Monday, July 15, 2019

YouNow token offering qualified; are Reg. A floodgates opening?

By Mark S. Nelson, J.D.

YouNow, Inc., has obtained an SEC notice of qualification for a Regulation A token offering of its Props token, making it the second company in as many days to receive a notice of qualification for a Regulation A token offering. Although William Hinman, Director of the SEC’s Division of Corporation Finance, hinted at the SEC’s desire to see such offerings go forward during remarks at the 2019 SEC Fintech Forum, it remains to be seen exactly how many offerings will proceed and how quickly that could happen.

Props token. YouNow and its subsidiary The Props Foundation Public Benefit Corporation (Props PBC) are a Delaware corporation and Delaware public benefit corporation, respectively. The YouNow offering is being conducted under Tier 2 of Regulation A, which allows for offerings of up to $50 million with audited financials. As stated in YouNow’s offering circular, it plans to distribute 133,000,000 Props tokens to reward users of its only app to date, the Props Live Video app. The company also plans a secondary distribution of 45,000,000 Props tokens to Props PBC to reward developers who contribute to the Props PBC offering.

According to YouNow’s offering circular, the offering has significant risks. As examples, the company said the tokens may be of limited use initially because it has just one app and tokens do not provide any voting rights (other than in-app voting rights), although the company may give token holders an advisory vote on decisions by Props PBC.

Another significant risk is that of volatility. YouNow said the price of its token may be volatile because of more general market concerns, but also because of the Simple Agreement for Future Tokens (SAFT) it conducted in March 2019. The company said investors who bought tokens under the SAFT may want to sell their tokens and that token holders in the Regulation A offering should be aware of the potential for price volatility or even “price drops.”

Moreover, YouNow noted that its Props token uses Ethereum’s ERC-20 token, one of the most common tokens for intitial coin offerings. YouNow also noted that Ethereum’s consensus mechanism and the ability of its validators to validate transactions could be impacted by the complexity of the current proof-of-work mode of achieving consensus or by future development of a hybrid proof-of-work/proof-of-stake mechanism or a change by Ethereum to a proof-of-stake consensus mechanism. With respect to private keys, YouNow said token holders must secure the private keys used to associate with their wallet and that loss of these keys could result in loss of Props tokens.

Getting to qualification. Speaking at the May 2019 SEC Fintech Forum, Director Hinman indicated SEC staff were hoping to see successful Regulation A token offerings, but that a number of issues still hinder such offerings because of the novelty of blockchain-themed securities and the lack of experience by many smaller companies in dealing with SEC disclosure requirements. Director Hinman suggested that companies mull the following topics:
  • Clarifying the issuer’s business plan, including by describing what stage of development has been reached.
  • Explaining how the issuer will account for the sale of the original token and whether it has sufficient capital to achieve its plan.
  • Describing how the issuer's token will operate, i.e, will the issuer use a well-known token (e.g., the Ethereum ERC-20 token) or will another token be used, while also describing the consensus mechanism and governance of the token.
  • Describing how security will be maintained regarding private keys and explaining risk of loss.
  • Describing the arrangements for transferability.
  • Stating how the rights of token holders differ from other holders of interests in the issuer.
  • Explaining how tokens taken as consideration in an offering will be valued, especially given the potential volatility of many tokens.
  • Stating whether the issuer will seek to dissociate from the token by structuring the token to morph into something that may not be a security and describing how this transformation would be achieved. 
Several days ago, the SEC issued the first-ever notice of qualification for a token offering under Regulation A to Blockstack PBC. In a press release announcing the qualified offering, Blockstack explained why it had sought SEC qualification. "We decided to work with US regulators to figure out a legal framework for our token offering because we wanted to open our token offering to the general public, without excluding the US. We believe that this was the harder but better path to take."

In April, the SEC issued a framework describing the factors SEC staff consider in determining whether a token is an investment contract and, thus, a security. The SEC also simultaneously issued the first-ever no-action letter recommending against enforcement if TurnKey Jet, Inc., proceeded with a tokenized jet card business on a fully functional network without registering its tokens as securities.