Understanding the Mainstreet ICO / ITO - Smith + Crown

Understanding the Mainstreet ICO / ITO

(On March 2, Intellisys halted the Mainstreet sale and will return funds to investors) Intellisys Capital was holding an ICO for shares in its private-equity-like Mainstreet fund. Smith + Crown dug into the details and came away with these conclusions.

Update: As of March 2, 2017, Intellisys has halted the Mainstreet sale due to technical issues with their exchange partners and will return funds to investors. According to S+C records, they had 7845 ETH, worth approximately $150,000 (with ETH at $19). They are considering relaunching at some point in the near future.

The sale page now reads:

Intellisys Capital, general partner to Mainstreet Investment, LP, has halted Mainstreet’s digital-token sale due to technical issues. Invested funds have been returned to buyers without question. A revised sale plan will be announced at a future date. Thank you for your support and feedback. If you have any questions please contact hello@intellisys.ai

What is Mainstreet?

Mainstreet Investment LP is a Cayman Islands investment fund that will operate like a private equity firm by purchasing companies for growth, reform, or resale. Mainstreet Investment Tokens (MIT) crypto-token holders will be the Limited Partners in the fund and entitled to share in a portion of the profits. The Mainstreet fund is managed by Intellisys Capital, an investment management firm formed in 2016.

Intellisys is offering a stake in their Mainstreet fund to investors in their ICO / ITO (Initial Token Offering). Intellisys will use both funds raised in the ITO (with a goal of $25 million) and additional debt (personally guaranteed by Intellisys CEO Jason Granger) to buy companies and invest in their growth. The fund plans to allocate investment capital across American ‘mainstreet’ companies, real estate, fund of funds, and blockchain companies. The first acquisition will be an unidentified sanitary waste management company in Michigan.

Key Points about this Crowdsale

  • US and Hong Kong residents will not be allowed to invest in the token or receive dividends. On Feb 3, 2017, Intellisys announced it would open the sale to anyone other than US or Hong Kong residents, lifting an earlier restriction on EU residents. They have stated this sale is a security offering according to SEC regulations, so it they will verify the identity and residency of investors to ensure US and Hong residents aren’t participating. This likely means that US and Hong Kong residents are not eligible for quarterly earnings distributions. All interested investors will need to complete an extensive identification verification form on the sale page before they will be eligible to buy tokens or claim dividends.
  • Mainstreet is different from traditional private equity. Relative to current private equity firms, Mainstreet will be much smaller, make smaller deals, and be open to a wider array of investors. That said, it does have differences that might cause traditional private equity investors concerns, including higher fees.
  • This is about trusting the team, not blockchain technology or official legal protection. Blockchain technology does not play a role in this model other than raising funds and transferring shares in those funds. Investors also don’t participate in any investment decisions–and may not receive much information about potential investments. They are pitching the token as a legal “security,” though the ITOM repeatedly states it has not been registered with various national securities commissions. As such, it may fall under appropriate securities laws but the sale has not been officially reviewed, approved, or licensed by regulatory authorities. However, it does seem like the team has done extensive review of relevant securities laws and seems to make attempts to be compliant, though no legal protections can be guaranteed prior to a successful legal ruling. Like in a traditional private equity firm, investors will need to trust the founding team to make good business decisions, manage companies well, pick competent advisers, and pick honest auditors to distribute earnings accurately and honestly. Honestly, Mainstreet.ky faces several dilemmas: they want to be more transparent than a traditional private equity firm (which do not need to supply much information about investments to investors) but can’t release proprietary financial information about the companies it invests in for obvious reasons. They also want to issue a legal security to help legitimize the blockchain-based security offerings, but registering the sale in each country could hamper it as a global tradeable token.
  • Mainstreet.ky is similar to private equity but open to those who couldn’t otherwise directly access it. Compared to traditional private equity, this investment would seem a poor one. The management fee on for mainstreet.ky is higher, Intellisys (the investment management company) takes a larger percentage of earnings, and the fund has added legal complexities by tokenizing ownership . However, not everyone can access traditional private equity outside of purchasing shares in private equity companies. Mainstreet.ky offers a unique opportunity for them to invest directly in a fund that owns a portfolio of businesses.

Mainstreet is an ambitious project. If successful, it could help expand private equity to small-scale investors–and if the model is legalized, expanded to US and Hong Kong residents too. However, the devil is in the details and investors must trust that the team will avoid pitfalls, foreseeable or otherwise.

If the reader is interested in the research supporting the above, please scroll to the bottom or click here.

What is the token being sold?

The Mainstreet Investment Token (MIT), is an Ethereum metatokenrepresenting a share in the Mainstreet Fund, managed by Intellisys Capital. Tokeholders will receive dividends based on the performance of Intellisys’ investments, with the payout terms explained in greater depth below.

The supply of MIT is capped at 50 million, but the actual supply will depend on the level of investment. Unsold tokens will be burned. 100% of MIT tokens will be distributed to investors. No tokens are withheld for the development team and early investors, although they will receive fees based on the performance of the fund, as explained below.

What are the sale terms?

The ICO begins on February 28th at 5am GMT (1pm China, 9pm Feb 27 PST) and end April 26, 2017. 1 ETH buys 12 MIT. For the first week of the ICO, investors will enjoy an 10% bonus. For weeks 2-4 there is a 5% bonus. For the remainder of the ICO there is no bonus.

Mainstreet is also offering “bulk discounts” on MIT. For investors who contribute $2 million or more will receive a 7.5% discount and investors contributing between $500,000 and $2 million will receive a 3.75% discount. Bulk discounts stack on top of the weekly discounts outlined above. Investment funds will be sent to an Ethereum smart contract that will pay out MIT to investors when the ICO ends. There is maximum investment goal of $27.5 million.

Courtesy of Blocktrades, investors can contribute a variety of other currencies that will be valued in ETH at the time of transaction.

The sale is not open to US or Hong Kong citizens. If such individuals hold tokens, they are not entitled to dividend payouts. Token holders wishing to receive dividends must register (and verify identity and residency) through the same process ICO investors will go through.

What is the project status?

At the time of writing, Intellisys Capital is engaged in acquisition negotiations with a number of companies. They say 20 deals are currently in their pipeline. As deals are finalized, more information will be made public. Currently, Intellysis capital has released a prospectus about their first acquisition, a sanitary waste management company based in Michigan. The prospectus does not include the identity of the company in question or any information about its cash flows. Intellysis plans on extending this company’s market reach by buying up smaller competitors in the region.

Funds from the ICO will be used to acquire companies, while Intellisys will finance additional investments in expanding the individual businesses through business loans, with CEO Jason Granger personally liable.

Who is the team behind the project?

Intellisys Capital CEO Jason Granger is a Michigan-based businessman with experience working in private equity, venture capital, and blockchain technology. His Linkedin includes a partnership with AIG to build a $2 billion senior living community.

Charlie Shrem is an entrepreneur, founding member of the Bitcoin Foundation. He made headlines around the world when he was sentenced to two years in prison for aiding and abetting a money-transmitting business related to the Silk Road. He was released in July 2016.

Some members of the Intellisys team are anonymous. The identities of the Acquisitions Director, the Investment Director, the Controller, and the Office Manager are all listed as “confidential” in the Mainstreet Investment Memorandum.

Official Resource

Background Research

Mainstreet.ky vs. traditional private equity

Mainstreet.ky differs from traditional private equity funds in a few key ways. First, it’s much smaller than most private equity firms. The fund aims to have $25 million in operating capital and leverage additional debt to finance its deals and create more purchasing power. Their deals will be $1-5 million, in mostly small companies.  To put those in context, the average fund size for private equity firms in the US is around $720 million, with an average investment size between $17 – 59 million1. In 2015, deals under $100 million represented less than 10% of total buyout capital, and the average deal size ranged between $100 – 150 million2.

In recent pitch documents, they have provided additional details about their existing pipeline, including $40.5 million in equity deals, although it is worth nothing that there is no way to verify actual reported numbers or companies. The lowest reported purchase is $4.5 million, with the highest single purchase at $20 million. These will translate into equity holdings ranging from $2 million to $10 million.

Second, there is no minimum to participate as an investor. In traditional private equity, the majority of capital is represented by institutional investors and very wealthy individuals: most funds want contributions at levels of $5-10 million with minimum investments as high as $250,000. However, in order to attract more investors, some private equity firms are lowering the barrier to entry. As reported in the Wall Street Journal, several recently formed private equity firms are dropping minimums down as low as $50,000.

Third, shares in private equity are not usually liquid: to participate, investor contracts usually limit how quickly and how much investors can draw out of their funds. Investors can’t sell these shares on a secondary market as if they were stocks. In summary, Mainstreet would be unique as a private equity firm across a number of factors, not just raising money globally with cryptocurrency. A successful Mainstreet fund should be disruptive to traditional private equity.

Some of Mainstreet’s differences from traditional private equity raise concerns. The Coinfund community compiled a list of issues of the mainstreet.ky ITO, using private equity as an implicit benchmark. Those interested in more distinctions between mainstreet and traditional private equity should review the document in full, with the caveat that it is not maintained in light of updates to the sale terms. Their points include the following: (1) the token sale disproportionately benefits bulk and early investors–something unheard of in traditional investing. (2) personal guarantees on the leverage debt are complicated, non-traditional, and create conflicts of interest. (3) having a non-traditional funding structure [with an ICO, tokenized ownership, and personally guaranteed debt] could make them less competitive in auction processes.

Trusting the team, not the technology (or the law)

Many companies today are using blockchain technology to disintermediate various business and economic relationships. The technology allows some aspects of trust to be recorded on a transparent blockchain or encoded into a distributed smart contract.

That is not fully the case with Mainstreet.ky. There are many aspects of this arrangement that are handled off-chain or require trust in the team itself.

Here are some issues that investors will need to trust the team about:

  • In which companies will the fund invest?
  • How will the team ensure accurate and transparent financial reports?
  • What will the terms of future deals look like?
  • What actual legal protections do token holders have?

However, many of these wouldn’t be known to private equity investors either. Those investors trust the private equity group and the web of regulations that surround their activity. In this case, given the ambiguous legal context of the investments, investors in mainstreet.ky wont be able to rely on regulators to to provide oversight. This means that investors will need to trust that Mainstreet.ky will make the right choices.

There are two kinds of trust involved: trust they are being honest and trust in their skills as private equity partners.

A breach of the former type seems unlikely; everyone has a lot to lose in being dishonest. Charlie Shrem was recently released from prison and is likely still under soft surveillance by federal agencies. Jason Granger has an open digital trail and an established business reputation at stake. The team has been receptive to questions and even made some changes to their fee structure and token sale terms in response to concerns raised by the community. They have also engaged a number of well known partners, including international law firm Cooley.

Just as in any private equity fund, Investors will need to trust Jason and Charlie to make the right moves as fund managers. They will finalize the deals, manage the companies, and do the accounting. More importantly, they will select the yet-to-be-identified experts who will help them along the way. The fund itself and each deal will have a committee of experts to discuss strategy, management, and finance decisions. However, investors won’t necessarily know everyone who is part of the team and must trust Intellisys to make the right call.

Explaining Mainstreet’s Fees and Earnings Distributions

Like a private equity firm, Intellisys Capital will pay out earnings to those who have shares in the fund. When a company acquired by the private equity firm earns profits (after operating costs and debt servicing), the profits are divided among the fund management company and the investors according to pre-defined terms.

There is typically a ‘waterfall’ method of distribution, whereby money is given to different ‘pools’ in order of priority: once one pool is full, money flows to the next pool. The pools usually consist of a management fee (around 2% of total assets under management), a ‘preferred return’ which investors get before any other allocations are made (typically 8-10%), a ‘catch-up’ for the fund management company (there isn’t a clear market consensus, but it’s usually calculated as a percent of the preferred return), and finally the remaining amount split between the investors and the fund management company (typically split 80% investors, 20% fund management company)3. The above is just a template, and there are plenty of nuances across the thousands of operating private equity firms.

Mainstreet will operate like a private equity fund in this regard, with a couple twists. First, it will use the initial $25 million raised in the ITO to secure additional debt financing for its investment. Jason Granger will personally guarantee that debt. Accordingly, Jason Granger seems to be assuming greater risk than a typical private equity firm would. Second, they will calculate returns on a deal-by-deal basis rather than at the fund level. This is uncommon but not unheard of. This means if one investment is doing very well and another is not, the results don’t get grouped together: earnings from each deal go through their own ‘waterfall’ distribution.

Finally, many private equity firms realize returns by re-selling companies. That is, they purchase a company for $1 million, invest another $1 million growth and reform, sell the company for $4 million and then distribute gains accordingly. Intellisys has stated a preference for holding onto companies for the long term, suggesting earnings will rely more on company performance than on resale events.

Mainstreet will have the following terms for those allocations:

  • Management Fee: 5% of investor capital involved in the deal
  • Investor Preferred Return: 10% of investor capital involved in the deal
  • Intellisys Catch-up: 10% of the investor capital, equal to investor preferred return
  • Carry: 50/50 split on remaining earnings, though this may be changed in future deals. If a project did not involve debt, the funds are split 80% investors, 20% Intellisys.

The actual returns from the Mainstreet fund are impossible to predict. They have a stated preference of pursuing smaller companies and holding them for the long-term, meaning significant revenues might not be realized until later in the fund’s life. However, while a portion of Intellisys’ deal pipeline has been announced in its investor pitch deck, there is no way to verify the amounts.

  1. Humphery-Jenner, Mark. “Private Equity Fund Size, Investment Size and Value Creation”. University of New South Wales Review of Finance, Volume 6, Number 3. Table 2. 2012. Web. www.papers.ssrn.com/sol3/papers.cfm?abstract_id=1623660. 11 Jan 2017. Calculated based on summary tables in paper and converted from USD 2008 to USD 2016. Sample consisted of 1222 US-based private equity firms, with vintages ranging from 1985 – 2007.
  2. “Global Private Equity Report”. Bain and Company,  February, 2015.  Figures 1.09 and 1.11. Web. www.bain.com/Images/BaIn_rePOrt_Global_Private_equity_report_2015.pdf.11 Jan 2017.
  3. Preqin. “48% of Private Equity Separate Accounts Charge a 20% Performance Fee, Compared to 85% of Commingled Funds”. September 11th, 2015. Web. https://www.preqin.com/docs/press/Fund-Terms-Sep-15.pdf. 11 Jan 2016.

Special thanks to Alex Felix, an early stage technology investor and former VP of private equity at American Capital.