If tokens are securities, what exactly do they securitize? A veteran IPO lawyer digs in.
by Rodney Koh
A) The distinction between shares and tokens
Once a company has conducted an ICO (and if it has not issued any bonds or debentures), it will have two types of securities; shares and tokens, with a high likelihood that the number of tokens issued will far exceed that of the shares in the company.
So, what is it then that token holders do pay for? If tokens are securities, what do they securitize?
To answer that question, one has to examine the fundamental nature of a share. A share is in effect a bundle of rights that accrues to the registered owner of the shares. It gives the holder the privileges as outlined in the comparison table below:
|Shareholders provide capital to the company.
|Token holders are donors to the company.
|Shares represent equity in the company.
|Generally, tokens do not represent ownership in the company or any property.
|Shareholders have the right to receive notices of, and to vote at general meetings of the company.
|Token holders do not have any right to attend or vote at company meetings.
|Shareholders may dismiss the board of directors subject to a resolution being passed by them in a general meeting.
|Token holders have no say in the management of the company.
|Rights of shareholders are defined in the companies act or equivalent legislation, and in the memorandum and articles of association of the company.
|Rights of token holders are limited to what is set-out on the ICO whitepaper. There is no statutory protection for token holders.
|If the company is wound-up, shareholders are entitled to the residuary assets of the company after all creditors have been paid.
|Token holders are recorded as donors on the books of the company and hence do not enjoy any pay-out from the residuary assets when the company is wound up.
The table above shows very clearly that token holders hold no rights that are accrued to holders of equity in a company. What many token holders typically enjoy is access to blockchain based platforms that provides services which are valuable, or allows participation to the business itself. There are too many permutations out there to list, but it suffices to say that generally, token holders participate in the business of the issuing company without having any ownership of it.
B) Assets and goodwill
Businesses are oftentimes difficult to value. Although shares can be valued employing, say, the capital asset pricing model, or valued at its net realisable value, but it alone does not tell the whole story. Accountants have long recognised that the goodwill attached to a company arsing from its reputation, market share, perceived potential for growth, all intangible qualities of a company, can be far more valuable than the value of its assets. The long-standing formula of defining goodwill as the difference between the price paid for a company over the realisable value of the assets is a good means of quantifying goodwill.
Token holders do not own the goodwill of the business. That still belongs to the shareholders. But in a company that has both shares and tokens in issue, it can be said that shareholders own the equity in the assets and goodwill of a business, but token holders are participants in the goodwill of the company.
Hence, it can be said that tokens are a securitisation of a participatory interest in the goodwill of a business, whereas shares represent the ownership of assets and the goodwill of a company.
This distinction is important as it will form the basis of accounting treatment of tokens and provide a justification for their values on exchanges. Token prices may rise on the success of the business of the issuing company in much the same way as shares do for the same reason on an exchange. Moreover, having tokens listed is another way to value the market’s measure of the goodwill of the company.
The views in this article are merely suggestions. There is more debate to come on many issues which will require detailed discussion before any of the ideas herein can be realised. Chief among them will be how the ICO industry begins the very important dialog with regulators to help shape the regulations.