Token Warrant, SAFT or Token Sale Agreement: a Guide to Choosing a Web3 Fundraising Document
The task of each investment document is vital. It must protect the interests of founders and investors in a balanced way. For founders, the key aim is to get financing without losing control over the company and avoiding excessive dilution of their shares. For venture investors, the goal is a little different; to give themselves the highest possible chance of receiving a return on their investment.
In Web2 startups, investors invest in the company by purchasing shares of the company and hoping that the value of the company, and subsequently the value of their shares, will grow. In Web3 startups, the asset that offers the possibility of a return on investment is the token. Therefore, when it comes to choosing an investment tool, the goal of every Web3 investor is to guarantee and legally protect their token rights.
The different outcomes that investors and founders wish to achieve must be reflected (and protected) in the investment documents they use. Depending on the different goals of both parties and the stage of development that the Web3 startup is at when the fundraising occurs, there are a few options of different legal instruments that both parties can choose from:
- Simple Agreement for Future Equity (SAFE)/Convertible Note + Token Warrant
- Simple Agreement for Future Tokens (SAFT)
- Token Sale Agreement
Read more: How to prepare a Web3 startup for fundraising.
Who needs the “SAFE/Convertible Note + Token Warrant” option?
When the startup founders have gathered their core team and developed their idea to the “Proof of Concept” stage, they will begin to attract their first investments, hire new people, and develop a fully-fledged product. At this stage, the founders usually don’t yet have a detailed White Paper with developed tokenomics and a token distribution plan, although these steps may have been mapped out in the startup's Web3 roadmap.
As for a legal structure, in most cases, founders will have only registered a product development company, which is probably registered in one of the IT/IR-friendly countries like Delaware in the USA, the UK, and some European countries.
Therefore, considering the early stage of startup development, many investors suggest that startups structure their investment by signing a SAFE or other regular convertible instrument (Convertible Note, Advanced Subscription Agreement, etc.), as well as signing a Token Warrant, which guarantees the investor the right to receive tokens in the future if any are released.
How does a Token Warrant work?
A Token Warrant is a generalized document that guarantees investors’ rights to tokens that will (or may) be issued in the future. This type of document is a relatively new concept. Although the SAFE approach proposed above is a quite well-known document generally accepted in the venture industry, many may not be familiar with a Token Warrant. In the process of negotiations during fundraising, some investors insist on signing a Token Warrant as an appendix to the SAFE for the following reasons:
- At the early stage of Web3 development of the startup, when the project has not yet issued tokens, the tokenomics have not been finalized, and the founders themselves are not completely sure whether they will even issue tokens, the investor wants to have a guarantee that if for some reason tokens will not be issued in the future, then the investor will at least receive shares of the company. These shares are a kind of ‘insurance’ or ‘guarantee’ that the investor will receive their stake in the company and, as a result, will protect their right of return on their investment.
- At an early stage, the investor may understand that the type of token that may be developed by the founders in the future may require special regulation, and therefore the jurisdiction of the developing company may not be suitable for issuing and distributing the token. In this case, the Token Warrant will allow the project to create a separate company in the future to issue and transfer tokens to the investor in a compliant way.
Thus, the Token Warrant is the document that guarantees the investor the rights to the tokens that will be (or may be) issued in the future, without detailing the amount of the issue, the allocation for the investor, the price, and other significant conditions, but only establishing the right of the investor to receive these tokens in proportion to its investment.
What is a Simple Agreement for Future Tokens (SAFT), and when should it be used?
A SAFT (Simple Agreement for Future Tokens) is a document that is usually signed with a startup that has already decided on the type of tokens it plans to issue, and already has detailed the tokenomics, and created a token distribution plan (including prices and stages of distribution) and a White Paper, which describes the above. There are a couple of reasons why a SAFT is usually not signed before these steps have taken place.
Reason 1: A SAFT cannot be signed without detailing the material terms of issuing and transferring tokens to investors. SAFT terms usually include:
- the total volume of the token issuance;
- the amount of investor allocation of tokens;
- the price of tokens at the time of transfer to the investor;
- conversion event (the moment when SAFT is converted into tokens for the investor);
- information about vesting, lock-ups and other encumbrances on the investor's tokens, which are important for the successful operation of the project's tokenomics.
Therefore, a detailed White Paper with a description of token use cases, tokenomics, and token distribution plans is necessary to prepare a full-fledged SAFT.
Reason 2: As mentioned earlier, a development company (Dev Lab company) may not always be suitable for issuing tokens, given that various types of tokens (utility, security, payment, etc.) require an accommodating regulatory climate for their issuance and distribution. In this regard, many Web3 founders register a separate company in a crypto-friendly jurisdiction to issue and distribute their token and sign all token-related documents from this company.
In summary, it is also worth noting that when SAFT is used as a tool to attract investment for a Web3 startup, it should be used in conjunction with three additional tools:
- A usable or near finalized (i.e., not just a draft) White Paper with detailed tokenomics;
- a ready-made Token Distribution Company, on whose behalf the SAFT will be signed, and which, based on the results of the conversion of the SAFT, will issue tokens to the investor; and
- a clearly defined date of issuing tokens, or a specified event that will be a trigger in the SAFT for the issuance of tokens and their transfer to investors.
If any of these three criteria are missing, it is recommended for Web3 founders to consider the SAFE + Token Warrant option.
What is a Private Token Sale Agreement, and when to use it?
The key criterion that will help Web3 founders determine when it is better to sign a SAFT or sign a Token Sale Agreement is the matter of token issuance. If the tokens have already been issued and the process of their distribution (private/public sale, airdrops, issuance of token options, etc.) is ongoing, then for the purposes of Web3 fundraising, founders should consider the Private Token Sale Agreement (TSA).
The material terms of the TSA are almost the same as those of the SAFT, except that the TSA lacks a description of the conversion event and indicates a clear date of transfer of tokens to investors.
Because the Token Sale Agreement is signed at a more mature stage of a Web3 project’s development and the investment amounts are quite significant, investors often have questions about obtaining control rights over the company and receiving tokens. In these cases, we can distinguish two general approaches.
Approach 1: The project issues and distributes tokens without a plan to launch a DAO
If Web3 founders plan to control the emission of tokens and the process of token distribution in a centralized way, and do not plan to launch a DAO to decentralize the governance of their project, then at later stages of investment, investors may start requesting the control rights over the Token Distribution company.
Investors usually structure these rights in the form of a right of veto on certain decisions of the company or as a list of reserved matters for which the company requires investor consent. Also, the investor can claim the Token Distribution company shares to consolidate his control rights. In such cases, classic corporate equity investment documents are also signed in addition to the Token Sale Agreement, namely, the Subscription (Share Purchase) Agreement and the Shareholders Agreement.
Approach 2: The project issues and distributes tokens with a plan to launch a DAO
If the Web3 founders of the project plan to "decentralize" its ownership and governance by launching a DAO in the future, it will be important for the investor to understand exactly how the members of the DAO will be selected, and how exactly the governance rights for these DAO members will be structured, as an investor is likely to apply to participate in the DAO.
Thus, if the rules of the DAO will provide for the issuance of governance tokens for its members or the receipt of Liquidity Provider (LP) tokens by existing tokenholders who have staked project tokens, investors will want to reserve the rights to such governance/LP tokens to become DAO members and participate in the future in its governance. This, in turn, can be reflected in the Token Sale Agreement in the process of structuring the investment round or specified in the DAO Constitution, which is similar to the Shareholders Agreement in traditional Web2 investing.
Read more: The ultimate guide to DApps legal structuring.
How to Choose the Best Fundraising Document for your Web3 Project
There are three scenarios in which a Web3 project may find itself when the matter of fundraising arises.
Scenario 1: You’re at the beginning of developing your project and haven’t yet registered a token issuing company and don’t have any established tokenomics. The best option in this scenario will likely be a SAFE/Convertible Note + Token Warrant.
Scenario 2: You have a finalized White Paper, have registered a Token Distribution company, and know when you plan to issue tokens. In this case, the best option may be to sign a SAFT.
Scenario 3: You have already issued a token, in which case, the best route may be a TSA (Private Token Sale Agreement). The terms and additional documents might depend on whether you plan to launch a DAO or not.
If you’re looking for legal support for the fundraising process for a Web3 company, Legal Nodes can help. Our Head of Web3 Legal can provide a Legal Discovery Session during which you can explore the best fundraising options and get further insights into the relevant documentation. Book a session here.
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.