Tokenizing Equity: Benefits, Risks and Practical Considerations

By: Max Dilendorf, Esq., Rika Khurdayan, Esq. and Gleb Zaslavsky, Esq.

Special thanks to Carlos Domingo from Securitize and James C. Row, CFA from Entoro Capital for their insights and comments on this article.

One of the advantages of blockchain (or distributed ledger) technology is that it allows for the instant, secure, traceable and cryptographically secure distribution and transfer of highly customizable, digitized exchange units without the need for intermediary parties trusted by both sides of the transaction.

This feature distinguishes such digitized instruments from conventional securities and has made offerings utilizing blockchain technology a liquid and innovative way to raise capital for emerging and established companies alike.

Because almost all such digitized units offered at the fundraising stage in the U.S. are considered securities, they have been commonly referred to as “security tokens” and an offering to investors of the tokens as a security token offering (“STO”).

Equity tokens (or tokenized equity) are traditional shares issued and maintained in a digital form on a blockchain and all transfers and settlement of such shares are recorded on the blockchain. Since such equity tokens are, in fact, entirely digital, the offering for investment of such tokens may be more precisely referred to as a digital security offering (“DSO”).

A company may “tokenize” both common and preferred equity, or either of them, in one or several DSOs. However, this article explores in more detail the offering, issuance and sale of preferred share tokens (or tokenized preferred equity), which are a type of digital security tokens that are specifically designed to have traditional features of preferred equity.

While the legal process of tokenizing common and preferred shares is generally similar, preferred share tokens have certain distinctive features and advantages that make them a particularly attractive financing tool for private issuers.

In recent decades, the issuance of preferred shares has been largely adopted as a means of venture capital financing. And tokenizing preferred shares is designed to provide liquidity, as well as simplify and streamline the process of issuing, selling and managing preferred shares during their lifecycle.

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