By Myles Milston CEO of Globacap
Initial Public Offerings (IPO) have been around since 1971 but, as a way of raising finance for companies, they are beginning to fall out of favour.
In fact, earlier this year the Wall Street Journal declared Small Cap IPOs dead, suggesting venture capital financing had become the preferred method of securing funding for small to medium-sized enterprises (SME) in recent years.
It’s certainly true that since the Financial Crisis SMEs,in particular,have looked for alternative ways to raise funds. But they are not alone. The decision earlier this year of music streaming app, Spotify to opt for a direct stock market listing skipping the traditional IPO model made headlines around the world.
With a market cap of around $27bn Spotify can hardly be described as a small company. But by opting for the direct listing approach, the music streaming app exposed many of the failings of the existing IPO model. It illustratesthat companies don’t need to rely on the legion of brokers and advisers in the marketplace to successfully list on the stock exchange and create liquidity for their investors.
The seeds for this rebellion were sown during the Financial Crisis a decade ago. The immediate aftermath of the Financial Crisis saw banks being forced to stabilise their balance sheets. That led banks to withdraw funding to each other, with companies requiring funding being caught in the crossfire.
In the immediate aftermath, the resulting nervousness of investors meant the chances of any company launching a successful IPO reduced considerably, at least until markets and investors had calmed down, which didn’t occur until 2010.
Coupled with reduced access to bank funding (at the smaller end of the market, a European Central Bank task force recently estimated 36% of European SMEs still cannot get a bank loan), it should hardly come as a surprise that we have seen the rise of various fintech platforms attempting to bridge the funding gap in the last decade – from peer-to-peer lending, to crowdfunding, asset-based lending, and invoice factoring.
Spotify’s reasoning for not pursuing the typical IPO route will resonate with many business owners.
Spotify’s chief finance officer, Barry McCarthy, laid it out bluntly in the Financial Times: “The US public offer market is broken.”
He went on to comment that IPOs were financially draining, with a requirement that “money is left on the table” to keep participants, and particularly underwriters, happy. For many firms, especially SMEs, IPOs are inaccessible and prohibitively expensive, and this out-dated model is desperately in need of a makeover.
Advisory firms, on average, charge small businesses 10-15% of capital raised to list their equity on a small cap exchange, due to the high costs associated with each bespoke IPO. Larger businesses are charged less, usually 2-5% of capital raised, since the deal sizes are bigger. However,even that is excessive. Spotify’s direct listing of its shares – rather than going the traditional market IPO route – was a direct rebuke of these excessively high advisory costs.
Many alternative funding routes have their drawbacks too. Recently, for example, the Financial Conduct Authority (FCA) announced a crack-down on peer-to-peer lending and crowdfunding, for potentially mis-selling the level of risk to various investors. Conversely, while invoice factoring has had some success, it is still only a tiny portion of the lending market.
Another alternative funding route, the Initial Coin Offering (ICO), has exploded in popularity this year. In the first three months of 2018 alone, ICO’s raised $6.3bn, more than during the whole of 2017.The largest ICO, blockchain project EOS’s, raised a record-breaking $4.1billion in its token sale. However, while ICOs can be useful for tech-friendly businesses, they are not applicable to a lot of businesses and there have been a number of reputational issues and regulatory soundings in recent months which have stifled ICO activity.
A better alternative is Digital Security Offerings (DSOs), which harnesses blockchain technology in a regulated way, to offer a more transparent and cost effective form of funding. These are not ICOs, nor ‘token sales’ but use blockchain to issue securities in entirely digital form – for a significantly lower cost – something revolutionary in the financial services industry.In addition, those regulated equity or debt “tokens” can be more easily listed on and accessed through multiple trading venues globally, providing issuers with greater access to liquidity at a more cost-effective price, and with greater transparency and security.
Applied to the right areas, Blockchain and automation can potentially reduce issuance fees to as little as 3% and 0.5% for small and large companies respectively. Creating a security in blockchain form also provides a more efficient mechanism to administer that security on an ongoing basis, and also improves the entire workflow of clearing and settling in the secondary market.
There are already a number of initiatives underway that are designed to enable the trading of blockchain securities.The Gibraltar Stock Exchange has set up a blockchain exchange for digital assets.The Swiss Stock Exchange recently announced the formation of a Digital Exchange for the trading and settlement of purely digital assets.The US Securities and Exchange Commission (SEC) is considering applications for blockchain-based securities exchanges.Here in the UK, the Financial Conduct Authority (FCA) is also looking closely at this area, inviting a number of blockchain companies into its current Sandbox cohort
Globacap is one of the companies in the FCA Sanbox Cohort 4. The full platform, launching in late 2018, will allow companies to issue debt and equity in blockchain form, with FCA regulatory oversight. Tokens issued on the platform will comply with all relevant company law and FCA regulations, including Know Your Customer (KYC) and Anti Money Laundering (AML) rules.
It is firms like Globacap that will be at the forefront of a new wave of innovation in the financial services industry. Working in partnership with regulators to tokenize traditional securities, we will bring to companies raising funds the benefits of digitalisation, including 24/7 trading, real-time settlement, and chain-of-title.
We are entering a new era, where old-style capital raising methods such as the IPO, characterised by high fees, opaqueness, and favouritism, are being displaced by more efficient, cost-effective, and transparent processes. Blockchain technology, with regulatory oversight, is ushering in a new framework through which all market participants can benefit.