TL;DR A CSO (Continuous Securities Offering) is a radically better way to finance your company’s growth. If you are an eCommerce, SaaS, Fintech or Marketplace company generating revenues and growing, a CSO can help you raise non-dilutive capital at market price valuation, while letting anyone in the world who supports your mission become an investor. This post is a high-level explanation of how a CSO works.
Valuation & Revenues, a direct link
First, for context, in finance, a traditional way to get an idea of a company's value is to look at their price-to-sales ratio. Each industry has its own average ratio (see here for a list of those ratios for public established companies). Companies can have a P/S value superior to that of their industry if they're growing faster (or their margins better, or their defensibility superior etc...) or they can have a P/S value inferior if investors see weaknesses in a company. As an example, SaaS companies were valuated at 12x their revenues in average in Q4 2019.
Raising funds at public market valuation
A CSO enables you to raise funds at public market valuation: raise funds by letting the market continuously value your company on a revenue multiple basis. And the beauty is: every time the market increases your valuation, your company receives more financing.
As a company, launching a CSO is akin to putting a fraction of your future business on the market and raising funds by letting the market price it.
A concrete example
Imagine a company ACME, whose business it to sell all kind of accessories for cartoon characters, generating $10M ARR with a 30% year-over-year growth. To launch its own CSO, ACME decides to commit 10% of its revenues over at least the next 5 years and named its security $ACME.
To launch its CSO, ACME sets a minimum market capitalization ("market cap") of $1M for $ACME, hence 1x its revenues ($1M = $10M revenues x 10% revenue commitment x 1 revenue multiple). As long as $ACME does not reach this minimum market cap, investments remain in escrow so that ACME can cancel its CSO at anytime.
It makes sense for ACME to set an attractive initial market cap because, unlike in a traditional IPO, every time the market increases $ACME's market cap, ACME will receive proportional financing.
Take away. A CSO security works similarly to equity, has properties equivalent to equity but is not equity.
How does $ACME's market capitalization increase?
The market cap of $ACME is equal to the number of $ACME issued multiplied by the latest of price $ACME. Nothing new here. The novelty lies in how $ACME securities are issued.
In the traditional equity fundraising model, the management decides to issue a fixed number of shares to sell and negotiates with investors the price of these shares. In a CSO, the mechanism is different in 2 meaningful ways:
- $ACME securities are issued (we say "minted") automatically: Every time there is more demand than supply, new $ACME securities are being minted immediately and automatically, financing ACME... without anybody being involved in the process 🧙♂️
- Nobody gets to set the price of $ACME securities. Every new $ACME security minted is automatically sold at a slightly higher price than the previous one. So the more demand there is for $ACME, the more $ACME are being minted, the higher the price of $ACME 📈
Also, keep in mind that $ACME is completely fractionable (you can buy 0.000001 $ACME) so, when investing, you think in terms of "How much money do I want to invest?", rather than "How many $ACME do I want to buy?".
Take away: In a CSO, there is no endless negotiation on price or valuation. The investor either buys at the current price or not. This is what enables CSO investments to be friction-less and continuous.
Who sets the initial price of $ACME?
Short answer: no one does. ACME simply decides what is the minimum market cap it wants for $ACME. This minimum market cap is the threshold below which ACME is not interested into doing a CSO.
When ACME launches its CSO, it starts with a trial period which ends when $ACME reaches the minimum market cap set. While in trial period, ACME does not have to contribute its revenues yet and can cancel its CSO at anytime, in which case investors would get a full refund of their money.
Take away: Buy early, buy low: if you have a strong conviction on the company launching a CSO, you should consider buying its securities during the trial period as it is unlikely that they will ever have such a low price again in the future.
What you need to believe to invest in ACME's CSO
As an investor, if you're considering investing when $ACME's market cap is $1M and your goal is to make a 10x return on investment, then you need to believe that $ACME's market cap will reach $10M. If you believe that the market will value ACME 10x its revenues, $ACME is now seriously undervalued in your eyes and investing at a $1M market cap is a no-brainer.
A few months after the launch of ACME's CSO, $ACME's market cap is now at $5M, effectively valuating $ACME 5x ACME's revenues. To make a 10x return, you now need to believe that $ACME can reach $50M market cap. To do that, you need to believe that $ACME will keep its 5x revenue multiple valuation and generate cumulatively 10 times its current revenues over the next 5 years (equivalent to a 60% CAGR).
Now, it is important to understand that the management of ACME can unilaterally decide to increase (but never decrease) the duration of its CSO at anytime... and it's a good thing for both investors and the company!
Indeed, under normal circumstances, a CSO provides the company with low cost capital. To keep this low cost capital coming, the company has a strong incentive to extend its CSO to extend the financial horizon and potential upside for investors.
Of course, the company can also decide not to extend its CSO and close it instead. ACME then has to pay an "exit fee" that amounts to the latest market cap minus the revenues that ACME has already contributed. Investors can then all redeem their $ACME at the latest minting price. Thus, closing a CSO is likely to result in a positive outcome for investors.
One last thing: ACME is and remains a private company while running a CSO, as such, they are under no obligation to provide any forecast or guidance to investors. On top, given its market exposure, ACME has to be prudent about its communication to the market. Don't expect ACME to provide investors with a traditional fundraising pitch deck displaying through the roof financial forecasts!
Take away: To make an informed decision on whether you should buy or not a particular CSO security, the market cap of the CSO and the revenue multiple of the company should guide your decision.
You can sell anytime... but to who?
THE RESERVE. To launch its CSO, ACME put on the market 10% of its future business. Concretely, it means that ACME periodically contributes 10% of its revenues to an escrow account ("the reserve").
Any investor who holds $ACME securities can redeem them at any time (24/7/365) against the reserve to receive their due proportion of the cash already contributed by ACME. The redemption price is automatically calculated based on the amount of cash in the reserve and the number of outstanding securities in the market.
Important: ACME cannot access the funds that are in the reserve. Only investors can by redeeming their $ACME.
Take away: The reserve concretely creates a floor price for $ACME that increases with ACME's revenues. As an investor, it's a great safety net that de-risks your investment over time.
To maximize your return on investment however, it is best to sell on the secondary market. The good news is: a CSO, as provided by Fairmint, comes with a secondary market included.
THE SECONDARY MARKET. Unlike traditional secondary markets that you can find in today's exchanges and which use order books to match buyers with sellers, Fairmint uses a new type of secondary market, which has very interesting properties, particularly:
Buying or selling is predictable and immediate because you trade with a digital contract, which guarantees the instantaneity of the trade. A game-changer.
Fairmint seamlessly integrates this type of secondary market, thus supercharging customers like ACME who now have the ability to not only automate the issuance of new $ACME (the "primary market") but also offer trading of $ACME (the "secondary market") directly from ACME's website in a fully secure and compliant way.
For investors, Fairmint offers the simplest user experience. Investors simply have to enter the amount that they want to buy or sell and Fairmint automatically and transparently routes their orders to give them the most optimized price.
Take-away: a CSO guarantees liquidity in the sense that you know you will always be able to buy $ACME and you know you will always be able to sell. An enormous difference with equity.
Conclusion: A New Deal
The CSO reshapes the relationship between founders and investors:
- Founders get financing while keeping control of their company.
- Investors get access to private companies with a clear path to liquidity.
CSO are particularly suited for online revenue-generating businesses with traffic like SaaS applications, online marketplaces, fintech companies or eCommerce businesses. If you’d like to explore the opportunity of running a CSO for your company, head over to https://fairmint.co.
To learn more about CSOs, we highly recommend you to take a look at our CSO Handbook.