Transcribed from: https://youtu.be/VKz8Uz89_Zg
Just because you want to do an STO, and you create a security token and call it a security token, doesn’t make it so. You still have corporations, and corporations or LLCs are byproducts of state law. As you see in traditional equity markets, you have classes of securities. You have not only debt, but then in the equity realm, you have preferred common, and you have a series of preferred series of common or classes of common. You see often in the context of STOs, companies that are stating that they have this security token for sale, but they are not incorporating that into the corporate form. They are not accounting for that properly in the context of state law. So the question becomes: “Do you really have the security?”. Just because you call it a token, it is represented by a token, or it is represented by a piece of paper, it does not make it so.
So that begs the question: “What do you do?”. I think the best practice, as I see these, I read these offering memorandums for STOs and it is not a common thing, whereas it needs to be almost a mandatory exercise. That is with respect to creating a class of securities that are representative of, or equal to the security token itself. So if you are doing, let’s say a preferred equity token, you would want to make sure that there is sufficient authorized, preferred stock in the company’s articles of incorporation. Then, create a series through a certificate of designation, just something that you can file with the state, which enumerates the rights that are associated with that class of preferred stock, or it could be like a Class B Common, or if it is just a Class A Common. You need to enumerate that. You need to not only enumerate that from the perspective of the company’s charter, but also in your offering memorandum because if not, nobody knows what they are getting. It opens the door to mass chaos and lawsuits, and things of that nature when people don’t know what they have effectively bought.
One methodology that I tend to like is the creation of a series, or class of equity securities, and the concurrent issuance of that, or the issuance of a reserve with that of the token. To the extent that you say you had 10 million authorized shares of Series A Preferred, and your token is equal to one share of that Series A Preferred and you sell 5 million. I would either concurrently issue that into the treasury for the benefit of the token holders, or create a reserve that would disallow you from issuing more than the 10 million that it has been authorized, and then somehow impeding the 5 million that you have sold. That way people have some protection that what they have is, in fact, representative of the security that you are representing to sell on the rights associated therewith.
If you are doing a redemption function, which you see a lot in STOs, where one could effectively burn their token exchange for a certificated share of some form of equity. Then, of course, you have to do this. You would have to have some reserve. That is really where custodians and transfer agents come into play because they can hold that reserve and account for those shares. It is a very good idea to engage a transfer agent to the extent that you can because it is a very cost-effective way of effectively keeping track of what you have and what you have issued.
It is just all too often that you see a company that is issuing a preferred equity token, but on their corporate charter, they have zero authorized preferred stock. Or they are offering a Class B Common, but there is no authorization provided for or series of a certificate of designation with respect to that class common. So there has to be, there has to be in order to effectively be honest with your investors and to provide them some level of protection as it relates to what they are purchasing in an STO because the STO obviously takes. You are taking it outside of the 400, 500 plus years of the assurance of equity and going on a blockchain. You have to match the two, you have to provide for that accounting that relates to both sides of the transaction.
That is my take on a problem that I see all too often, but it can be easily solved. Even if you issued an equity token and did not account for that in the articles of incorporation simple filing. It can be simply fixed after the fact if you had to do it. But definitely, something to be aware of. If you have any questions, definitely hit me up: adam@adamtracy, T-R-A-C-Y.io, I will be happy to discuss it in greater detail.