How to Evaluate STOs — An Investor’s Perspective

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Much is being spoken about STOs across various media channels, from online articles to ‘expert’ opinions and across a plethora of panel discussions as part of events across the world. Ironically, these events were all initially targeted towards ICOs, but changed color closer to the day and had a ‘dual focus’ on both ICOs and STOs.

I am not here to speak about the merits and demerits about such events; I feel they play an important role in terms of bringing the community together and their relevance would change (in a good way) as the industry matures. Speaking about STOs, I thought of presenting a high-level view of people on the other side of the table — the investors!

So, what eventually makes an STO attractive to the end investors? The common perception in the market that any running business with a viable revenue stream can go for an STO – this notion though partially correct, we must be cognizant of the fact that the business should be appealing enough to the investor for them to put their money in. This is no rocket science and is pretty much the same when you consider VC / PE funding or even when conducting ICOs.

NOTE: Though often used interchangeably both VC (Venture Capital) and PE (Private Equity) are different, the common element here is that they are both firms that invest in companies and exit through selling their investments in equity financing. The biggest difference is the stage at which their target is currently in. VC firms mostly buy stakes in companies that are young including day one or even pre-operational. PE firms usually purchase firms that are slightly more mature and established and have operations- they can be either private firms or public firms.

In the ‘golden era’ of ICOs one could throw around money at almost any ICO and could expect a decent return. The question was not if they would make profits, but more about how much profit would they make. Accredited Investors (AIs), Sophisticated Investors (similar to AIs) and QIBs (Qualified Institutional Buyers) are very careful with planning investments and would obviously look beyond the shiny website and the colorful whitepaper when considering any STOs. At the very high level, I can think of 5 parameters which AIs & QIBs would look at:

1. PROSPECTUS

Unlike a whitepaper, the prospectus is a legal document mandated by the SEC that provides details about the particular investment offering (the STO). The level of detailing in the prospectus might vary, but at a broad level, it would comprise of information such as — business details, background information, financial details, risks and the fees involved.

The most important aspect is the investment roadmap i.e. why is the business raising the money and what will be the money used for? This is a key point since the utilization of funds post STO would determine the attractiveness of the STO. For example, instances such as ‘raising money for expansion or for top line growth’ would be more appealing, as compared to ‘raising money to repay loans or buying equity from founder(s)’

Analyzing the details within the prospectus means getting through some legalese and long cautionary statements that protect the company more than the investor. However, it’s the legal nature of the prospectus that can give an investor some important information about prospective companies, namely the nature of their risks, prospects and industries.

2. BUSINESS MODEL

The underlying business model is a key factor when considering an investment for companies going in for STOs. Both AIs and QIBs look for evidence of a strong, healthy, thriving business — and top-line growth is the best indicator of this. Rate of revenue growth also factors significantly into the level of interest among investors leading up to the STO, as well as the actual valuation at time of STO.

3. CASH-22 SITUATION

Firstly, for those who didn’t get it, it’s a pun on the phrase Catch-22

What I mean is that, while access to capital is one of the common reasons for doing an STO, it is possibly the worst time to do an STO when you actually need the money to continue funding the business!

Let me try and explain this conundrum — if I am an investor, I would look at investing in a business, which is already making profits as compared to someone who will break- even in the future. If your forecast financials and business plan show a shortfall that’s intended to be plugged by the STO, AIs and QIBs might view this less favorably — that the management is resorting to a quick fix solution by raising capital from the market rather than trying to build a self-sustaining business. The best positioning for an STO would be that the business will use the proceeds of the STO to fund an even higher revenue growth rate, reinforcing an already strong balance sheet.

Trivia Question: What’s the difference between Money and Cash? Answer at the end of the article 😊

4. THE SYNDICATE

The ‘Syndicate’ is a temporary group of individuals or firms who might come together for the period of the STO with the intent of handling large-scale transactions, which otherwise would’ve been very difficult to manage individually. Such a syndicate would comprise of Underwriters, Bookrunners, Investment Banks (traditionally speaking), Broker-Dealers and others.

The composition of such an entity is also key to raising capital for the given STO. Their individual and collective credentials can sway investment decisions in the mind of an investor. The STO market is still in its infancy and it might take a while before we see such syndicates in action; the current deal sizes would not really warrant such a structure is what I personally feel.

5. LEADERSHIP & GOVERNANCE

If you thought Leadership and Governance mattered in ICOs, they would matter 10 times more while doing an STO. It is of absolute importance, who are the people at the very helm of the STO and their past/present credentials. Blockchain related experience might take a backseat in lieu of business experience since unlike ICOs the ability to run & steer the business is more critical than just being a technology geek.

Equally important would be ‘governance’, a term often misunderstood in the ICO fraternity. Being under the purview of the SEC would by default call for some governance and transparency and it is not something one can circumvent at will.

 

Please note that the above list is by no means an exhaustive one but rather an attempt to look at a small set of parameters, which an investor would look at while evaluating an STO. The idea is to partially weed out bad advice in the market by self-proclaimed STO consultants (who are promising an alternate route for raising money to their existing ICO clients) and also to educate general public regarding STOs. I feel SMEs (Small and Medium Enterprises) should look at their businesses from the perspective of an investor before they decide to take the plunge of doing an STO!

Trivia Answer: Cash means the mode of payment and normally it is available in the form of currency notes, whereas, Money means the worth of liquidity and they are available in different forms including cash.


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About the Author: Abhishek Majumdar

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