By Michael del Castillo,
Charlie Shrem wants to use blockchain technology to move millions of gallons of waste through the state of Michigan – six million gallons to be precise.
In a prospectus published today, the controversial and convicted founder of the shuttered bitcoin exchange service BitInstant revealed his intentions to use an Ethereum-based platform to let investors around the world buy a slice of the undisclosed waste management firm.
While Shrem’s investment platform could prove just the shot in the arm the 20-year-old company needs to become a leader in the $75bn US waste management industry, American investors won’t be allowed to participate. Nor will investors in the UK, thanks to concerns about the nation’s extensive regulatory requirements.
Instead, the only people who will be allowed to participate in the first-of-its kind investment vehicle will be those who fall outside these jurisdictions.
But blockchain won’t simply be used to let investors back the companies vetted by Shrem’s firm,Intellisys Capital. The tech will also be used to help turn those investments into highly profitable companies by streamlining back-end procedures.
Assuming all goes to plan.
In conversation with CoinDesk, Shrem explained the double-role be believes blockchain can play to modernize the entire investment industry.
Shrem said:
“What we wanted to do was have a synergy plan where we can look at these companies and see how we can integrate blockchain technology into these companies and how can we save these companies money, reduce their cost, or use the technology to make them more money.”
With the epic failure of another blockchain-based investment platform known as The DAO, that last year disintegrated after a hack drained millions of dollars-worth of the currency, what not to do is now much more clear.
But as the launch date of a $25m fundraising round to invest in the unique portfolio rapidly approaches, the way forward is still only slowly coming into focus.
Different from The DAO
A key difference between The DAO and the fund – called Mainstreet Investment LP – is that while the former was primarily an experiment with blockchain itself, Shrem considers the latter an experiment with the technology’s application in business.
He describes himself as “frustrated” with the proliferation of token-based fundraising rounds, or ICOs, as a way to build new technology, when he says the existing technology in bitcoin and ethereum are more than sufficient to support the construction of imaginative new applications.
So, instead he partnered with a member of the established investment community, Jason Granger, formerly of The Granger Group, to build what the duo calls the “first securitized blockchain asset,” called a Mainstreet Investment Token, or MIT.
Also unlike The DAO, the token owners themselves don’t have any say in the investments, but rely on the due diligence performed by Granger and Intellisys’s advisors to select what they can only hope are the best possible investments in US middle market companies.
Details of the fund were first published in December in its “Initial Token Offering Memorandum”, though CoinDesk has learned that some crucial components of that memorandum have changed.
Based in the Cayman Islands, Mainstreet plans to raise its first round of capital over a 60-day period beginning 23rd January – a week later than originally planned. Tokens will be issued on two separate exchanges, one in China and another elsewhere, with know-your-customer diligence being performed by the hosting platforms to help ensure that only investors outside the US and UK participate.
MIT tokens that are not sold will be “burned”, meaning they can’t be used and no one involved in the development of the company will be awarded tokens in advance.
Instead, 10% of the MIT fund has been set aside for operational expenses, including paying Shrem and Granger’s salaries. To increase security, $1m of the funds will be held in a wallet connected via the Internet for rapid deployment as necessary, with the remaining funds stored in a so-called “cold wallet”, or digital currency account not connected to the internet.
While these measures are designed to enhance the security of the dual smart contract system that receives funds and disperses dividends, it may not be perfect.
In order to avoid the fate of The DAO, Intellisys said it is working with an international public accounting firm that will audit the entire portfolio. Intellisys has also contracted two outside code audit firms to trouble-shoot the smart contracts and has delayed its initial launch by a week to offer bounties, or rewards to those who might identify bugs in the code.
Shrem said:
“We will open source that before the token sale, and I will say, if you do find anything, I will handsomely reward you before the token sale.”
Build, measure, learn
But it’s not just the code that could be subject to change. The structure of the fund itself has already been modified and further changes could occur prior to the official launch.
After the initial publication of the investment memorandum, Shrem and Granger received feedback on how the possible benefits of the fund were scheduled to be divvied out.
Originally, 70% of the benefits would accrue to Intellisys and 30% to the stakeholders.
But following exchanges with potential investors, the fund itself is now structured so that 50% of the carried interest earned goes to Intellisys, with another 50% to be divided among the token holders, according to confidential documents provided to CoinDesk.
Further, the percentages vary based on other portfolio conditions.
“We all know that not every investment is going to go exactly according to plan,” said Granger, who owns three-quarters of the firm to Shrem’s one-quarter stake. “And as long as we’re making sure that we’re covering them first, we’ll carry any losses forward and any expected returns forward and be able to pay that back so they’re always made whole.”
Shrem described the reasoning behind the change:
“We looked at the risk-reward ratio as levers and we wanted to make sure we got the levers correct.”
Profit from waste
Another key difference between The DAO and the Mainstreet fund is that details about the potential portfolio have been released prior to the crowdsale.
Today, Intellisys released exclusively to CoinDesk the prospectus for its first potential investment. Importantly, it is not a blockchain firm, but if backed, would be turned into a blockchain firm, a model they hope others might repeat in the future.
Though the name of the Michigan-based waste management company isn’t yet being made public, the prospectus describes it as having been around for about 20 years. In addition to pumping six million gallons of waste last year, it has 570 portable toilets and is positioned in the top 10% of the largest waste management firms in Michigan, according to the prospectus.
Granger told CoinDesk the waste management firm is operating at “roughly”40% margins of cash flow to operations.
To grow the firm, Granger plans to use part of the $25m he intends to raise via the tokensale to acquire between 60 and 100 independently owned firms over five years.
Based on the prospectus, Shrem and Granger expect the strategy of consolidating local companies to result in a 7.5% price increase to all services, and increased cash flow of approximately 15% after paying off debts. And that’s without any savings that might result from moving part of the workflow to blockchain smart contracts.
“That is kind of, I’ll call it, our shining star,” said Granger. “That we want to be able bring into the portfolio and continue to grow that into a national company over the next 10 years.”
Specifically, Shrem said Intellisys could use the ethereum blockchain to help the waste management firm cut costs on the logistics of managing their fleet of trucks, streamline accounting and perhaps pay employees.
Shrem said:
“We’ve got to look at, where are their major costs? Where are they spending a lot of money and where can they save money, potentially using blockchain technology?“
Double-edged Charlie
While investing always includes an element of risk, the Mainstreet fund is unique for more than just its business model. But the possible rewards are also immense.
In spite of Shrem’s industry contacts (which have helped the young company build a board of advisors including Tradehill’s Jared Kenna and Airbitz’s Paul Puey), his past convictions for money laundering-related crimes could spell trouble for the project.
As a result, Shrem and Granger hired cryptocurrency lawyer Marco Santori, a partner at Cooley LLP, to write a letter of opinion on the possible impact of Shrem’s history on the business.
Santori declined our request to see the letter, citing both attorney client and work product privilege. But Shrem summed up its contents as advising him to go “full-steam ahead”.
“The message we got back was the risk is very low, if not at all,” Shrem said.
Staying free
But that doesn’t mean they aren’t being cautious.
Shrem said what he missed most while in jail was a “real cup of coffee”, something he doesn’t intend to go through again.
As already noted, to help keep on the right side of the law, US investors are currently disqualified from participating, and Shrem and Granger are optimistic that planned actions in the state of Delaware might pave the road for eventual changes at the SEC level.
Also possible in the future are implementations similar to Airbitz, which used Title III of the SEC’s US JOBS Act to raise $1.15m from five investors in exchange for actual equity in the company.
What’s at stake is nothing less than the future venture capital investment itself.
While a total of $58.8bn was invested in US companies in 2015, only about $1bn was invested in blockchain companies.
To give an idea of the potential growth, in 2016, token-based fundraising rounds using similar technology as Mainstreet resulted in a meager $232m raised from 66 firms – the lion’s share of which came from The DAO, according to analytics from Smith + Crown.
But until the regulatory uncertainty that concerns Shrem and others is straightened out, firms like Intellisys are being advised to play it safe and self-regulate.
Shrem concluded:
“It’s too much of a gray area in blockchain securities in the US right now. Maybe down the road, when it’s become a lot more clear, we can open it up. But at this point, the risk assessment is too high to keep it open to the US market. But you know what? I don’t want to go back to jail.”
Editor’s note: An earlier version of this story based on an interview with Charlie Shrem reported that the fund was being sold via an SEC exception to Reg D, known as rule 506. The company has since clarified that is not the case.
