SECURITY TOKEN OFFERINGS | STOs
Dilendorf Law Firm guides clients through the whole process of a security token offering (STO)- from structuring to conducting the STO in compliance with securities regulations and other US federal and state laws. Our attorneys leverage thorough understanding of US securities laws and experience with blockchain projects and DLT in guiding clients through the STO process to quickly and effectively bring it to a successful conclusion.
We also advise clients on appropriate structures and consequences of asset tokenization – be it real estate, collectibles or income-producing assets.
Represented FinTech company developing a digital currency exchange and e-commerce platform in structuring STO, including defining several types of security tokens with and without rights to dividend distribution and structuring complex distribution rights and restrictions for different types of security tokens
Represented company in structuring STO for raising capital to develop renewable energy farms and data centers in the US and abroad through Regulation D and S offerings, including assisting with the preparation of the private placement memorandum, subscription agreements and providing guidance with the process of investor accreditation as well as AML/KYC checks
Represented client in connection with setting-up a tokenized real estate lending master feeder fund (US/Cayman), including all potential tax implications and assisting with the application of US securities and investment regulations
Advised client regarding the process of tokenizing a commercial property in the Midwest, including identifying applicable securities regulations and token transfer restrictions for US and non-US investors, selecting legal structure for tokenization (LP, SPV, Trustee), assisting with the underwriting process on a smart-contract and issuing a legally compliant ERC-20 token
Advised client on potential issuance of fund tokens and the possible effects that they can have on existing LP structure
Consulted fund manager on setting up SPV for the tokenization of LP interest in a venture capital fund, including advising on structure’s classification for purposes of US and Cayman securities regulations
Defining the Scope of STOs
STO can be any offering and sale of digital tokens that are considered securities under US law. The broad Howey test, which has become commonplace for digital token issuers, still defines a “security” as any contract, transaction, or scheme whereby (a) a person invests money or anything else of value, (b) in a common enterprise, (c) and is led to expect profits, (d) predominantly from the efforts of others.
Security tokens sold during STO are any virtual tokens that exist on a blockchain and meet the definition of a security under US law, whether the tokens represent function on a platform (known as “utility tokens”), ownership of a real-world asset (asset-backed tokens), interest in a fund (fund tokens), equity (equity tokens) or debt (crypto bonds).
Accordingly, the scope of STO is very broad and may include, for example:
- Tokenized traditional securities, like shares of stock in a corporation;
- Tokens issued during ICO serving certain function on the project’s platform/ecosystem;
- Tokenized fund interests, including venture capital and real estate funds;
- Real estate;
- Diamonds or precious metals;
- Works of fine art, luxury cars and boats;
- Interests in a limited partnership or other business entity;
- Profit-sharing right in a business entity, etc.
Understanding the Advantages of STOs
By going through STO process, companies and funds can raise capital from investors while benefiting from the advantages that blockchain affords, including:
- Increased liquidity;
- Simplified access to capital on a global scale;
- Fractionalization of ownership;
- Increased transparency and security;
- Simplified investors’ management, etc.
Addressing the Risks Associated with STOs
While STOs are becoming one of the most viable methods of raising capital and dividing ownership or profits, security token issuers must structure each STO very carefully to take into account various pitfalls presented by securities regulations, AML/KYC requirements, tax rules applicable to a different type of assets or entity type, etc.
Some of the major practical considerations that should be addressed by an issuer prior to launching STO are that security tokens may be subject to limitations on resale, trading on alternative exchange platforms in the U.S. and foreign jurisdictions, number of investors, and amount of capital raised.
Our lawyers are well-versed in the legal and practical issues that arise in the context of planning, developing, and offering security tokens in the US. We help our clients develop a comprehensive STO strategy that anticipates and responds effectively to the arising challenges.
STOs Can Be Conducted Under Exemptions from SEC Registration: Reg D, Reg S, Reg A+, Reg CF
Before any security, including a security token, may be offered or sold in the US, it must be registered with the Securities and Exchange Commission (SEC) or qualify for an exemption. Registering security is a costly and time-consuming process. But if an exemption applies to an offering, then it does not need to be registered.
Most commonly, STOs are structured under one of the following exemptions from registration offered by the US Securities Act: Regulation D, Regulation S, Regulation A+ or Regulation CF. Although exemptions under the SEC regulations eliminate the need to register STO with the SEC, qualifying for an exemption still requires careful compliance with US securities laws.
Helping Clients Through Every Stage of STO
Our attorneys represent a wide range of clients in all kinds of STOs, providing comprehensive services throughout the STO process, including:
- Conducting a comprehensive token analysis to determine whether the token is a security under US law;
- Determining the appropriate token structure;
- Determining the appropriate corporate structure for STO (SPV/trust, fund, hybrid, etc.);
- Structuring STO to qualify for an exemption from registration as security using Regulation D and Regulation S;
- Drafting private placement memorandum, investment agreements, and related documents;
- Developing AML/KYC policies and helping clients implement them to verify investors’ identities and eligibility to participate in the STO;
- Providing post-STO legal support, including by advising our clients on secondary trading issues, subsequent usage of security tokens, and the applicability of money-transmitter and other laws.
Token issuers must consult professional tax advisers to develop a sound tax-planning strategy in the weeks and months before an STO. Any such strategy must account for (among other issues):
- The type of tokenized interest and the rights associated with the token;
- How income generated in the token sale will be treated for tax purposes;
- What reporting and withholding requirements may apply.
The IRS issued IRS Notice 2014-21, IRB 2014-16, as guidance for individuals and businesses on the tax treatment of transactions using virtual currencies.
The IRS also published Frequently Asked Questions on Virtual Currency Transactions for individuals who hold cryptocurrency as a capital asset and are not engaged in the trade or business of selling cryptocurrency.
Launching a security token offering is a highly complex process that requires thorough research and careful planning. PLease read our Guide for Launching Security Token Offerings (STOs) in the US.
- Understanding Digital Tokens – Lowell Milken Institute
- Security Token Offering Research Papers
- Spotlight on Initial Coin Offerings (ICOs) – SEC.gov
- SEC Halts Alleged $1.7 Billion Unregistered Digital Token Offering
- Statement of Cryptocurrencies and Initial Coin Offerings
- Use Caution When Buying Digital Coins or Tokens – CFTC Guide
- Regulation of Cryptocurrency Around the World
- Colorado Digital Token Act
- Token Taxonomy Act of 2019
- Launching a Security Token Offering in Switzerland
- Security Token Offerings STOs are the new ICOs
- Crowdfunding Capital in the Age of Blockchain-Based Tokens
- From Securitization to Tokenization
- Coin-Operated Capitalism – Penn Law: Legal Scholarship
- Implementation of the “Do No Harm” Approach in Initial Coin Offerings
- Sample Offering Statement for Debt Until Security Token Offering
- Proposed Rules to Govern Trading of Equity Securities on Boston Security Token Exchange
- Tokenization of Assets: Why Liechtenstein is Revolutionizing Security Token Offerings?
- H&G Science | Security Token Offering Statement
For a consultation about structuring a security token offering in the US
For a consultation about structuring a security token offering in the US
please contact Dilendorf Law Firm by sending us an email or calling us at 212.457.9797.