Tokenized Real Estate Syndication – Where Syndication meets Blockchain
What are digital asset securities?
Digital asset securities refer to financial instruments or investment contracts (i.e., instrumentalities or schemes that are deemed “securities” under the Securities Act) that are issued utilizing blockchain technology. Digital asset securities are generally understood as digital representations of traditional securities (ex. stocks, bonds, convertible promissory notes).
A digital asset’s status as a digital asset security is often determined on a case-by-case basis, typically involving a thorough analysis under the test established in SEC v. Howey, and its progeny.
Of course, issuers and holders of digital asset securities are subject to federal and state regulatory requirements akin to those of traditional securities issuers/re-sellers, including the need to either register the securities offered or comply with an exemption from registration under the Securities Act, and state registration, qualification and/or notice procedures.
What additional value does tokenization offer me and my investors?
Tokenization of traditional securities offer several potential advantages to issuers and investors. For one, by leveraging blockchain technology, issuers and investors may see increased liquidity and streamlined transfers and/or redemptions. Moreover, tokenization offers greater information security, transparency, and reliability with respect to maintaining a complete and accurate investor ledger. Another highlight, particularly with respect to the use of digital asset securities in connection with real estate syndication, is that digital asset securities can incorporate programmable logic through smart contracts. This programmability feature provides a path to automate processes such as dividend distributions, on-chain voting, and enforcement of compliance requirements.
What are some of the limitations of tokenization today?
Tokenization is a relatively new phenomenon, and, in the United States, Congress and regulators are still developing a cohesive framework to regulate digital assets, including digital asset securities. This means that the regulations and limitations surrounding digital asset securities can and will change over time. Some of the common categorical limitations for digital asset securities in the United States include, security risks, lack of secondary market infrastructure, regulatory uncertainty, as well as compliance requirements and related challenges.
Am I able to offer digital asset securities in any type of exempt offering (Reg CF, Reg D, Reg A)?
Yes, tokenization is generally available for securities offerings that are exempt from registration under the Securities Act. However, you will want to consult with legal counsel to determine whether tokenization holistically makes sense, and more specifically is compliant, in the context of your proposed transaction.
How do I tokenize?
Tokenizing a securities offering involves the process of representing traditional securities as digital tokens on a blockchain or digital asset platform.
Legal Framework: Gain a thorough understanding of the securities regulations that apply to your tokenization project in the jurisdiction where you plan to operate. These regulations may encompass registration requirements, investor accreditation, and disclosure obligations. Seeking legal advice is crucial to ensure compliance with these regulations.
Choose a blockchain: Choose a blockchain platform that supports the tokenization of securities. Ethereum is a popular platform due to its ability to create and execute smart contracts. However, consider other blockchain platforms that align with your specific requirements.
Engage legal and technical expertise: Issuers typically seek out vendors who have substantial experience in facilitating digital asset securities distributions both from a legal and technical perspective. Legal professionals can assist with navigating regulatory compliance, drafting necessary documentation, and ensuring investor protection. Technical experts can help with the smart contract development, token creation, and security audits.
Develop smart contracts: Smart contracts are self-executing contracts with the terms of the securities offering written into code. These contracts automate various processes, including issuance, ownership transfers, and compliance requirements. Work with blockchain developers to create and deploy the smart contracts on the chosen blockchain platform.
Conduct investor due diligence: Implement necessary measures to verify investor identities, accredited investor status (when applicable), and compliance with regulatory requirements. This may involve Know Your Customer (KYC) procedures and anti-money laundering (AML) checks to ensure a legitimate and compliant investor base.
Offer and distribute tokens: Once the smart contracts are deployed and the offering is prepared, you can launch the securities token offering (STO). Promote the offering to potential investors and provide them with the opportunity to purchase the tokenized securities. The distribution process can be managed through the smart contract, which ensures transparency and security.
Compliance and ongoing obligations: Following the digital asset securities offering, it is essential to maintain compliance with applicable regulations. This may entail fulfilling periodic reporting obligations, engaging in investor communication, and adhering to federal and securities laws. Engage legal and compliance professionals to assist you in managing these ongoing obligations.
Am I able to tokenize my syndication after funds have already been raised?
In general, an issuer may tokenize its capitalization table after the conclusion of the capital raising period. This means that existing shareholders / limited partners / members may receive digital asset securities representing their ownership stake in the syndication after traditional book entry securities have already been issued. It is important to consult legal and compliance professionals familiar with securities regulations to ensure proper procedures are followed when distributing digital asset securities after establishing a cap table.
Can any type of security be tokenized?
Yes, equity shares/interests, debt instruments, or other types of securities may all be represented as digital asset securities. Of course, you will want to consult with legal counsel to determine whether tokenization aligns with your goals in any given offering.
What blockchains are commonly used to mint digital asset securities?
Ethereum is by far the mostly commonly used blockchain for digital asset securities. However, other blockchains that issuers typically use in minting include Algorand, Binance Smart Chain, Cardano, Stellar, and Tezos. These are just a few examples of blockchains commonly used for minting digital asset securities. The choice of blockchain depends on various factors, including the specific requirements of the project, scalability needs, interoperability considerations, and ecosystem support. It’s important to evaluate the capabilities, security, and community adoption of a blockchain platform before choosing it for issuing and distributing digital asset securities. The nature of your proposed transaction will help determine which blockchain is the best fit for you.
Once the tokens are minted, where can they trade?
Alternative Trading Systems (ATS) platforms that are registered with the U.S. Securities and Exchange Commission (SEC) can facilitate the trading of digital asset securities. These platforms must operate in compliance with applicable securities laws and regulations.
It is important to note that the regulatory landscape surrounding digital asset securities is evolving, and the availability of compliant trading platforms may change over time. It is advisable to consult legal and financial professionals to stay informed about the latest regulatory developments and identify platforms that offer compliant trading services for digital asset securities within the United States
Are digital asset securities freely tradable immediately or are there lock-up periods required by law?
The tradability of digital asset securities and the presence of lock-up periods can depend on various factors, including the specific securities regulations and the terms of the offering. Generally, there may be restrictions on the immediate tradability of digital asset securities, either imposed by law or through contractual agreements. Reg D tokens are generally subject to a lock-up period of at least one year before they are eligible for resale. In some cases, such as where the holder is an affiliate of the issuer, resales may be subject to additional restrictions or even be prohibited.
It’s essential to review the specific offering documentation, securities regulations, lock-up agreements, and any applicable platform policies to understand the tradability of digital asset securities. These factors can vary on a case-by-case basis and may influence the ability to freely trade digital asset securities immediately or require adherence to lock-up periods. Consulting legal and financial professionals is advisable to navigate the complex regulatory landscape and understand the specific tradability requirements for digital asset securities.