Private equity has long been synonymous with lucrative returns, yet its traditional exclusivity coupled with limited liquidity and opacity have hindered access for most. Tokenization aims to break down these barriers by converting investments into digital tokens, making private equity more accessible to a wider range of investors while providing an innovative fundraising avenue for private equity firms.
In this article, we shed light on the following fundamentals of private equity tokenization:
- Evolving trend in the private equity market
- Role of private equity tokenization
- The regulatory landscape for tokenized private equity
- The private equity tokenization process
- Benefits of tokenizing private equity for both issuers and investors
Let’s go into details.
Private Equity Sees Individual Investors as The Next Great Growth Engine
In the private equity market, groups invest in non-public companies, historically yielding superior returns compared to public stock markets. Data from CAIA shows an impressive 11.0% annualized return for private equity over 21 years (2000-2021), outperforming the 6.9% annualized return for the Public Stock Benchmark.
Traditionally, the private equity market is characterized by:
- Illiquidity: Investments are often illiquid, limiting immediate access to capital. However, this can lead to higher returns for patient investors.
- High Investment Minimums: High minimum investment requirements, often ranging from $100,000 to several million dollars, exclude many investors.
- Limited Access: Many deals are closed-door affairs, further restricting access for the average investor.
But now, “Private equity is targeting individual investors” - said Band & Company’s Global Private Equity Report.
Individuals control over half of global wealth, but only a small fraction (around 5%) is invested in alternative assets such as private equity and hedge funds. According to a Bain study in November 2022, a significant portion of high-net-worth individuals (53% with $5 million+) plan to increase their allocation to alternative assets such as private equity to improve diversification and seek higher returns.
In the meanwhile, according to Bain & Company’s Private Equity Midyear Report 2024, private equity deals, exits, and funds closed slowed in the first half of 2024. Most funds are still struggling to raise fresh capital.
As a result, it is reasonable to anticipate a gradual shift in the private equity landscape, with more funds exploring strategies to attract individual investors and diversify their capital sources.
How Private Equity Tokenization Helps Bridging Private Equity Firms and Individual Investors?
In short, tokenization introduces accessibility and democratization to the private equity market.
Private equity tokenization involves converting ownership in private equity assets, such as shares in privately held companies or stakes in private investment funds, into digital tokens on a blockchain. These tokens, which can be equity tokens or investment tokens, represent ownership and are tradable assets, allowing for easier transfer and fractional ownership of traditionally illiquid yet lucrative private equity investments.
For example, a private equity fund traditionally requires a minimum investment of $1 million to participate in their portfolio of established companies. With tokenization, they could create digital tokens representing ownership, priced at $10,000 each. This allows individual investors with smaller portfolios to participate in this potentially lucrative opportunity.
Moreover, tokenization serves as an entrance to the Web 3.0 economy, facilitating off-chain assets' access to the on-chain world and enabling investors to maximize their holdings through Decentralized Finance (DeFi) applications such as staking, liquidity mining, lending and borrowing.
Citi projects that by 2030, the value of tokenized private equity will reach $0.7 trillion, representing 10% of the overall $7 trillion private equity and venture capital market.
How Private Equity Tokenization Works
The process of private equity asset tokenization from a high-level perspective involves the following steps.
1. Asset selection and evaluation
The private equity asset tokenization journey begins with selecting suitable private equity assets for tokenization. This could be a private company, buyout funds, real estate holdings, or infrastructure projects.
The value of the asset is then carefully assessed and documented, following standard financial practices.
2. Legal structuring
When designing a robust legal structure for tokenization projects, it’s crucial to ensure that the digital tokens represent a valid claim to the underlying asset. This involves defining the specific rights associated with the tokens and choosing an appropriate tokenization structure.
The two common tokenization structures include Tokenized Special Purpose Vehicle (“SPV”) and Direct Asset Tokenization.
- Tokenized SPV involves holding the asset in an entity, then tokenizing that entity's ownership, providing indirect interests to investors and complying with securities regulations.
- Direct Asset Tokenization directly tokenizes the asset, providing tokens with direct claims, but faces regulatory challenges, non-fungibility, and limited use cases.
More on this topic: Real World Asset Tokenization - Is A License Needed?
3. Tokenization
The representation of the ownership of the private equity asset is converted into digital tokens (which we often call “Real World Asset Tokens or “RWA tokens”) on a chosen blockchain and launched on either the issuer’s website or via licensed asset tokenization platforms like InvestaX and IX Swap.
4. Primary Offering
Once tokenized, private equity tokens are listed on primary marketplaces for investors to participate in the initial offering.
For tokens classified as securities, investor registration, and KYC/AML checks are mandatory. Investors then can store RWA tokens in whitelisted digital wallets such as Metamask or Coinbase Web3 wallets or with a licensed digital asset custodian.
5. Secondary Trading
Following the initial offering, private equity tokens can be traded on secondary markets through various channels:
- Licensed RWA broker-dealers such as InvestaX
- Licensed RWA exchanges such as InvestaX’s IX Exchange
- Decentralized exchanges (DEX) like IX Swap's DEX
6. Ongoing Management
Post-tokenization management involves essential services like regulatory compliance, tax management, regular asset valuation, and facilitating corporate actions such as dividend distribution and voting rights. This management continues throughout the token's lifespan until its maturity or redemption.
7. Regulatory Compliance and Maintenance
Post-tokenization, ongoing compliance is necessary to ensure continued adherence to regulatory requirements. This includes monitoring changes in securities laws, implementing necessary updates to smart contracts, conducting periodic audits, and managing investor relations.
Real World Examples of Tokenized Private Equity
Below are some real-world examples of tokenizing private equity.
- Quadrant Biosciences led the way in private equity tokenization in 2018 when it raised $13 million by issuing Quadrant Tokens, equivalent to 17% of the company's diluted equity.
- BFToken is a private equity fund investing in early-stage blockchain companies. It raised over $100 million through an initial token offering (ITO) in 2018.
A Win-win Scenario For All Participants
Private equity tokenization fosters a win-win scenario for all participants in the investment landscape.
Benefits of private equity tokenization for issuers:
- Global Investor Reach: Tokenization enables issuers to access a broader pool of investors globally, beyond traditional geographical limitations.
- Enhanced Fundraising: By tapping into tokenization, issuers can streamline fundraising processes, potentially reducing costs and increasing efficiency.
- Increased Liquidity: Tokenized assets offer improved liquidity compared to traditional private equity investments, allowing issuers to unlock value and potentially access capital more readily.
- Transparency: Tokenization enhances transparency in the investment process, providing clear documentation and visibility into asset ownership, transactions, and performance to build investor confidence.
Benefits of private equity tokenization for investors:
- Opportunities for Diversification: Tokenization enables investors to diversify their portfolios by gaining exposure to previously inaccessible private equity assets, reducing concentration risk and potentially enhancing overall portfolio returns.
- Greater Transparency: Investors benefit from increased transparency in the investment process, with access to detailed information about the underlying assets, investment terms, and performance metrics.
Benefits for service providers such as investment banks, auditors, transfer agents and custody providers:
- Reduced Reconciliation: The blockchain acts as a single source of truth for all fund data, eliminating the need for constant reconciliation between different service providers.
- Faster Trade Settlement: Tokenized equity interests can be settled on the blockchain almost instantaneously, significantly reducing settlement times compared to traditional methods.
- Potential for New Revenue Streams: Tokenization creates new opportunities for service providers to develop and offer specialized services tailored to the tokenized private equity landscape, such as digital asset custody.
More on this: Top 8 Benefits of Tokenization
What Challenge Remains?
Regulatory uncertainty is one of the main concerns of issuers and investors entering the private equity tokenization market.
In the private equity tokenization landscape, tokens and associated intermediaries, such as tokenization advisers, platforms, trading platforms, and custodians, are subject to securities regulations to protect investors and ensure market integrity. However, the regulatory framework for tokenized private equity in specific and digital assets in general is still evolving and varies by jurisdiction. While some regions adapt existing securities laws to digital assets, others create new regulations specifically for digital assets.
More on this topic: Real World Asset Tokenization - Is A License Needed?
According to KPMG Singapore’s October 2023 analysis, Singapore, Hong Kong S.A.R., and Switzerland are leading jurisdictions for asset tokenization. Notably, the Monetary Authority of Singapore's Project Guardian—a collaborative initiative with the financial industry to test the viability of blockchain technology for asset tokenization and decentralized finance (DeFi) applications—highlights their commitment to blockchain and DeFi innovations.
For issuers looking to tokenize private equity assets, it is important to ensure that you obtain the requisite licenses to conduct token offerings to your target investor base, either by yourself or through a licensed tokenization platform.
InvestaX is here to simplify this process with our Tokenization SaaS Platform, licensed by MAS. Our CMS and RMO licenses enable the issuance, offerings, and trading of real world asset tokens, including tokenized private equity. With InvestaX, you can seamlessly launch global RWA token offerings and connect with investors worldwide through our secure and regulated platform.
Tokenize Your Asset On Top Of Our Infrastructure
InvestaX's Singapore-licensed Tokenization SaaS platform offers a complete and regulatory-compliant solution for tokenizing real world assets (RWA), including private equity. Our SaaS offering grants issuers access to tokenization technology, licenses, and Singapore-regulated primary and secondary marketplaces. This enables quick, cost-effective, and legally compliant asset tokenization, connecting issuers with investors globally. Contact us to discuss your private equity tokenization strategy.
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