face of venture capital has changed.
Rumours of ICOs’ lack of applicable regulation have been greatly exaggerated (the FCA, for instance, has stated that existing rules and statutes apply by interpretation), but the crypto fundraising space still suffers from a disconcerting lack of clarity and the relative obsolescence of existing legislation. Add to this the apparent lack of issuer accountability and investor recourse (it is estimated that up to 80% of ICOs are scams) and the method seems severely compromised.
Enter the ETO.
Equity token offerings involve the sale of tokens which can entitle the holder to voting rights and part-ownership of a company in a manner comparable to a ‘traditional’ shareholding. Investors benefit from enforceable ownership and governance rights (including to profits) as well as the potential to trade privately-held investment interests on secondary markets in a compliant manner. Entities raising funds in this way do not need to be blockchain companies, and benefit from fast, cost-effective access to large numbers of engaged investors. There remains a far lower regulatory burden than for methods such as IPOs, and many of the problems with ICOs are reduced.
Risks remain. Equity tokens may be viewed by UK authorities as units in a collective investment scheme (and therefore requiring compliance with the UCITS Directive), or a transferable security subject to prospectus requirements (requiring careful legal assessment of transferability, standardisation and negotiability on a case-by-case basis). Secondary token sales between investors in the EU may also be subject to the Market Abuse Regulation. Possible exemptions exist – particularly with respect to the prospectus requirement – but these may carry certain resale and issuance restrictions which go to the heart of the fundraising structure.
As the market awaits regulatory clarity, it remains of paramount importance that legal advice be sought before proceeding with token offerings, and especially where equity rights are attached.
In the meantime, rule-makers must seek to strike a balance between protecting investors and sustaining innovation, rather than heavy-handedly stifling new technology and approaches which have the potential to fuel world-changing ideas.
James Paton-Philip is a partner in the Corporate team at Irwin Mitchell. Harry Taylor is a Solicitor in the Banking team. They both advise on ICOs, ETOs and other related corporate and banking matters.