A disclaimer — we are not lawyers and we are not providing legal advice, we are simply sharing some of the experiences that we had in the process of creating our security token ICO, Property Coin.
If you’ve been reading the crypto news lately, you might have seen that ICOs are getting some bad press in the US, with many people, including regulators, considering them potentially illegal securities and exposing them to heavy scrutiny from regulators.
In a prepared statement to Congress on February 6, 2018, SEC Chairman Jay Clayton said “When investors are offered and sold securities — which to date ICOs have largely been — they are entitled to the benefits of state and federal securities laws and sellers and other market participants must follow these laws.” Strong words from the head of the worlds most influential securities regulatory body.
You might be considering creating your own ICO. Perhaps you have an idea for an innovative blockchain application, or are intrigued by a Kickstarter-like alternative to raise money for your company and / or project. Maybe you’ve heard that raising an ICO is a path to easy money. While this might have previously been the case, if you are based in the US and want to follow all applicable laws, it’s now a much more difficult journey. But it is possible. In the spirit of open source code that is the foundation of blockchain technology, we figured we would share some of our observations and experiences with the world.
ICOs don’t neatly fit into the traditional security classifications that have decades of laws, best practices and issuance templates to rely on; and likewise ICO advisors are figuring out much of this as they go along, so together we all forge a new path.
So, why did we choose to offer an ICO?
- We need more money to grow our existing business, which primarily invests in houses to repair, renovate, and resell to end users. We will use the proceeds raised in our ICO to buy real estate assets and share the profits from these investments with our investors.
- We view Property Coin as a corporate financing tool, and were interested in an ICO as a means of accessing a new form of permanent capital.
- We thought that our experience as investment bankers would be useful in developing an “asset financing” ICO which might resonate in the market, and focused on transparency and incorporating best practices from structured finance.
Your checklist for issuing an ICO in the US
Do you want to spend $200,000+ to begin in this project?
You will need to spend more than that in total, but some expenses can be paid from sale proceeds and / or using your coin as currency. Make sure you are able to cover the upfront costs and remember, costs and timelines always slip. Be prepared to spend more.
Do you want to work on this project for 6 months (or more)?
If you already have a day job then you are going to be extremely busy. Advisors can help alleviate some of this pain, but in the end, this is your project and your reputation on the line. You need to dedicate yourself to this. Side note: most “full service” providers have a 6 month or longer waitlist for new projects and want a lot of fees so be prepared!
Do you have the expertise to select appropriate advisors?
Make sure you interview all prospective advisors extensively. Ask them about their experience on similar projects and the feasibility of your project goals. Beware of “experts” who before 2017 were not at all involved in running companies, structuring deals or financings, marketing, or offering legal advice. Also, beware of large “up front” contracts. A lot of under/ unqualified people have jumped into this space and you could find yourself working with an advisor who has limited or no experience in running a project like this.
Can you find a securities lawyer who is willing to take you as a client?
And we don’t mean some local attorney. To do this the right way, you are going to need a real law firm that specializes in securities offerings. Seriously, find one of the firms that Wall Street hires and make sure they have a strong securities practice as well as a start up or technology practice. ICOs do not fit neatly into one bucket so you will need a firm that can pull resources from various practice areas.
Do you have a gigantic network who’s going to find your project interesting, and significantly spread awareness of the token sale?
If not, you’ll need a really good marketing firm who specializes in ICOs to help sell the project. This is crucial. ICOs are sold through your project’s website. You need to tell the world that you exist and why people should care about your project in an already crowded marketplace. You need to make people want to go to your website, listen to your story and buy your ICO.
Who’s going to write your smart contract or blockchain code?
If you are not doing this yourself, interview the person/ group you are considering extensively. Get references and be 100% certain you trust them. If it is a person and you can hire them, do it. If not, make sure you do your due diligence. You will also need to get your code audited.
Next up is a hot topic; is your ICO a security token, and how do you avoid breaking securities law?
Of course you will need to work through the specific circumstances with your attorney, but here is our interpretation: if you live in the US, and your answer to any of the following questions is yes, you are probably a security token.
- (a) are you providing an expectation of profit?
- (b) can you characterize or should reasonably characterize your token as an investment?
- (c) are ANY of your product, company, team, legal documents, tokens, code incomplete at the time you start selling?
- (d) does your team have a role making decisions on behalf of the project participants?
Make sure you are 100% sure of your answer to these questions because this is how the SEC will review your project. Again, this is not legal advice, just our thoughts. Speak with your external counsel before making any decisions.
Do you need to register as a security with the SEC?
There are exemptions to SEC registration requirements based on where you are selling, income/ asset restrictions and more, so it really depends on your project specifications. When in doubt, ask your lawyers!
Should the issuer of your securities token be based in the US or another country?
Some countries like Cayman Islands, Estonia, Gibraltar, Singapore and others are more friendly to ICO issuance, but you will need to be mindful of local laws, local securities issuance requirements and local AML/ KYC rules. Ask your fancypants attorney about current legal and regulatory conditions but you’ll probably need to hire lawyers in your issuance of jurisdiction as well. More cost, yay!
How do you ensure that you are not taking money from terrorists?
Do you need to perform AML/ KYC on the funds you are receiving? Hint: YES, and with “real” vendors!
What are you allowed to say and what should you not say in marketing communications to prospective investors?
One thing you should certainly do is paint an accurate picture of what you are doing and why. Be truthful and don’t exaggerate. Clearly explain how proceeds will be used, what the fees and expenses are, what rights the coinholders do and do not have, and how the coin is expected to work. Make sure that buyers understand all of these mechanics as well as the risks. Not only is it good protection for you as issuer, its also the right thing to do.
You should also be transparent in providing regular reporting and updates. This is common practice in traditional securities world and we think it should become the new standard in the ICO world as well.
How do you convert the cryptocurrency raised into US dollars?
This is a particularly tricky subject, and banks haven’t yet figured out how to address this market. Most US banks don’t want to touch crypto proceeds and therefore this remains a difficult issue. Be sure you have a plan (and a contingency plan)!
How does the selling process work?
You need to spend a lot of time and money going to conferences, building a thriving online community and just generally spreading the word. Keep in mind, with over 1,500 ICOs issued in 2017 alone, buyers have a lot to digest. You should assume that any buyer’s initial interpretation of your project is that (a) it is a scam, and (b) your project contains numerous problems that they will soon discover. It’s up to you to be open and transparent in order to build investor trust and encourage people to participate in your ICO.
Get Ready for Some Long Nights
While ICOs can be an effective financing solution for issuers, they also require a lot of work and upfront expense. Before committing, make sure that you have good advisors, clearly understand what the roadmap for your project looks like, obtain an assessment about the likelihood of success and go in eyes wide open.
In the spirit of honest and open sharing, we’re always available to discuss our experiences with companies looking to issue an ICO. Feel free to give us a shout by contacting us at firstname.lastname@example.org
We are Matt Miles and Andrew Jewett, the Co-Founders of Aperture, a California based real estate technology and investment company and the creators of Property Coin, a security token ICO. Our team includes former investment bankers who have spent most of their careers structuring complex financing transactions and we thought that others might be interested in what we learned.