How to Raise Capital with Tokenized Digital Asset Securities, with 10XTS CEO Michael Hiles

So without further ado, uh, Michael Hiles is the CEO of 10XTS. He was also the former managing director of Founder Institute in Cincinnati before he founded 10XTS. And so you led 3 successful cohorts prior to founding the company. And so today Michael's team is helping founders, institutional investors, and asset managers launch token-based securities as a primary offering. And so you can also list and trade those tokenized assets across registered and decentralized capital markets. Michael, this has been a long time coming. I'm super excited to have you join us today. How are you doing?

I'm awesome, Ryan. Thank you. Really appreciate coming back. The first tokenization webinar we did was back in 2018, very nascent in the space. So it's great to come back and get a good update for everybody. So welcome everybody. My name's Michael Hiles. I'll I guess I'll show you guys some cool stuff on the screen.

Perfect. You're good to go.

Awesome. Cool. Well, thanks for attending Raising Capital with Tokenized Digital Asset Securities today. And I am Michael Hiles, founder, CEO of 10XTS. So who's this presentation for? Startup founders and corporate leadership, first and foremost. But also, interestingly, there's a lot of discussion around VC fund GPs and LPs. And then you of course, get into a lot of lean-in on the topics of broker-dealers and intermediaries that are involved in the traditional security space. So what you're going to get from this session today is the differences between crypto assets and digital programmable securities tokens. They're similar, but not the same. A view of the current state of the market and regulatory for tokenized securities. Why do secondary markets and trading matter to investors for early-stage investments? How are decentralized autonomous organizations, DAOs, changing funding models? And how to tokenize a securities offering in a regulatory-compliant way to raise money for a startup or fund is a token that can be traded in secondary markets. So what this session is not: this session is not legal counsel or financial advice. Seek counsel. It is also not a deep technical primer on crypto or blockchain technology, not necessarily finance or the law either, even though we reference all three. So who am I? I'm Michael Hiles, founder and CEO of 10XTS, and as Ryan said, I'm former managing director of Founder Institute Cincinnati, and I'm also a general partner in the Cincinnati Crypto Fund. So let's first talk about digital securities tokens versus crypto tokens. Crypto tokens, of course, that's Bitcoin, layer 1 cryptocurrency networks with a utility token of some sort. Bitcoin, Ethereum, Solana, Avalanche, to name a few. It's also NFTs representing ownership or benefits that are encapsulated in that NFT token. And these trade on centralized crypto exchanges governed around the world by various jurisdictions, like Coinbase, Gemini, Kraken Exchange, Binance, and OpenSea marketplace for NFTs. And then they also at times trade on decentralized exchanges and DeFi markets through Uniswap, SushiSwap. And some of these may be considered securities by the SEC. Digital securities tokens, however, are actually securities that are tracked in a token form. You're using blockchain technology to create a programmable share of stock in your company as the unit of account, as opposed to book entry in a spreadsheet or in some form of cloud-based cap table management system. It uses that blockchain technology to represent a programmable form of that share or ownership interest. It also has to connect to the traditional records of a security for governance and compliance purposes. It is the foundation for global decentralized capital markets and trading, which is emerging. We'll talk about that shortly, like crypto, but it's all regulatory compliant. It's all licensed exchanges, licensed broker-dealers in the securities world. A digital token itself is basically just that unit of account that's backed by the real-world security asset that you issue as a founder or as a general partner in a fund. Quick question mark, what is a security? Anytime you talk about a security, I always reference the SEC v. W.J. Howey Company. It's a 1946 Supreme Court decision, and under the Howey Test, Any transaction is considered an investment contract if it is an investment of money, there's an expectation of profits from the investment, the investment of money is in a common enterprise, and any profit comes from the efforts of some other promoter or third party. And that's the measuring stick that is used to determine what constitutes a security. Now in the United States jurisdiction, which is one of our principal focuses, but similarly in Europe and the EU under FINMA purview, there's several forms of exempted securities And then of course you have registered securities. So exempted securities are most often what startups sell or offer as part of their fundraising, 506(b) offerings or 506(c). There's also Regulation Crowdfunding, Reg A, and then of course Reg S exemption, which means you're selling the security to somebody not in the United States. And this could also be shares of stock, partnerships or LP units, bonds, convertible notes, SAFE instruments, options, warrants, futures contracts, you name it. Now let's talk about the tokenized securities market. One of the definitions in the tokenized securities market is, of course, the government enforcement actions that have, on one hand, defined what you can't do, but then also it has been very instrumental in understanding what you can do. The SEC has been very active with enforcement. You've got early ICO cases like SEC versus Munchie that declared a token a security, and then you've got unregistered broker-dealer promotions where celebrities have actually promoted token offerings and got slapped by the SEC because they were functioning as an unregistered broker, like Floyd Mayweather, DJ Khaled, for example. BlockFi, for example, was fined over $100 million over DeFi lending. And then, of course, the ongoing case between the SEC and XRP as an unregistered security, and so much so now the SEC is encouraging traditional crypto exchanges to register as alternative trading systems under Securities Exchange Act. You've also got state-level action, New York, Texas, a cease and desist of Celsius for their DeFi lending. The SEC recently blocked a Form 10 registration of a DAO, American Crypto Fed DAO. Bottom line is securities are securities, and just because the technology is new and novel, it doesn't mean that because the technology says you can do it, that the law says you can do it. So now what's interesting specifically in the tokenized securities market are the SEC statements and no-action letters that don't get as much press as the enforcement. But under the no-action letter that was, produced as a request of FINRA. They defined a 3-step process. A digital token security cannot be self-custodied. An ATS or an exchange may not custody. They may only match orders. The ATS notifies the seller of a match who directs the custody, and then the token on the custodial deposit is considered unencumbered. There's no margin trading against digital token securities in the marketplace, so it's fully funded. And so there was a second joint statement, crypto and digital asset securities only broker-dealers, which permits a broker-dealer to engage in crypto and digital asset securities only. They can't do any form of traditional securities placement or fundraising or transaction. What this does is also allows the broker-dealer to physically take custody of the tokenized security itself. There are a couple of interesting paths from a regulatory market standpoint that have defined how this market is now growing and thriving. How big is the market? So last year, the World Economic Forum produced a report that estimated $866 trillion in assets will move on to a tokenized infrastructure over the next couple of decades. You contrast that with the $2.5 trillion of cryptocurrency market cap, and then you look at the size and scope of all of the other traditional asset classes that will eventually adopt the similar technology. And then you look at the current market of tokenized securities and what's trading. It's this tiny little speck. We're so early into this market. Space that— but it's growing rapidly. It's growing and expanding quickly. So now let's talk about tokenized secondary capital markets. This is important to understand because even though you're raising company as a startup, ultimately there's a reason secondary markets matter all the way back to day one on how you're raising money for your company. So you have to understand a traditional market infrastructure. You have an issuer, corporate management team that would then potentially hire a transfer agent. Like if you're doing a Reg A or a Reg CF offering, you're going to need a transfer agent. Reg A, you do. And then you have all of the custodians and the brokers that represent the seller and buyer as securities then trade back and forth as shares on a stock market, for example. And understanding how this market works is important because it helps you think through the mind of your investors who principally want liquidity. And this is why secondary markets matter all the way to the most early stage of your startup. Always be thinking about what is the liquidity event? What is the liquidity event? Your investors are going to put money into a project based on a whole bunch of variables and factors, but they're counting on some manner of liquidity at the end. They gotta get their money back out. And as a director of Founder Institute, I found myself explaining a lot I teach this a lot to startup founders over and over. You need to explain to your investor how they're going to get their money back out of your deal. They're not just giving you the money so that you can pay expenses and then eventually the liquidity fairy comes and strokes your head with the wand. You actually need to figure this out. Investors want liquidity for their investments and they actually place a premium on the ability to get liquidity for their investments. Well, what does this mean? It means the illiquidity discount of any given asset class can be 30%, or more, which means the price of your share of stock of your company could actually, on a secondary market, be a lot lower than what you think it's worth relative to your pro forma and your cash position as you're planning the development of the company. The tokenization market right now is building towards that emphasis on liquidity. How do I get liquidity out of my investments? Programmable securities are a very interesting novel invention, not just because it's cryptocurrency and blockchain, But because of these needs for liquidity and the ability to standardize the information and data about securities to make them more transportable, it's enabling this digital transformation of capital and capital markets themselves. The automation of what traditionally has been back-office broker-dealer processes, settling a trade and settling a transaction, that can now all be automated while also ensuring the automation of all of the governance, the risk, and the regulatory compliance of your security instrument as it trades. The most important thing is, it's going to enable, it is in the process of enabling inter-institutional exchange of liquidity. What this means and why this is important is because your share of stock won't necessarily just trade on NASDAQ. There's no monolithic centralized single source of truth of the price. If your security is trading on multiple liquidity pools simultaneously, it's going to give you better access to multiple liquidity pools themselves, which is very important because now that's buy side of people wanting to buy your security and buy your funding product. You need to be thinking in terms of you're developing a product. Every company that goes through this process not only is creating their value proposition, but your secondary byproduct of your company development is your security. What are you selling to raise money to fund the development of your primary value proposition? Now, you see there's an entire decentralized ecosystem that's cropping up that are are primarily focused on building their entire securities operation on blockchain rails. This is across every layer of market intermediary: broker-dealers, transfer agents, fiduciary trust custodians, banks, and of course, the ATSs and the exchanges. The alternative trading systems are very interesting because they can become very highly boutique and specialized in specific types of asset classes and trading in different types of funds that are related to VC and startups. Lots of different opportunities that are emerging as a result of this bigger ecosystem that has about $4 billion trading today. We anticipate that that's going to go to $100 billion or more within the next 12 to 18 months. So now let's talk about decentralized autonomous organizations, DAOs. You may, if you're crypto curious or affiliated, you probably understand what the concept of a DAO is, but it's a decentralized organizational entity that's using blockchain technology for operations. Why this is interesting is because it allows the organization and the governance of the operation of that organization to be actually encoded as software programs, as smart contracts. Ultimately, then, that organization and any capital that goes into that organization through the form of either funding mechanism or purchase of governance tokens, now that capital is controlled by the organization and not necessarily any centralized governance entity. That's usually through a voting mechanism, some form of staked voting mechanism, or you're voting your tokens and your participation. Typically, one of the things that DAOs do is they contemplate investments and how do I allocate out of the pool into various projects. It originated from blockchain network creation and crowdfunding out of the open source community, but has since expanded into some very interesting novel forms of investment funds themselves. Now, of course, the legality as an entity has some interesting implications for the limitation of liability of why you would originally want to create any kind of an entity to remote your liability. But fortunately, the limited legal entity status, at least in America, has been cracked. The door has been cracked with the state of Wyoming passing DAO laws to create a modified form of an LLC. This defines all the governance, the tokens, the membership interests, disclosures and reporting, and then they actually have a specialized state court for complex dispute resolutions. And as of the end of the year last year, there were 130 active DAOs as new forms of entity that have incorporated in Wyoming. So the question is, will DAOs disrupt VC and crowdfunding? It's very attractive for people to democratize capital as a cooperative community. People like the idea of that democratization of capital. On one hand, I can buy LP interest in a VC fund and let the GPs go out and put money into startups and manage a portfolio. And then in another instance, I might be interested in directly participating in the review and the criteria of that fund. So you're seeing an evolution in a way of that project capital funding allocation to the point now where within the past 2 years, $6 billion in capitalized digital assets are held by the 20 largest DAOs in existence. That's a massive climb of funding pool for the right kinds of projects that are seeking capitalization for their startup, for example. So of course, the big question, how to raise money with a tokenized securities offering. And it's complicated. It's not simple because it's an overlay of multiple competencies. You have already complicated securities. How do I raise money? Do I have securities counsel? And then you have all of the finance side of it, of planning, you know, what does a raise look like, capitalization? And then you, of course, are adding the tech layer over the top of that. What we did is we sought to define the asset tokenization lifecycle process, ATLP. And this is a model-driven approach by which we're out in the industry promoting and pushing the standardization of how these things get created and launched and managed and list and trade. So you start out with a primary offering, and then you've got some steps of things that you kind of need to do as part of that. And then you move into the secondary listing and trading side of it, which of course, that's got its own steps. And then at the end, what happens if your company gets bought? How do you get rid of these tokens, right? It's on a blockchain, it lasts forever. Well, that's a big contemplation, a consideration from a record standpoint. So primary offerings is where your startups are going to land up front. You're raising money for a company, you're trying to put money into a new entity, a new fund, and capitalize your company. Things that you need to think about, the technology is now able to help you do. It automates your primary offering investment experience for your investor. If you make it difficult to go back and forth via email, sending documents that need to be signed and accredited investor questionnaires and all of the administration that goes on with it, something's going to fall between the cracks. It's not a great experience. I got to email you my ABA routing number for my bank, my checking account so that you can wire your allocation into my company. And ultimately, you want to automate all these pain-in-the-rear things that are necessary necessary from a regulatory compliance standpoint to finally land at a tokenized book entry. A book entry is basically your cap table. That's your official record of who owns what. All of that automation is something that is capable of happening today. There are multiple providers for primary offering automation, and I encourage any founder, anybody that's starting a company at this point to skip the manual process of back and forth and explore some of the automation capabilities. And then, of course, once you start to tokenize, you've got all of those documents, you've got all of those payment receipts and all of the KYC identity checks, you've got all your sub-docs of your subscription agreements. All of that then has to be ingested along with the creation of the actual token that represents the share. So it's all of that body of record and information that has to be built into that token. And if we go back here to the previous slide, we can look and see that you've got this structure of your offering, and then you're going to configure the tech and everything that goes into that offering. And then once you launch, you're able to actually intake all of those documents and issue those tokenized securities to your investors. Of course, I would be remiss if I didn't talk about how we help folks do this. We help with universal tokenization. We help people avoid being locked into walled gardens of institutions to help you own your own data across decentralized markets, own your own governance and compliance, give yourself and your investors optionality in the marketplaces and custodians, and also even from a technology layer to give you optionality in what layer 1 blockchain that you use ultimately for your transferable form of token. Token. And then ultimately, the goal should be multiple custodial support for your investors, simultaneous registration with multiple exchanges and liquidity pools so that your security can trade in as many places as possible for as least amount of money for operating expense and cost as possible. And then ultimately, because now we're changing, we're decentralizing Wall Street, you can grab all of that trade data and aggregate that trade data in the analytics of your actual asset, the security of your own company, the shares of stock in your own company that are trading in these liquidity pools, you can actually grab that analytics and do really awesome stuff like market making, like arbitrage of your own asset. You can trade in shares of your own company just like the big boys on New York Stock Exchange and NASDAQ, but do it in a more cost-effective and efficient manner, manner across the emergent secondary market ecosystem. So if this kind of stuff's intriguing to you, we have what we call Digital Securities Lab. It's an an online community for professionals that are interested in digital securities and tokenized assets. And its founders, investors, funds, broker-dealers, law firms, exchanges, accounting professionals. And we give away a free VIP membership to people that come to our partner events. So that QR code, actually, if you scan that QR code on your screen, that QR code will, uh, launch you to a VIP application form. Fill that out and, um, we'll, uh, grab that application and you'll get some from us and you'll be able to get in. And it's literally, it's a no-pitch environment. It's an education resource. We post regular news articles and it's starting to bubble up as a great information resource. So I guess that's it, Ryan.

All right. Well, thank you for that. Thank you for the presentation. We've got some great questions in the chat here. And so while people are kind of digesting all the information that you just put out there, Let's start with this one, which you talked a little bit about this, but blockchain and tokenization, it's been around for a while. You think that it's going to grow to potentially $100 billion over the next 18 months or so. When do you think this will actually hit a critical mass where tokenized assets become the standard rather than the exception?

[Speaker:BRAD_STONE] You're still 3 to 5 years out. I contend that in 3 to 5 years, the over-the-counter markets won't exist anymore because why would any any company CEO want to register on pink sheets and face naked shorts. And you got a great company and you're trying to do the right things and provide a liquidity path to your investors, and then you've immediately entered into, you know, wide open sea marketplace of a bunch of sharks that are going to tear up your company and short the heck out of you and beat you down just because they can. And by moving away from OTC markets, um, you know, there's a number of OTC market companies that we've talked to that are interested in getting out of the OTC markets and moving into this ecosystem. So I think it's going to be 3 to 5 years to see the market really rolling full tilt. But within that timeframe, we anticipate you'll be able to buy and sell and trade, obviously subject to regulatory compliance, but you'll be able to buy and sell and trade alternative assets, early-stage companies, fund LP units, real estate on platforms like Robinhood, hood, right? I mean, they're adding crypto now. It's not that far of a jump from a technology implementation standpoint to then open up entire new market segments. And there's a lot of money pouring into the market infrastructure side to the space right now. I'm talking like big, big, big dollars from the big players. Franklin Templeton has leaned in into the ATS marketplace investment. Fidelity, right? They're all eyeballing how to get their toes in the water here.

Yeah. You know, even though 3 to 5 years feels like a long time, I mean, that's right around the corner, especially for founders that are just starting out right now. I mean, that's going to be when you could potentially like list these tokenized offerings on those exchanges and get that liquidity, because you're going to go through the, you know, the kind of initial 2 years of growing your startup, getting to product-market fit. And so as founders are thinking about this, this, there's kind of two categories here. There's someone who's at like the very beginning of their journey who, you know, maybe they're about to incorporate or they just incorporated. How would they go about the tokenization process? But then you have ones that are maybe, you know, a couple years down the line, maybe they raised a safe round, uh, pre-seed or seed, you know, how would they then go about this tokenization process? Does it matter that you start off with full tokenization or can you eventually adopt that as you go get further along that maturity curve?

That's a great question. We have both equally balanced. We've got legacy companies and funds that are wanting to transform their existing ownership table into a programmable form of security. And then we have folks that are launching brand new offerings out of the gate. Obviously, if you get it right all the way at the very, very beginning, in the beginning, it's a lot easier to manage the downstream effort. Regardless, keep copious records, right? I'm a records management guy. I'm an information knowledge management guy for large enterprise data lake knowledge management implementations. Organizations do a notoriously poor job of managing their records and their data in general. So the better that you are at that out of the gate, the easier it will be to convert those traditional records into a form of programmable token security.

[Speaker:TREY_LOCKERBIE] So there's a lot of good questions here that I want to get to. Along those lines, looking at this from an investor's perspective, because there has to be some level of education that a founder would need to do. One of the big pieces of advice I give founders is don't make it hard for investors to invest in you. New. If you have this DAO that's set up that is the structure, it hasn't hit mainstream yet. So someone who's used to seeing the Delaware C corp and they're like, "Okay, I understand that this is a Delaware C corp. This is a SAFE note with a cap. I understand how that converts." There's a little bit of this educational process that investors are going to have to undertake. And whether that's now or 3 to 5 years from now, I mean, what's your sense? What can founders, as they're thinking about raising capital, what's that friction-free way to be able to educate the founders, or excuse me, the investors around the whole tokenization process and why it's actually beneficial for them to jump through that extra knowledge gap?

Yeah, it comes down to that education curve 100%. There's been too much emphasis on the technology and the token, and it took on a life of its own with cryptocurrency discussion. So most investors have heard of Bitcoin by now. So really where the education leap is, is facilitating the segue from cryptocurrency and their understanding of how cryptocurrency markets operate, and then transitioning to It's the same technology, but applied to the traditional regulatory way. In that way, it's really just the mortar between the bricks. It becomes just part of that boring infrastructure of how things work at the enterprise computing level. We call it a digital transformation exercise in the CFO's office. If you're the issuer, you're making a decision, I want to make my cap table programmable, as a programmable form of security, what do I need to do to make that happen? And so, by changing the construct of that language and being less enamored with the glitter and the tchotchke aspect of, "I got a coin to do this and a coin to do that." We get asked all the time, "Well, I want a coin that operates in some kind of application, but I want to sell it as a security and I want it to be all one and the same coin and the same token." Well, those get to be complicated discussions, Our world is easy. It's a security. We started with the law, we worked our way backwards into the tech, as opposed to starting with the tech and then trying to figure out how to beat the law into a way, shape, or form to fit what the tech is capable of. Just go back to what is already on the books as law and then find those efficiencies. And that's what the industry has done. This is a much bigger conversation than just me. This is many billions of dollars already in play here. I think what it comes down to from an educational conversation standpoint is we're just going to make our cap table programmable. We're going to create tokens that can interchange with institutions and give you flexibility and optionality for what you do with your asset token down the road.

[Speaker:TREY_LOCKERBIE] The key point being that that token represents a share, so therefore they have the ownership of the underlying security.

[Speaker:SCOTT_LYNN] That's right. [Speaker:TREVOR_BURRUS] That's right. Now, there have been some interesting structures where you sell the share token and then they have a simple agreement for future token of some utility function that goes along as a bonus of the share. So there's been some novel ways that the legal beagles have come up with to try to somehow or another raise money in a securities fashion for a blockchain project, and then use that as a vehicle for distribution of what would not be considered a securities token. It would be an operational token, but only blockchain-focused. Focused companies, software companies really need to worry about those kinds of things. This applies to every startup. This applies to every venture fund, GPLP. This applies to every entity, every asset class in existence.

[Speaker:TREY_LOCKERBIE] Yeah. I think that's a good distinction. And I think Waleed's question here is at what point are tokens considered securities? Because I think clarifying that piece is going to be huge for the aha moment of a lot of the audience.

Yeah, we start with the presumption that the security exists on paper, right? It has to be a security on paper, which means whatever the compliance requirements are in your government jurisdiction that defines what is a security, it literally starts out as a contract. It's an incorporation, articles of incorporation, all of the proceedings of the board, all of the things that would be ultimately subpoenaed in a court of law to prove any aspect of the entity, the identity, the asset itself, the security itself, the transaction, it all goes back to the traditional words on paper. All the hash values are cool and all, but it still has to be made provable in a court of law in a regulatory environment. So that's a really important distinction that I think needs to be made of when this thing becomes a security. It's a security from day one. You're just happening It just so happens that you're using the technology and the token to designate and represent that security to make it more tradable, more flexible, more programmable.

Much in the way that a share certificate is like the paper that represents the shares.

That's right. That's right.

A ton of questions here. I'm going to try and go through as many as we can. Let's see if we could wrap up these because I want to get to as many as possible. All right. So, and we're all— you say any limitation— oh, that was already answered. Never mind. Any limitation on the stage of the startup to raise capital through the tokenized market? So it sounds like whether you're just starting off or whether you're a couple of years down the line, you can go this tokenization route. It just might be harder because you have to backdate certain things and account for past shares issued, Yeah, you can start from literally day one.

In fact, in many ways, it is easier to start from day one because that's when everything's fresh and new and you've got your first cap table of your first angel investors and friends and fam and folks that are throwing money into the company. And all of those agreements that are signed as part of that process, literally even graduating from a Founder Institute cohort, all of your incorporation documents, your warrant agreements, every document document that constitutes a legal construct that becomes part of the body of evidence that must be contemplated as a tokenization effort. So it is not too early. And then conversely, on the already little bit later stage, assuming you've got good cap table and good record keeping and all that, it's a function of ingesting those documents, constructing a blockchain-based token model that represents what your cap table looks like, and then issuing those wallets and those tokens to those already existing shareholders.

Now, can they trade the tokens separately from the shares?

No.

So it's all— the token then is the representation.

The token is the share.

This is another stage maturity level. Greg is asking, at what level maturity is this most applicable for a company? Is it pre-seed? Is it Series A? When do they actually need to start thinking about this? Should it be from day one, or do you think they can buy some time, keep it simple, and then start tokenizing maybe seed and beyond?

[Speaker:TYLER_WALKER] Well, it's relative on the earliest of stages of what do you spend your money on, right? So there is certainly a— while there's a reduction in cost over traditional forms of capital fundraising, in particular with the broker-dealer market, if you're going to hire a broker-dealer as a licensed intermediary to go out and raise money for your deal, deal, which is very hard to do at the earliest of pitch deck stages, that there is a cost savings over the traditional cost of capital acquisition. That being said, there is still a significant cost. It's cheaper than going public, millions of dollars for legal, millions of dollars in auditing and everything that you need to do to go public and be listed. It's significantly cheaper than doing that. So it does lend itself upstream to much earlier stage companies. And I remind everybody that it doesn't take very long when even your preferred shares of stock or your options or your warrants that you sell on day one of your first capital event, at least in the United States, there's a rule called 144A, which says that any private security is restricted from secondary market trading for 12 months. But then once that 12 months is up, assuming rights of first refusal and contracts and everything are going to allow it, that your preferred share can become tradable in a secondary market fashion as soon as that 12 months expires. And a lot of founders don't understand that and realize that, that if I need liquidity as an investor, I may be able to go access any number of secondary market marketplaces that aren't even tokenized. SharesPost, for example, right? Augment Markets. There's pre-IPO liquidity pools that I can go and figure out ways to get money out of. I'm going to get beat up with that liquidity discount for for certain, but it's not necessarily too soon to start thinking about it at all by any stretch of the imagination.

[Speaker:TREY_LOCKERBIE] It seems like that though, even though you have to deal with the complexity of converting a SAFE note into equity after a qualified equity financing, do you think that the best practice would be like you kind of need to start with, "Okay, who owns exactly what? Michael owns 100 shares, I own 200," and then it's just simpler to then tokenize it because there's an exact amount versus it being like, this might convert at this level depending on what might happen in the future.

[Speaker:TREY_LOCKERBIE] Yeah. We've had a lot of those debates even working with funds in particular, because it may not be a unitized fund. It may just be simply a percentage ownership of a cash pool as a limited partner. Well, tokens by their very nature have to be unitized in some capacity because I have a token that represents a thing. Thing. And so the complex modeling that goes into percentage of ownership of the fund based on monthly or quarterly up or down performance, and how do you make a token-based model to do those kinds of things? It's definitely an interesting exercise when contemplating that. That being said, you could still tokenize a SAFE note, and that SAFE note on an unconverted basis could theoretically trade in a secondary fashion in some capacity.

Preston Pysh Yeah. That's interesting. Let's talk quickly about tokenization costs, and then I want to get to DAOs. So Chris, Howard, and Brad, they all asked sort of a similar question, which is like, what's a ballpark cost for tokenization? So if I'm using Carta and I just raised my seed round and I want to tokenize all these things, what would that process look like?

Well, once again, I refer back to the asset tokenization lifecycle process is probably, I can tell you as a company, it's our go-to to start, take it from the start from the beginning. You're going to contemplate depending on really, there's a lot of variables. Are you going to automate your primary offering process? Well, the automation of the primary process, which I'm telling you, that's an expense I would have encumbered all the way back on day one had the platform technology been mature as it is now to automate these types of functions. That can run as high as 10 grand. $10,000 on the front end. Every penny worth it to me because I spent way more than $10,000 in shuffling inboxes and emails and DocuSigns and garbage back and forth. To have had it all in a nice consolidated stack, I would've gladly forked over $10,000, $20,000 to help me manage all of the chaos of the administration of a raise. To go through a full cycle and to list and trade, that That gets very complex and it can be as much as 100 basis points or 1% of the overall raise from a tech standpoint is kind of our benchmark target. So certainly, there is a cost layer that's there and that's relative to each deal, right? I mean, what's your cost of capital acquisition? If somebody's just raising $50,000 on friends and fam for a proof of concept or some pilot type, very early, early, earliest of stage, it may not be worth it to run it on that. But as soon as you start raising a million bucks, absolutely, it's worth every penny.

[Speaker:TREY_LOCKERBIE] Got it. So that answers that threshold question. So let's talk quickly about DAOs. Renata is asking, are there new companies that are forming DAOs before they're seeing revenue?

Yes.

Yep. Okay. So short answer, that's great. Dan is asking, how does tokenization plus the DAO handle voting rights when a startup tokenizes their cap table?

Yeah. So that's presuming that we're making the company a DAO, which I anticipate will come as well, not just funds, which is how some of the DAOs are operating today, but it's it's not that far away from what's already happening in some of the blockchain software project spaces, right? And so whether you're purchasing that DAO governance token in some open market or as part of a subscription process, the money that you pay for that token then goes into the pool on the initial capitalization funding side of it. And then the anticipation is the initial DAO members of the network will list and trade and there'll be secondary primary trading market activity of what we believe governance tokens, at least in the United States, constitute a security. So you're back to the construct of a business. If I've got the rights, now, can the economic rights of a share be separated from the governance function of a share? That's going to be an exercise for the SEC to contemplate in the next couple of years. But at least we're pushing that outer window. And I firmly believe there will be certain companies, certain communities that organize a business operating entity. They will capitalize their projects. They will make funding decisions based on a blockchain-based organizational operating agreement, which is effectively what a DAO is. It's less of an entity and more of an electronic form of operating agreement.

DAOs are still new. In fact, we've been getting a lot of questions around DAOs. Right now, the gold standard is if you're launching a startup, go and create a Delaware Delaware C corp, right? That's what investors expect to see. DAOs are a little bit more complex. I remember seeing something, I think it was from Andreessen Horowitz, where their recommendation is set up the Delaware C corp that then owns the DAO, and then you can operate within the DAO. What are you seeing as the best practice right now?

[Speaker:TYLER WINTLE] Wyoming's obviously the shining example because of the clarity in their state regulations. They amended their LLC Act to contemplate a decentralized form of operating agreement. I think the argument's still going to be The jury's still going to be out from a legal standpoint, from that judiciary. They were wise enough to form a tribunal at the state level with subject matter expertise in the technology, in the construct of the industry, so that you don't have local municipal judge scratching their head trying to figure out, "Well, what is this blockchain thing again?" Then multinational jurisdictions, there are DAOs that just form and operate just as a collective unincorporated association. Creation, then they don't necessarily care about a jurisdiction. Those will also be interesting to watch as we go forward in the market.

Preston Pysh So the investors participating in the DAO, they're obviously purchasing a piece of the DAO or through the tokenization process, but there are funds, VC funds that have compliance issues, they have mandates that could prevent them from investing in a DAO. DAO. So that's why you see this gold standard of the Delaware C-Corp, because everything's clear. And even when it comes to investing in S-Corps or LLCs, they have these limitations. And so if you're a founder and you're considering doing a DAO, but you're also considering going the standard startup route, how would you measure the pros and cons between those two decisions? Do you go and set up the Wyoming entity and just purely hope that you're going to raise the money purely through the DAO, or do you go the standard route and then figure out the DAO piece later?

[Speaker:JOSH_FARLEY] That's actually an interesting thought exercise because on one hand, the DAO could be used as the form of operating agreement of the corporation, if you think about it. So that's why I advocate that it's less about the entity at the DAO level and more about how we agree to collectively govern this "Legal entity, whatever it is, LLC, Delaware C corp, kind of doesn't matter. We as stakeholders of this entity agree to utilize this form of corporate governance as an entity." So I mean, in the end, I think it's going to be both in a way. Yeah.

I mean, it sounds like to achieve that, you would just basically update the bylaws of the corporation to then follow the the best practices of the DAO.

[Speaker:TREY_LOCKERBIE] That's right. Delaware was one of the first states very, very early on to pass legislation that enabled any business entity, corporate entity in Delaware to use a blockchain as an official form of corporate recordation. They led that charge. I think it was 2016 when they passed that legislation. So very, very early.

Yeah. So here's a sort of an interesting question around competition, protecting the company. So this comes from Daria. If my goal is to tokenize my business in a way of distributing the shares between hundreds of small players, how is the tokenized economy protecting me from being bought by large competitors? Because in theory, those hundreds of people could be selling to the same entity. Is there any right of first refusal?

Is there any way to kind of protect the organization I would consult with your corporate counsel on that. I think it comes back to traditional poison pill provisions and provisions in disincentivization of a form of a hostile takeover, which certainly is a possibility in this emerging marketplace. One would hope that if somebody's taking action to do that, that the price of the the buy side is certainly worth the effort. But once again, that's the market speaking, right? If it's cheaper for me as a competitor in a space to contemplate a market-based acquisition of a company, these are the things that smaller public companies that feed bigger public companies have to contemplate. It certainly comes much earlier in the lifecycle of a company. But once again, that's a very interesting thought exercise as well, is at what At what point does corporate counsel need to contemplate percentages? Some of the projects that we work on at the institutional level already have provisions for beneficial ownership because of the tax structure. So when we work in the real estate space, for example, a REIT is capped on who can control how much of the entity based on the tax structure itself. A straight corp with common voting, definitely an interesting thought exercise. Thank you for that. Good question. [Speaker:TREY_LOCKERBIE] Yeah.

And just to go one level deeper there, so normally if an investor wanted to sell their shares in a private company, there's usually some kind of right of first refusal where the company gets to buy the shares back first. In your experience, is that also happening with tokenized securities? Do they still have that same right of first refusal? Or because it's a little bit more liquid, they can sell it to whoever they want, and that's just the nature of it.

[Speaker:TREY_LOCKERBIE] I've seen it both ways. So I mean, it comes down to that is your first stopgap. Most companies that already exist that are contemplating tokenization already have some form of ROFR, right of first refusal clause in their shareholder agreement that has to be contemplated. Which presents the company with an interesting quandary because now you've got to maintain some level of possible liquidity as a company in your treasury, in your bank account, because if there's open market activity and somebody says, "Well, I want the secondary market liquidity, but I've got to give you first right of refusal." If you don't like the current price that it's trading at in the secondary market, then you better be prepared to inject that liquidity into that rojo. Before it gets out into the open wild.

Yeah, yeah, that makes sense. So Daria, it sounds like that might be the answer to your question, which is make sure there's a right of first refusal so you can have some kind of protection or control over that. Well, I know we have about 7 minutes left before we start the networking piece of this. It looks like a lot of people want to connect here in the chat with each other. Again, we'll send out that link to everyone here in a couple minutes, but let's get through a couple more questions. Here. So let's see here. Let's go to Steven. So this has to do with kind of like management of the entity and the tokens. How do you solve the dissemination of material information so that investors can make informed decisions without going through this lengthy due diligence process as part of the liquidity process? So is there, like you were saying, you have these records of information that you need to make available, right? Due diligence standard across the board, but is there a way to solve for that dissemination of information?

Yeah. That's actually what we do as a company, believe it or not. I mean, that cuts to the chase of permissioning those records across the network so that if a contemplated investor is looking at buy-side liquidity and purchase of an investment, how do I get access to this information? How does that information get permission to me if I'm contemplating it. So public view of what's available publicly. And then of course, there's the analysts, right? You've got an emergent sort of early flickerings of light with coverage of tokenized assets and companies and securities. They also want access to the coverage side of being able to report on the performance and traditional market analytics like a Bloomberg or like in any other analytics firm that's doing analysis on any other asset class. So what's their data look like? Right.

So does this look like some kind of form of like a deal room that's accessed on the site? So is this just like a public deal room that people can look at?

Can be. Yep. Yep. It's a SharePoint SharePoint and Ethereum had a baby. That's kind of what we do. Only we don't necessarily build on Ethereum, but you get my point.

So, you know, as we kind of wrap up here, like, are there any other like best practices or resources for DAOs or tokenization? You mentioned the group that you have that is kind of sharing these best practices. Um, we'll be sure to send out a recording so everyone can get that QR code again and join that network if they're interested, but are there other resources you would recommend around this topic?

[Speaker:SCOTT_LYNN] Yeah. There's a group of guys out of Florida. They've got a media company, Securities Token Markets. They're out of Miami and they're trying to cover the space. They do a lot of analysis and reporting. Haven't done a whole lot with those guys. We're just heads down on market infrastructure and the institutional level, but they've got a lighter weight entry point. I think that But just understanding the crowdfunding industry is also a major segue because that's really where there's a lot of overlap in the Venn diagram. The crowdfunding market is really moving this direction. So Crowdfunding Insider and all of the typical trade publications in that space is a good place to also tap a feed. And then of course, Twitter. Out of the norm from just tech. Crypto Twitter is good, crypto securities Twitter. You'll find some great attorneys and great folks in the community that are out there leading the charge.

[Speaker:TREY_LOCKERBIE] There was another question that was asked earlier around how do Kickstarter and others have a role in this tokenization of securities? Have you seen them, whether it's Republic or Kickstarter or some of these other crowdfunding sites, are they actually raising funds through tokenized securities yet, or is that yet to come?

[Speaker:SCOTT_LYNN] There have been on some platforms, some very early nascent offerings, early offerings that have been tokenized. I think all of them ran into the same quandary that they're all primary issuance portals. In every segment of the crowdfunding industry, there's primary issuance portals like real estate has CrowdStreet, for example, Yieldstreet, StartEngine. and we just call those guys basically primary portals. In the end, whenever you raise money on one of those portals, all of the shareholder docs, all the sub-docs, everything that constitutes that activity on that portal has to ultimately come out of that portal, be incorporated into a universal tokenization engine, and then be made available across that inter-institutional ecosystem downstream. And I think that's where the challenge lies right now. So from an advisory standpoint, make sure that your data, your information is not locked inside of that institution. I don't care if they're building you a layer 1 Ethereum-based ERC token to represent your share. That's easy to move from wallet A to wallet B. What's not so easy is all of the rest of the story, all of that record set, that records platform. It's not as easy to extract that data out of those portals.

Yeah. That's really good information. Well, I know we have 1 minute left here and we're already starting to share the Airmeet link in the chat. So just for everyone here, we're gonna keep this going, but we're gonna move platforms over to Airmeet so that we can start to talk to each other, take some of the concepts and the ideas that Michael talked about today and deep dive into it. So it's really, really good to network with people in this space. It is still a small community. So we wanna make sure that you have time to meet each other and talk about this topic. So, um, Michael, you're a total rock star. Thank you for joining us today, and thank you for everyone else who joined us as well. We're going to send a copy of this webinar in the next few days. If you're interested in joining Founder Institute, again, we are enrolling founders all over the world in over 200 cities now, so you can visit fi.co/join to apply to the nearest program near you. And, uh, Michael, any final closing tips for founders today?

Just go out and knock it down. You only fail when you quit.

That's right. Amen, brother.