The first things that generally come to mind for most individuals when discussing capital markets are stocks and bonds. The easy accessibility of the traditional public capital markets makes it fairly straightforward for anyone to trade securities in a public company. However, the regulatory process involved with bringing a company public is expensive, time consuming, and entails extensive disclosure requirements. As a result, many companies prefer to raise capital via private placements which are primarily accessible to accredited investors.
In fact, high profile companies such as Airbnb, Uber, and Spotify leveraged private market issuances to raise more than $1Bn in capital. These private offerings have proven to be not only less expensive but also less volatile and more valuable in terms of the ROI. Coupled with the trend of companies choosing to remain private for longer, many investors are now looking to access the private capital markets to achieve greater diversification while getting their hands on companies that are generally unavailable to them.
Problem # 1
Private markets are overwhelmingly restricted to institutional investors, market insiders, and high net worth individuals. At present there are two primary ways in which individuals can qualify to become accredited investors, or individuals who are authorized to buy securities which are not registered with the federal government via the Securities and Exchange Commission (SEC).
- Their income is over $200,000 (or $300,000 together with a spouse) and has been in each of the last two years and they reasonably expect the same for the current year.
- They have a net worth of $1MM+ (exclusive of the value of their primary residence).
Though the SEC has somewhat broadened this scope in recent months, the definition of an accredited investor remains narrow and limits the potential transaction volume in the private markets.
Regulatory authorities focus more attention on investor qualifications than they do on the private offerings themselves, thus ensuring that only those with a sophisticated knowledge base and a sufficient safety net are permitted to invest in private securities. Consequently, it is very difficult for ordinary retail investors to invest and trade in this market.
Problem # 2
Securities in the private capital market are generally very illiquid, meaning they cannot be easily sold or exchanged for cash. A few prominent examples include real estate, private company shares, and certain debt instruments. These private market investments are “locked up” for long periods of time making them only accessible to the accredited investors that can afford to keep that money on the sideline.
To overcome these barriers to entry in the private capital markets, it is of utmost importance that these eligibility restrictions evolve. By determining eligibility almost entirely on wealth or income, the SEC has effectively rendered the private capital market off limits to all but the most financially equipped investors. The more effective approach would be to require higher quality information availability and transparency.
To this end, the SEC recently amended the definition of an accredited investor. The modifications further emphasize ‘financial sophistication’ as a factor of eligibility to invest in unregistered offerings. To verify an investor’s ‘financial sophistication’ the SEC examines the following investor attributes:
- Professional Knowledge
- Relevant Experience
Even so, the former requirements which focus on investors’ income and net worth remain.
How Can Blockchain Help?
Tokenization offers a new medium of entry into the private capital markets. An immutable & distributed ledger enables the digitization of real tradable assets and offers all the benefits of Blockchain including accessibility, security, and transparency.
Companies can raise capital via a Security Token Offerings (STO), which is the process whereby a financial security is issued in the form of a digital asset. In such cases, the digital assets can be used to represent a share of the underlying asset which can then be exchanged over a digital network. STOs can be used to tokenize all sorts of intangible and tangible assets such as property, artwork, antiques, automobiles, and more. These investments have historically been out of reach for most investors.
Pending regulation, STOs can lower the entry barriers for non accredited investors further by fractionalizing the underlying asset. An investor may buy a tenth or a hundredth of a high value asset and trust that the transaction is recorded and the investment secure. The ability to then sell these tokens in the secondary market via a regulated platform or exchange further boosts liquidity.
How Is MetaFinance Making A Difference?
MetaFinance aims to bridge the gap between traditional and digital finance by offering a customizable and configurable securitization platform which automates administrative tasks, helps businesses collaboratively issue digital securities, and provides in-depth analytics while offering a secondary market infrastructure with near-instantaneous clearing & settlement.
Interested in a demo? Contact us or send us an email at firstname.lastname@example.org.