Security Tokens and Liquidation Preferences
In any Finance 101 class, students are taught that when a company goes bankrupt, those having offered loans to the company will be paid out before those who hold equity in the company. The nature of startups (no matter whether they have raised equity or token funding) is that the failure rate is inevitably high. So why don’t utility token buyers currently seek to shield themselves from the downside risk of a liquidation event, during which they will be entitled to recouping zero percent of the funds that they have committed?
Enter the security token holder. Because they are securities, security tokens will entitle the holder to certain liquidation rights which will actually be worth something, especially since many of the companies currently raising money through token offerings are unlevered and have little to no debt on their balance sheets. In fact, beyond representing traditional assets in a digital form on a blockchain, the format of a security token allows issuers to be much more creative than before. Now, companies can issue tokens that represent rights to a revenue- or profit-sharing arrangement, meaning the security token holder can capture value that the company creates before an equity or debt holder would.
Having said all this, what’s the main point? Will utility token buyers care about liquidation preferences? Having spoken to institutional participants in the space, some believe that the chance of running out of money in the first place can be avoided if the startup just raises subsequent tranches or rounds of funding for other types of utility tokens that can be utilized within the company’s platform. At that point though, it remains to be said whether the company will be able to woo the public into giving them a “second chance” in a crowded ecosystem where most participants seem to have “shiny object” syndrome and are more compelled to sell their positions of their tokens rather than be a loyal supporter, waiting out the storm.
What are your thoughts? Would you rather buy security tokens or a utility tokens of a promising startup and why? Let me know in the comments below.
