Just a few days before Alibaba issued an IPO, its shares were selling below $60 per share. On the first day of trading, the price skyrocketed to over $90 giving the Pre-IPO investors a return on investment of at least 48% percent.
Likewise, Facebook is known to have made a fortune for its pre-IPO investors when it finally decided to go public. According to a report by SecondMarket, Facebook shares were selling at $3.50 each, six years before the public sale. Just before the company filed for an IPO in April 2014, the price per share jumped to $42.72.
Without a doubt, the high growth rate of private companies preparing to go public presents the best capital gains opportunity for investors. But even so, these opportunities are not open to everyone and also come at high risk for the investors who access them.
According to the SEC, private companies are only allowed to sell their shares to accredited investors. These are investors with a demonstrated net worth of $1 million and above or a yearly individual income of $200,000+ (or $300,000+ and above for couples). Also, an investor can be considered as accredited if they are licensed or registered by the SEC as a broker or investment advisor. This means that if you decided to invest in high growth rate private companies such as UBER, Spotify, Dropbox or Airbnb today, you would need to meet the above thresholds.
Most investors do not qualify as accredited and therefore the opportunities presented by these companies are usually not an option for them.
Even for the accredited investors, the investment into the Pre-IPO markets is not without significant risks. These markets are highly illiquid so the investor cannot dispose of shares before the public sale.
When an accredited investor enters into a pre-IPO placement agreement, they commit to holding on the shares until the issuing company floats them in the stock exchange. This can take up to 10 years which means that that the investor’s capital is pretty much tied up until then.
The Stock Tokenization Solution
As we have seen, Pre-IPO investments are not only out of reach for most investors, but even for the few who can access them, they come with high liquidity risk.
Stock tokenization, which refers to converting traditional company shares into cryptocurrencies, is offering to bring liquidity into the Pre-IPO markets while ensuring accessibility to all investors interested in private equity.
For instance, a blockchain solution known as TheElephant has introduced a solution where the holders of private company shares can convert them into tokens which can instantly trade for cash. This means the shareholders can liquidate their investments at will and with maximum ease.
Likewise, investors who would like exposure to private equity and cryptos can buy and hold the equity-backed tokens. The value of the tokens is dependent on the underlying asset as well as on supply and demand. Unlike the traditional process where selling shares must involve a third party, the tokenized option is peer to peer and therefore does not take a long time or incur huge operational costs.
TheElephant project has already made huge strides with over 2000 registered investors and 20 pre-IPO tech companies listed for sale. Also, the company is in serious negotiations with top tier shareholders of US and EU Pre-IPO companies to tokenize their shares and register them for trading on the upcoming security token exchanges.
Another firm working on a similar solution is Morgan Creek Blockchain Capital, a Wall Street-based wealth manager with over $1 billion in assets under management. Even though still in the earliest days of development, the firm is working on tokenizing both the privately and publicly traded shares. Their primary goal is to eliminate tedious regulatory paperwork as well as costly intermediaries usually involved in the traditional share trading business.
In an interview with Fortune, Antony Pompliano, the founder and partner of Morgan Creek, notes that the tokenization of assets will also ensure that all companies adhere to the SEC regulations. This is because the tokens are coded, making it impossible to transfer them to unaccredited investors.
Switzerland’s Principal Stock Exchange has also expressed interest in developing a blockchain-based platform to tokenize traditional securities and non-bankable assets. According to Thomas Zeeb, Head of Securities and Exchanges, the platform will ensure full regulatory adherence while providing security, transparency and accountability. However, unlike TheElephant and Morgan Creek, this project is still in the ideation stage.
With the rate at which solutions geared towards tokenizing investment assets are coming up, there is no doubt that the future of investment belongs to blockchain and with blockchain making significant steps towards mainstream adoption, we can confidently say that better things are yet to come.