Dave Hendricks, Co-founder & CEO at Vertalo
Vertalo is a platform for issuers and broker-dealers to manage security tokens and cap tables. Vertalo is integrated with custody platforms and KYC/AML providers to make managing a security token investors’ data easy. Vertalo CEO Dave Hendricks joined me to discuss the security token ecosystem, tokenizing cap tables, the Reg D token offering, and on-chain security token ownership.
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What is Vertalo?
What we are is a very important data management layer that kind of knits all of the pieces together. We got into this because we issued our own security token in March 2018 and we couldn’t find anybody that could help us with managing the very important investor stakeholder data that was produced after an issuance. We thought, wow, this looks a lot like a cap table and we know a lot about cap table, so we should build a cap table that can manage digital assets and connect to broker dealers, issuance platforms, exchanges, KYC, and custodians. Basically what we are is a set of AP keys that connects all those players together and produces a nice visual layer so that you can see your data.
How does traditional equity fundraising work?
Well, it certainly looks a lot different than, say, doing an ICO or STO. Raising money is about meeting a lot of investors and finding the investors that like what you’re doing and can be supportive over a long period of time. In equity investing, specifically in startups, the life span of the relationship between an investor and an issuer in this case, like the VC and the company, often last seven to nine years or more. What you’re doing is you’re really trying to figure out who you can get married to, as a company, for many years. What happens when a VC invests in a company like Uber, they pledged funding that gets them a percentage of the company at a particular price with specific rights and they end up on a cap table. That’s kind of the result of the whole process. A cap table, in the most simple sense, is a spreadsheet that lists who owns how much stock at what price, when they bought it, and under what terms. Every company in the world that has more than one shareholder pretty much needs a cap table so that everyone understands how much they own and under what terms. To your question, regular fundraising collects a bunch of investors and puts them on to a spreadsheet. That is then managed for the life of the company until it’s sold or it dies.
Who manages cap tables?
Cap tables in the traditional sense are run either by someone in the finance department at a company. If it’s a small company, maybe by the CEO or if its a larger company, probably a corporate secretary or a CFO in conjunction with the law firm that helps the company. The cap table has historically been something managed by an outside law firm at the time of a funding event. Everyone wants to know, if I invest this much, how much do I own, who has invested previously, and so on. Until companies like Carta came along, that was often done on a spreadsheet and was often managed by the lawyers for VC companies.
For other companies, it was often just managed very casually on spreadsheets. The cap table is not so much a function of broker dealers or transfer agents for private companies or custodians because they don’t typically manage the cap table. It’s only until later on when that private stock is traded when broker dealers and transfer agents and custodians might get involved. In a private company, transferring stock from one individual to another or from one entity to another, doesn’t require a broker, dealer or transfer agent or a custodian. It could be done simply by the company itself or with the company’s lawyers. When companies get big, when there are legal jurisdictions involved, when they go public, that’s when you definitely need custodians to escrow funds, transfer agents to transfer the certificates from one party to another and keep record, and then when you might need a broker dealer to be a broker in the sale of the shares. Typically, those last three elements custodians, broker dealers, and transfer agents, are typically required and public equities, but not typically required or even utilized in the transfer or sale of private equities.
Do investors hold certificates of ownership?
The certificates are typically prepared at the end of a transaction, and they could be held in trust or they could be distributed to the end holder. In many companies, people never ever see their certificates at all. The ownership is just encoded on a spreadsheet or in some system and they never actually see the certificate.
One of the reasons why certificates are not that important and why people don’t place a lot of importance on them in private companies is because, unlike, cryptocurrencies, which are bearer assets, most private company equity stock certificates are not bare instruments, meaning just because you own this certificate doesn’t mean that you can sell the shares freely to any other party. Typically, you need permission. It’s called a right of first refusal or some other approval in order to transfer your holdings in a private company to another individual or entity. The reason for that is that companies don’t want their shares to be sold to competitors and they restrict transfer of those shares subject to board or other approval. Certificates are usually nice things to frame, but you can’t walk down the street and sell them to somebody and then say, I just transferred this. That typically requires approval.
How are securities traded on secondary markets?
Private shares are less liquid than public shares. The reason is that typically with public shares, you have a listing arrangement with an exchange or broker dealer, when they may and often do make a market in that security. There’s always a buyer of last resort in the public markets. That is what creates liquidity. There’s not only a market for them, but there’s also the established price history and then there are documents that contained disclosures and other information that enables the buyer to assess the shares that are being offered. All of that information, all that infrastructure, all the connections between those parties, the existing system, that is what creates liquidity for public equities, public stocks, and so on. This is much different in private equities. Private equities do not have markets like public equities do. Most of most private shares are sold through platforms like maybe shares post or they’re done in private OTC transactions, which are often managed by a broker dealer or a lawyer or somebody that is able to put the two parties together and complete documents.
When you go and you sell your shares of Apple, you don’t have to review a private placement memorandum. You don’t have to go and ask Apple for permission to do it. Basically, public means if you own these things, you have the right to buy and sell them. The reason why private markets are illiquid is because those rights of trade and transfer are not are not conferred to you with a certificate. They’re buried and usually dense private placement memorandums and before you decide to, you can trade them, you need to go back to the board or to some other party at the company in order to trade them. What’s happening in the digital asset markets is we’re busy building the infrastructure to improve liquidity, not create liquidity. Liquidity is not created by mechanisms, it’s created by demand.
What companies like Vertalo and its partners like Open Finance and Prime Trust and other players in this in the sector of this ecosystem, what we’re doing is we’re creating the rails to enable lower latency, see lower friction with trade and transfer of these private assets. The way you do that in digital assets is by imbuing some rights within smart contracts. The reason why you smart contracts for the ownership of digital securities instead of paper is because by giving the investor ownership of an asset in a wallet with the rules for trade and transfer imbued in the token or the smart contract, it’s easier for these trade and transfer operations to occur. Smart contracts are meant not only to confer ownership but also to communicate rights and to communicate restrictions on trade and transfer. This is meant to be an improvement on the current paper based process that’s where most private equities are managed now, where there’s a lot of people that have to get involved in the transaction.
Can companies STO on Vertalo?
Vertalo can work with issuers at any point in their life cycle. We can work with them before they’ve raised money or after they’ve raised money. Even after they’ve raised money and issued a token through some security token protocol, it doesn’t really matter. We can come in and help in any ways. I believe that it’s easier to raise money without a token, but if you want to raise money against the token, you can use for Vertalo. If you’ve already raised money via token and now you have this list of investors and you don’t know what to do with it, Vertalo can manage that token eyes that list of investors and give them an interface for managing their token holdings. We have interfaces for issuers, we have interfaces for broker dealers, and we have interfaces for investors to manage one or multiple token offerings. Vertalo can take any cap table and uploaded it into our system and turn that analog cap table into a digital tokenized version of that cap table and distribute those tokens to the investors who were previously previously invested.
We can also we can also tokenize an offering and distributed to wallets for investors without the investors having to know anything about how to operate a wallet. It’s our theory that the main impediment to digital asset adoption is the complexity and the hassle of working with tokens and wallets. Most people don’t know how to deal with it, it’s scary. They think they’re gonna lose their private keys or hackers are going to steal their stuff. We’ve scared away a lot of investors in STOs and in crypto because we’ve scared him with wallets, private keys, and tokens. In Vertalo, you probably take a look and think, Wow, that’s like Coinbase for digital assets. In Coinbase, you didn’t need to know about a wallets and you didn’t need to know about tokens. You just bought things that you liked based on the project in the price. You didn’t have to worry about custodying.
How does verification work with an outside wallet?
We started working with a custodian called Prime Trust to develop a wallet ownership mechanism. We developed a technique using a smart contract, using a token, not like one that we sold or raised money with, just one we actually use the blockchain technology to help someone prove that they owned a wallet. It’s kind of similar to the mechanism that you used to prove you own a bank account or credit card. You make deposits. This wallet control mechanism is something that we developed so that people could bring their own wallets and they could bring as many wallets as they wanted for every offering and and then store their tokens or digital asset securities in whatever wallet they want to. So that’s something that we developed in mid 2018. Subsequent to that, we came to the realization that people didn’t want to manage their own wallets, and they didn’t want to hold private keys, so we developed custodial wallets
Would you compare Vertalo to E-Trade?
For an investor, Vertalo looks similar to e-trade. In Vertalo, you can manage multiple tokens from any issuer. We currently support Tezo and Ethereum based tokens in our system. You can manage any of your holdings in these two protocols in our system. As an investor, you don’t really need to know anything more than that. As an issuer, we are very similar to a cap table. You can see all of your investors and their holdings, and you can communicate with your investors and you’re connected to them by smart contract. There’s really two sides to it. There’s an issuer side and the investor side. The reason why were different from Carta is that Carter doesn’t offer you any ability to trade shares. Vertalo puts that ownership in your control, we call that direct ownership, we’re able to connect your wallet to the listing exchange, and then we give you the opportunity or the option to potentially trade. Right next to your assets, there’s a little button that says trade and that little button in the system links by API to the listing exchange that the token is trading on. It doesn’t have to be a security token. It could be any token where there’s that relationship where we set that up. The difference is direct ownership in direct listing.