If you are planning on launching a security token offering there’s an extensive due diligence checklist which should be performed. This checklist will be divided between business and legal compliance. The business aspect is somewhat globally consistent while the legal may vary from jurisdiction to jurisdiction, and this should only be a guide, with full legal-compliance being performed by an Digital Securities Attorney.
Business Due Diligence:
- Whitepaper should be reviewed by unbiased third parties which have reviewed these type of documents before. Common mistakes include promising high returns, failure to communicate effectively the technology, or explaining what the company is designed to perform.
- Tokenized securities should include enough details to actually make sense to investors. If it’s a tokenized real estate fund, are we investing in residential or commercial properties? In what cities? Is the goal to flip distressed properties or to invest in luxury high rise accommodations? These are the types of questions which are important to investors but are often overlooked.
- Business plan. If it’s a start-up that’s seeking to raise funds via an STO, we need details on what the business is setting out to achieve. Simply being an “AI” or “Blockchain” company is not enough.
- Profit Sharing – This should be broken down. Investors should understand if dividends will be paid out quarterly, annually, the payout, etc.
- Does the product or business make sense? Simply tokenizing a business and calling it “AirBNB on the blockchain” is not enough. We need to understand what the business model is, why now, and how the company plans on accomplishing its goals.
- Differentiating factor – Having reviewed 100s of businesses this is often where business plans, whitepapers, and founders fail completely. It’s a competitive landscape, and this level of competition is simply increasing over time. Explain what differentiates your product/company from competitors and explain this in details. It can be the team, the technology, patents, etc.
Legal Due Diligence:
At its root level legal due diligence is performed to ensure that the corporate entity is formed correctly, with sound corporate governance in place.
It is always significantly more cost effective to be legally compliant from the start, then it is to retroactively change the corporate structure.
Due diligence will ensure that all shareholders and other entities are legally authorized to perform the investment. Additional due diligence may reveal additional risks and liabilities which may not be obvious to someone who does not practice law.
Hiring an attorney to perform due diligence can raise red flags while it is still early enough to take corrective action. This can include discovering undisclosed risks, potential liabilities, compliance/tax issues, litigation issues, or simple contractual issues.
These are what a legal team should be hired to uncover.
- Background checks of management and shareholders. This includes running them through multiple international watchlists which include OFAC sanctions list, and the exposed persons list which is also known as PEP.
- Preparation of essential corporate documents which include articles of incorporation, bylaws, minutes of stockholder meetings, partnership agreements, shareholder agreements, fund offering agreements, and capitalization tables, etc.
- A legal team should review material contracts with partners, management, employees, service providers, and other, which could potentially cause legal issues.
- Trademark & Intellectual property rights.
- Compliance review, this includes but is not limited to registrations, SEC form filings, state filings, licensing, and compliance policies.
- Ensuring that proper KYC and AML is performed for the jurisdiction that you operate in, and based on where investors are headquartered.
- Whitepaper review to ensure that securities regulations are adhered to. For example, specific returns should never be promised.
While this breakdown may offer some clarity on some of the due diligence that should be performed, SEC regulations are complicated and it is important to hire a legal professional. The information on this page is for entertainment purposes only and is not meant to be construed as legal advice.
Below is a list of companies that are currently assisting STOs with the legal process:
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