How to Legally Structure Fundraising in Web3 PART 2: Web2 Solutions with Utility NFTs

October 28, 2022
TABLE OF CONTENTS

How to Legally Structure Fundraising in Web3 PART 2: Web2 Solutions with Utility NFTs

October 28, 2022

This guide is Part 2 of our series of guides on fundraising for Web3 founders and investors. Check out other parts of this series here:

In this piece, we will define Web2 solutions with utility NFTs and explain what role tokens play in these startups’ fundraising and exit strategy. We’ll also cover how to approach such projects’ valuation and the instruments for structuring the investment deal. 

Web2 solutions for the Web3 industry: what are they?

This type of startup includes projects where the product’s main component exists off-chain. As such, it involves the operation of the product on centralized IT systems, which might include cloud-based or on-premise applications with centralized databases and web/mobile app interfaces. The business models of such startups include subscriptions, licenses, white labels, and other types of Web2 business models. These are usually various analytical systems for the Web3 industry (Chainanalysis, Wombi), blockchain explorers, SaaS solutions, some GameFi projects without fungible tokens, etc.

Categories of Web3 projects

This category of startups may have on-chain elements, but their role is usually minimal. For example, such on-chain elements can include utility NFTs that work as “pre-ordered subscriptions” or “license keys,” which users can use to pay for a product subscription or to access some tech ecosystems. They can also be membership NFTs that give exclusive access to the early adopter community or act as on-chain event tickets.

In order to fit into this category of projects, startups must provide essential features, like:

  • A centralized business model: All revenue from the product’s operation is centrally aggregated at the startup company, with the possibility of further distribution in the form of dividends among the shareholders of such a company (founders and investors);

  • Minimal on-chain components and their lack of independent capitalization: In the case of utility/membership NFTs, the founders are usually NOT interested in the volatility of the price of such NFTs. Those NFTs are often not liquid and are not traded on secondary markets—the founders centrally control their emission and distribution (at the same time, such NFTs might be sold as public NFT drop or NFT crowdfunding campaign);

  • Product revenue in the form of fiat and existing cryptocurrencies (ETH, USDT, etc.).

Tokens’ role in developing a fundraising strategy for Web2 solutions for the Web3 industry

It is crucial to emphasize that the utility NFTs described above are often used for crowdfunding (pre-sale of subscriptions / early access to a product or community). This, in turn, does not allow the assets involved to be considered investments. The money received from the sale of NFT is not a direct capital injection into the company. 

Instead, it represents the company’s sales income from a “pre-sale of subscriptions in the form of NFT.” It’s also important to remember that the tax rates on funds received as direct capital injection VS sales income will differ from the taxation point of view.

💡 Worth checking: Token types, their legal status, and choosing the best jurisdiction for token issuance.

Valuation calculation, legal structuring of fundraising, and exit strategy

Web2 solutions with utility NFTs approach their valuation and fundraising strategy similarly to Web2 startups. The key assets capitalized are company shares, and the multipliers for calculating the startup valuation are applied to the growth metrics of Web2 business models. 

For example, in startups with a SaaS business model, this might mean a 10x-15x multiplier applied to a startup’s ARR to calculate its current valuation. Therefore, traditional venture instruments, be that convertible (SAFE, Convertible Note, Advance Subscription Agreement) or priced round instruments (Subscription/Share Purchase Agreement + SHA), work best for this category.

As for the exit strategy, two liquidity events open up the opportunity to exit for founders and investors. The first is a sale of the startup, meaning all or part of its shares. The second is a sale of its Initial Public Offering (IPO).

On-chain elements of such a startup (usually utility NFTs) do not participate in the exit and typically do not affect the multipliers and valuation of the startup. However, they work as a good indicator for investors about the innovative approaches to crowdfunding. In other words, they can attract investors who want to participate not only in the growth of a traditional Web2 business but also witness the application and adoption of innovative blockchain-based features in it.

📚 Read more: Token warrant, SAFT or Token Sale Agreement: a guide to choosing a Web3 fundraising document. 

Fundraising strategy for Web2 solutions for the Web3 industry

Summarizing this guide, we can say that the fundraising process of Web2 solutions for the Web3 industry is almost the same as for classic venture startups. Shares of the startup (product development) company are the primary capitalization and valuation assets. In contrast, the on-chain token assets, usually utility NFTs, don’t affect the startup’s valuation or the investment instruments to structure the deal.

Whether you’re looking to attract investments or make a decision to invest in a Web3 project, we recommend the following action plan:

  1. Understand what role the token plays in the project;
  2. Categorize the Web3 project depending on the role of its native token;
  3. Decide on a fundraising strategy (rounds and milestones that must be achieved);
  4. Select an exit strategy. Will the main asset of the company’s capitalization be shares or tokens? At what moment will the liquidity event of each of these assets occur?;
  5. Choose the most appropriate legal documents to structure the fundraising.

To learn more about fundraising and exit strategies for Centralized Web3 projects with ecosystem tokens or Decentralized Web3 projects with protocol tokens, check out the other parts of this series:

Disclaimer: the information in this guide is provided for informational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice. Mentioning any of the assets in this article is not an endorsement to purchase them.

{{fund-guide-1="/blog-temp"}}

Nestor is a Co-founder & Head of Web3 Legal at Legal Nodes. Having over seven years of legal consulting experience, Nestor loves working with innovative startups and Web3 projects, helping them navigate the regulations and scale on global markets.

Subscribe to our monthly Web3 legal newsletter