Traditionally, companies looking to raise money through the sale of equity had a choice between angel investors, venture capital investment or an initial public offering (IPO). Today, thanks to blockchain-powered tokenization, companies can also raise capital by conducting a security token offering (STO).

In this article, you will be introduced to security token offerings (STOs) and how they compare to traditional equity fundraising models.

What is a Security Token Offering (STO)?

A security token is a financial security on the blockchain. For example, instead of receiving a share certificate as you would when you buy stocks, security token holders receive a digital token that represents a share in the issuing company (if the security token comes in the form of an equity token).

Security tokens are increasing in popularity since regulators have started to crack down on unregulated initial coin offerings (ICOs), primarily because security tokens fall under Securities Law and are, thus, regulated. Moreover, raising funds through an STO is much cheaper than through an IPO, which is why startups and SMEs are particularly drawn to this new form of financing.

It is important to note that security tokens can come in all shapes and sizes. Security tokens do not only need to provide equity to its holders. They can also come in the form of digital bonds or other fixed-income instruments.

However, for the comparison with traditional financing methods, we will assume in this article that we are talking about equity tokens when we are talking about security tokens as they are currently the most common type of security tokens in the market.

STOs Vs. Traditional Equity Financing

Traditionally, startups have had the choice between reaching out to angel investors or venture capital firms while more established companies have had the option to go public via a stock IPO.

Let’s look at each of these funding options in more detail and then compare them to security token offerings (STOs).

Initial Public Offering (IPO)

By “going public,” a company sells shares to investors in exchange for fresh capital. To launch an IPO, a company will first need to find an underwriter (usually a bank) who will help them to go public. Then, the company will have to go through vetting to ensure that it is suitable to have its shares listed on a public stock exchange. Finally, the company will have to go on a roadshow with its underwriter(s) to meet as many institutional investors as possible to ensure that its IPO will become a success.

The primary issues with IPOs are that they are costly, time-consuming, and are only available to companies that have been a going concern for several years. Hence, startups cannot utilize this form of funding.

Venture Capital

Venture capital firms usually invest in startups during seed or series A or B funding rounds by purchasing equity in the company through a private share transaction.

A venture capital firm aims to invest in promising startups and SMEs that they believe will have the chance to go public or to be bought up by a larger company further down the road. That is how they “exit” their investments.

However, VCs are known to want preferential terms and often engage in investments that will benefit themselves more than the company owners. Hence, for entrepreneurs, venture capital investment can be a blessing or a curse, depending on the terms of the investment.

Angel Investors

Finally, there are angel investors who are wealthy individuals who want to invest in early-stage startups with the intention of potentially multiplying their invested capital if the company goes public or gets bought out.

Angels tend to invest primarily during a company’s seed round and will usually be less demanding — when it comes to preferential terms — than VCs but that may be different from individual to individuals.

Angel investors can be a great source of funding for early-stage startups as the right angels can also help to open doors to new investors or clients if they are well-connected in the industry the company operates in.

Similar to VCs, it is important for companies to find angels that fit the business and do not come with overly demanding investment terms.

STOs Vs. IPOs, VCs And Angel Investors

As you can see from this comparison, security tokens can offer several advantages over traditional financing methods are they come with low barriers to entry and allow the company to decide the terms of investment, among several other benefits.