STO: how to target big?
One of the most essential benefits of tokenization is the democratization of investment. Inspired by this notion, many STO freshers rush to exclude institutional investors from their target audience.
One of the most essential benefits of tokenization is the democratization of investment. Inspired by this notion, many STO freshers rush to exclude institutional investors from their target audience. However, democratization is not about excluding large investors – it's about including small ones.
The pragmatic reality is that professional investors matter. They invest vastly larger sums, provide professional support and enhance the company's reputation. These three checks are crucial for many fundraising campaigns, so approaching institutions should be a skill for such companies.
This article is brought to you by Analytical Centre Stobox, the company's team of analysts passionate about tokenization, based on research we conducted earlier. While the study aimed to discover the influence of institutional investors on the STO's success, you can read our simplified article to find out:
- the types of institutional investors
- their preferences
- how to pick the right ones for your offering
- and how you should target them.
Why do institutional investors matter?
First of all, the average paycheck of an institutional investor is orders of magnitude bigger than an individual's. Retail investors usually invest from a few hundred to a few thousand dollars. High net worth individual investors invest from ten to a hundred thousand dollars. Institutional checks start at a hundred thousand and go into tens of millions.
If you aim to raise over $10 million, targeting them is essential to closing the round. For example, if your target is $50 million, relying on thousand-dollar contributions requires fifty thousand investors. This is problematic because marketing channels have diminishing returns, which basically means that starting at some point, getting each new investor becomes increasingly more expensive. According to SurveyAnyplace data, the lead costs for the financial services sector are by far the largest of any industrial sector worldwide. The average cost of a lead for a financial services firm is $47, and to make matters worse, traditional media purchasing channels are the most expensive, costing $71, while referrals are far less expensive, costing $54 per lead.
Secondly, professional investors offer valuable experience and connections, such as board members who went through similar challenges. In their article “How can the board add value?” Ada Demb and F.-Friedrich Neubauer position responsibility, identification with the brand, and prioritizing standards against which the corporation will allow itself to be judged as the board’s key value. Having whales on board improves your reputation, which can actually make you more attractive to smaller investors by providing social proof.
Thirdly, institutions (mostly pension funds, according to Marion Hutchinson, Michael Seamerb, and Larelle Chapple’s article in the International Journal of Accounting) usually have a longer planning horizon than individuals. Consequently, they are more accepting of long-term strategies that don't pay back cash for a long time. This is especially important if you have a high return on capital, which makes it much more beneficial for the company to reinvest earnings instead of distributing them.
However, by creating liquidity, tokenization makes this characteristic less important. If reinvesting grows your share price, and investors can actually see thanks to the active market, they will more likely accept the lack of dividends. Moreover, short-term investors get the possibility to exit when they want instead of pressuring you to pay dividends or even to sell the company.
Related: How asset tokenization brings liquidity to equity crowdfunding
Types of institutional investors
There are many ways to classify institutional investors. The one we offer isn't all-encompassing or mutually exclusive but includes the most typically used types.
Mutual funds. Mutual funds offer safe investment strategies, which is the premise of their popularity; they aim for slow but consistent growth. This is the most widespread fund type, favored by non-accredited investors. You can invest in it or exit at any time, which requires mutual funds to work solely with highly liquid assets, such as public equities or public bonds.
For most STOs, receiving funding from mutual funds will be complicated. Still, it's possible if your valuation is high enough and can create sufficient liquidity.
Private equity funds. Although they invest in privately-held enterprises, they are unlikely to invest in STO. The reason is that PE funds prefer acquiring the whole company, changing the management team, and doing the overall turnaround. Consequently, private equity funds will only be interested in STO as a way of syndication, raising additional capital from broad investors to fund the acquisition, with the fund remaining a general partner with a controlling stake. Engaging private equity funds as an investor is feasible if you mean to sell the company.
Related: How to sell a company via tokenization
Venture funds. Primarily, venture funds fund startups with the potential of 100-fold or even 1000-fold growth. Although most of our clients are linear businesses, VCs can be your best investors if you are a startup with such growth potential. In this case, tokenization will help you create liquidity earlier in your lifecycle, giving investors more flexibility to exit.
However, you must be careful while working with VCs as they tend to push companies hard to achieve lightning-fast growth, which can be very unsustainable. Recent history knows a notorious WeWork case: trying to push too hard and make the company go for an IPO resulted in a dramatic drop in value when the company had revealed its true valuations.
Related: Conventional clauses in venture agreements and why you should choose tokenization instead
Family Offices. These are private funds created by wealthy families to manage their assets, grow them in value and sustain the family members' lifestyle. Family offices are a very diverse investor class, so you can find them investing in almost any asset class. Thanks to this flexibility, family offices are ideal investors for STOs. Most such investors are conservative about their risk expectations, so working with them will be simpler if an underlying business has less risk; however, some offices may have a higher risk appetite and will gladly give out a part of their portfolio to risky ventures.
According to a 2018 Credit Suisse report, globally, there are around 50,230 individuals who have a net worth greater than $100 million. Many of these individuals manage their net worth within their firms, many pool their assets to create multi-family offices, and many are different branches of the same family. As such, Credit Suisse's estimates in terms of how many individual family offices exist range widely from 6,500 to 10,500.
Sovereign Wealth Funds are usually the biggest funds existing. This is where the countries place their income from selling oil, gas, or other natural resources. As they possess enormous capital, these funds consequently invest in large undertakings, so you should approach them only with an investment request in billions. You'd also have to consider the fund's strategy, particularly whether they invest domestically or overseas.
Pension funds. Like the previous one, pension funds prefer investing in big projects as they possess significant capital. However, liquidity is less necessary for them compared to mutual funds. As people investing in pension funds invest from a long-term perspective, pension funds can afford to work with private placements.
Crypto funds. This is probably the youngest subtype of investment funds that was established very recently but is already gaining traction on the market. Their total AUM constituted $4.1 bln in 2021, some of the leading players being
Multicoin Capital, Home | Pantera, and 10T Fund.
Despite not retrieving information about fund attitudes toward STOs, the research indicates that security tokens most likely accounts for a small portion of hedge funds' digital assets. In other words, funds must be mostly invested in cryptocurrencies instead of security tokens.
Which investors are the best for your STO?
You should consider several factors to understand which investor type is the best fit for your offering.
The first and foremost thing to consider is, of course, the size of the round. A round of $1 million may be easier to close with retail investors, while a $100 million round will be impossible to finish without institutions.
Secondly, think about the desired level of liquidity. It will determine whether you can raise capital from mutual funds and other investors who value liquidity. One of the primary advantages of tokenization is increasing the liquidity of private assets.
Related: How does DeFi unleash the potential of tokenized securities?
Thirdly, consider the industry of your offering. Institutional investors often specialize in a specific industry and region. It's much easier to get replies from entities already interested in companies like yours.
Lastly, think about the risk/return ratio. It determines whether you should reach out to more or less risk-averse investors, as well as the positioning of your offering: stable, safe harbor, or a high-return gamble.
How to reach institutional investors?
There are two main ways you can get in touch with institutional investors.
Search for the lists of institutions by industry and geography online. Sometimes it's enough to search on Google or LinkedIn, while in other cases, you should buy the lists of family offices or use other platforms like Crunchbase or Angellist.
Visit the events tailored to investing in a specific industry. Although travel expenses and entry tickets increase the cost of fundraising, getting feedback is much faster in face-to-face interactions.
Meeting investors in person is just half the job; presenting a compelling offer is the key point. Security token offering is an excellent instrument for making institutional investors even more interested in working with your business, as they have an interest in doing anything enhancing their liquidity or returns.
At the same time, they conduct a much more qualified due diligence than retail investors. This is why properly structuring your offering is vital. For this, it's advisable to use the services of a consulting company like Stobox, whose specialists can advise you on improving your business plan, legal structure, and capital structure. To verify whether we are the right fit, feel free to book a complimentary 30-minute consultation with our team.