Tokenize This: Week 70 ~ Tokenization of the Capital Stack

The next era of investor management is on the back of the blockchain.

Complex financial structures and capital stacks typically come with added management fees. This makes sense — there is more work to be done in the back and middle offices ensuring everything from cap tables to distributions to conversions are handled properly for investors all across the capital stack.

In the Excel-driven financial services landscape, factors and changes to the cap table, returns, and projections need to manually be modified. That means a team of analysts and associates that handles investor management, ownership, reporting, projections, and more. All manually.

Since 2014, per Institutional Investor, the average cost of managing a dollar in the asset management world has risen 4%. Similarly, profit margins in asset management fell from 34% to 32%, symbolizing less profitability and a greater squeeze among asset managers. This can be attributed to greater regulatory, compliance, and investor management expenses, and in an industry that is so percentage fee driven, increased expenses and decreased margins is nothing to scoff at.

Common repsonsbilities of the front, middle, and back offices in asset management. (Source)

Asset management is indeed a fee-driven business just as much as it is a returns-driven business. One asset manager may generate 10% for its investors, but also charge a 2% management fee. Compare that to an asset manager that generates 8% but charges a 0.50% management fee. In favor of keeping fixed costs lower, investors may vie for the lower fee, lower return asset manager over the one with greater fees and greater returns.

Suddenly, the differentiating factor becomes: who can perform for the least costly amount.

That’s where looking at the back office fees and expenses really comes into play. By nature, lowering expenses means an asset manager can lower its investor fees while still maintaining the same level of profitability, thus making itself more attractive to the investor base. And with roughly half of all management fees being spent on middle and back office work, there is a strong correlation here that may yield benefits to both the manager and investors.

While not all of the aforementioned management points can be outsourced, the backbone of it all can be automated and codified via tokenization. In fact, this is the premise of **Episode 4 of Security Token Market and Arca’s joint video series, **Tokenization for Institutions: What You need to Know.

Value Adds:

• New efficiencies to the back and middle office functions, which reduces the need for a large workforce and therefore reduces payroll expenses
• Improved profitability to the same operation (i.e. less labor expenses = greater bottom line)
• Ability to streamline other management processes and shift resources towards more value creation

USPC is a cryptocurrency backed by physical, income-producing real estate. They aim to provide an effective tool to work around rising inflation and market volatility whenever and wherever in the world it may occur.

USPC is the first real estate-asset backed digital currency in the world’s largest economy. Funded and sponsored by Southern California real estate development firm Primior, USPC tokens will function as fractionalized ownership in a diversified portfolio that is expected to benefit from current income and long-term appreciation of real estate assets, creating a more reliable store of value and medium of exchange

Management foresees a day when token holders, who initially seek value in a rapidly appreciating asset, would see greater value in USPC as a more risk-adjusted investment option.

For more USPC project information, please visit their website at uspc.io or join their Twitter and Discord communities.

twitter: https://twitter.com/USPCoin

discord: https://discord.com/invite/EpsD7HrCye

**Capital stacks**, which are simply the makeup of financing for an asset, have been getting increasingly complex. While capital stacks used to be simply debt and equity, newer and more nuanced tranches have been making appearances.

Nowadays, the typical financing for a real estate project involves senior debt, mezzanine debt, subordinate debt, preferred equity, and common equity. To make matters even more granular, there can be multiple levels of debt that all have various preferences and return profiles. This is common especially in the structured product field through examples like Mortgage-Backed Securities and credit swaps.

This can be a lot to manage, and it makes sense that asset managers have whole divisions dedicated to ensuring each investor across each tranche is serviced properly.

Sample commercial real estate capital stack per ArborCrowd.

Still, that’s not the best use of resources. Tokenization, as we know, is the digitizing of a cap table on a blockchain. It’s designed to enable cap tables to self-update and automate, and distributions and reporting are a key add-on feature of that capability.

There is little need for a full back office division that costs 7-figures (or more depending on the size of the asset manager) when investor management, distributions, reproting, and conversions can all happen programmatically via smart contracts in security tokens.

These various tranches — from senior debt to common stock — can all be codified with the proper dividend amounts, yields, and rights so that the capital stack is always correct.

Even if the senior debt tranche offers 4% interest, the mezzanine tranche offers 6% interest, the preferred equity offers 8% interest, and the common shares offer equity, the manual labor required doesn’t change much since these distribution rights will always match up to the proper investor in the proper tranche.

It shifts from an *FP&A analyst double checking an Excel* sheet to find an investor’s ownership profile and tranche to simply clicking a button periodically to send the proper distribution amount to every investor. Again, the investors are always properly accounted for since the entire capital stack is tokenized and self-managed on the blockchain.

Even if investors trade shares across the varying tranches or to external investors, the cap table will always be correct and reflect the accurate table of ownership across all tranches of debt, equity, and other instruments.

This can be applied not only to smaller investors, but to all General Partners and Limited Partners involved — making it a true full stack overhaul.

New edition coming next Wednesday 8/3/22!

Disclaimer: This is not financial or investment advice and should not be interpreted as such. Please do your own research on investments and financial decisions before partaking in any ideas or ventures depicted in this publication.