STO Launch Strategies
STO Due Diligence Checklist: Business & Legal Guide
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If you are planning on launching a Security Token Offering (STO), there is an extensive due diligence checklist that should be performed. This checklist is generally divided between business and legal compliance. While the business aspect is somewhat globally consistent, legal requirements vary significantly from jurisdiction to jurisdiction. This article serves as a guide, but full legal compliance should always be performed by a qualified Digital Securities Attorney.
Business Due Diligence
Business due diligence involves basics that are not unique to tokenized securities, but also includes additional reviews catering specifically to digital assets.
First, the whitepaper should be reviewed by unbiased third parties who have experience with these types of documents. Common mistakes include promising high returns, failing to communicate the technology effectively, or not clearly explaining the company’s function. The whitepaper must include enough detail to make sense to investors. for example, if it is a tokenized real estate fund, investors need to know if the assets are residential or commercial, where they are located, and the specific investment strategy (e.g., flipping distressed properties vs. long-term luxury holds).
Beyond the whitepaper, the core business plan must be solid. If a startup is seeking to raise funds via an STO, it requires details on what the business is setting out to achieve. Simply being an “AI” or “blockchain” company is not enough. For example, simply tokenizing a business and calling it “Airbnb (ABNB ) on the blockchain” is insufficient. Investors need to understand the business model, the timing (“why now?”), and how the company plans on accomplishing its goals.
Finally, the financial structure and competitive landscape must be clear. Profit-sharing should be broken down so investors understand if dividends will be paid out quarterly or annually. Furthermore, the company must clearly articulate its differentiating factor. Having reviewed hundreds of businesses, we find this is often where business plans and founders fail. The landscape is competitive; the company must explain in detail what differentiates its product, team, or technology from the competition.
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 than it is to retroactively change the corporate structure.
Due diligence ensures that all shareholders and other entities are legally authorized to perform the investment. This process may reveal additional risks and liabilities that may not be obvious to someone who does not practice law. Hiring an attorney to perform this review early can uncover undisclosed risks, compliance or tax issues, litigation threats, or contractual errors while there is still time to take corrective action.
A legal team is typically hired to uncover specific liabilities. This includes running background checks on management and shareholders through multiple international watchlists, such as the OFAC sanctions list and Politically Exposed Persons (PEP) lists. They are also responsible for the preparation of essential corporate documents, including articles of incorporation, bylaws, partnership agreements, and capitalization tables.
Furthermore, a legal team should review material contracts with partners, employees, and service providers to prevent potential legal issues. This review extends to trademark and intellectual property rights, as well as general regulatory compliance (SEC form filings, state filings, licensing). Finally, the legal team must ensure that proper KYC and AML procedures are performed for the specific jurisdiction where the company operates and where its investors are headquartered.
Summary
While this breakdown offers clarity on the due diligence that should be performed, SEC regulations are complicated. It is important to hire a legal professional.
Disclaimer: The information on this page is for educational purposes only and is not meant to be construed as legal advice.
