Choosing a Web3 Fundraising Document in 2023: a Playbook for Founders
Choosing a Web3 Fundraising Document in 2023: a Playbook for Founders
Welcome to Legal Nodes’ Playbook for Founders. In this guide, we’ll be focusing on fundraising for Web3 projects. When it comes to fundraising, the big question often is “which Web3 fundraising document should I use?”. We’ll analyze all the different documents and explore when they may be most suitable to use. We're also going to explore when it may be best to use token warrants instead of token side letters, and how a Token SPV influences the fundraising process. Finally, for those who are considering launching a DAO, we’ll look at all you need to know about using token sale agreements.
Remember! All the information in this guide is for educational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice.
What are the three Web3 fundraising scenarios?
If you’re considering fundraising options for your Web3 projects, you’ll most likely find yourself in one of the three following, rather common, scenarios:
Scenario 1: You’re at the beginning of developing your project and haven’t yet registered a token company (i.e. a Token SPV). You also don’t have your tokenomics established yet either. Your best option in this scenario is likely to be using a SAFE/Convertible Note + token warrant/token side letter. Ultimately, the decision will come down to a few factors, which we will explore further on in this guide.
Scenario 2: You have finalized your White Paper, registered a Token SPV company, and know when you plan to issue tokens. In this case, the best option may be to sign a simple agreement for future tokens (SAFT).
Scenario 3: You have already issued a token, in which case, the best route may be a private token sale agreement (TSA). The terms and additional documents you require may depend on whether you plan to launch a DAO or not.
How to choose the right Web3 fundraising document
Here's an easy flow to use to figure out which option may work best for your project.
A Token company (also referred to as a Token SPV) is a company within a project's legal wrapper that is responsible for the initial token release and distribution. This company is usually registered in a jurisdiction where the legislation permits token issuance and provides defined rules for taxation of token-sale transactions.
How do you know if your tokenomics is ready? Ideally you will have thought about and planned for the following aspects of your tokens’ lifecycle. You will have:
- decided on a mechanism for your token supply and demand
- decided on what your token utilities will be, in other words, you’ve pinned down details on all the rights and benefits that your token will give to its holders
- chosen a blockchain network and technical standard for your tokens
- planned some security measures for the token protocol and treasury
- a Token Cap Table with token pools, distribution plans, and have decided if you wish to pursue a route of a hard cap or no cap
- defined rules for the project governance
- set a date for the Network & Token Launch (NTL)
To learn more about tokenomics and how it influences the legal structure of your Web3 project, read more in our dedicated guide on tokenomics.
Depending on the state of your tokenomics (is it ready or is it still in the works?) and the type of signatory company you’ll be using to sign your fundraising documents, you’ll have a number of different fundraising documents you can choose from. Let’s explore these in the next chapters of this guide.
Which Web3 project should use a SAFE/convertible note + token warrant/token side letter to fundraise?
Once the startup founders have gathered their core team and developed their idea into the “Proof of Concept” stage, they can begin to attract their first investments, hire new people, and start the journey to develop a fully-fledged product. At this stage, founders won’t usually have a detailed White Paper with developed tokenomics, or any kind of token distribution plan, although these steps may have been preliminarily mapped out in the startup's Web3 roadmap.
For startups in the early stage of development, many investors will suggest or even expect the startup to structure their investment by signing a SAFE or other regular equity convertible instrument (Convertible Note, Advanced Subscription Agreement, etc.). Investors may also expect to sign a token warrant (or a token side letter), which guarantees the investor the right to receive tokens in the future should any be released.
As for a legal structure, in most cases, founders will have only registered a product development company (DevLab), most likely in one of the IT/IP-friendly countries currently available, like the US state of Delaware, the UK, UAE, Singapore, Estonia and other countries.
Depending on where the DevLab is incorporated, the following scenarios will unfold:
- DevLabs registered in the U.S. (usually registered as a Delaware C-Corp) should follow a specific route for token issuance
- DevLabs registered in other jurisdictions outside of the US, like in the UK, Singapore, Hong Kong, or one of a handful of European countries, will have more freedom to choose which legal instrument to use.
Let us look closely at each of the routes.
What is the best route for projects with DevLabs registered in the US?
If the DevLab is registered in the U.S. a founder should strongly consider using a standard SAFE document. Additionally, if the DevLab also plans to issue rights to tokens to its investors, this is best done via a token warrant (and not Token Side Letter) because of the following 3 reasons:
Regulatory uncertainty in the US
The regulatory landscape in the US is still under development, which causes some regulatory uncertainty, particularly concerning the legal status of tokens in the U.S., as well as the high risk of tokens being considered as securities. American companies should be very careful about how they participate in the distribution and sale of tokens. Using the right legal instrument is critical and by using a token warrant and a SAFE, founders can reduce the chances of falling into a regulatory pitfall.
The right to purchase tokens in the future
The token warrant provides investors with a right to purchase tokens in the future at a predetermined price or with a predetermined discount, while also specifying when the Token SPV will be formed. The Token SPV will be responsible for the distribution of tokens, meaning that the company will distribute the tokens once the token warrant is executed.
No participation of the DevLab
As the token warrant is signed together with the SAFE, the prices set out in the SAFE includes the value of the token warrant, which is also called a token purchase right. However, when the token warrant is executed during the initial token sale, the investors will be making a transaction with the Token SPV directly, at the rate of the previously determined price or discount. As a result, this process completely excludes the American company (the DevLab) from the token distribution process.
📝 Free template: Token Warrant Agreements Template and Guide
What is the best route for projects with DevLabs registered outside the US?
If the DevLab is registered in a non-US jurisdiction (in Hong Kong, the UK, and some European countries) and, in addition to using a standard SAFE, also plans to issue to its investors the rights to tokens, the DevLab will have more flexibility in choosing between the token warrant and a token side letter. Here’s why:
Lighter regulatory pressure
Registration of the DevLab outside of the U.S. usually means that the applicable laws will be a bit more flexible and a bit more certain; outside US jurisdiction, the risk of tokens being considered securities tends to be lower and so DevLabs are free to be partially involved in the distribution of tokens. Consider the following three points when comparing the registration of DevLabs in the US vs outside the US.
The DevLab can hold the token pool for key contributors’ distribution
The involvement of the DevLab in token distribution often occurs after the Token SPV issues tokens, and reserves a part of the tokens for key contributors (founders, advisors, team) and investors, subsequently transferring this pool to the DevLab.
The DevLab converts the token options and token side letters
DevLab, in turn, converts token options into tokens for founders, advisors, and team members, as well as token side letters into tokens for investors.
No additional payments with the side letter
The token side letter provides an additional advantage for investors, as no additional payments are required to receive tokens. This is not the same for token warrants, where their value is already included in the value of the SAFE, to which the former is signed as an annex. Consequently, the DevLab is not involved in token sale (the paid token transfer) but instead it covers only the distribution of tokens previously received from Token SPV.
In summary, if a DevLab is registered in the US, then it's best to use a token warrant along with SAFE. If founders have registered the DevLab outside of the US (i.e. in Europe or elsewhere), then they have more flexibility in choosing between the token side letter and the token warrant to sign along with SAFE.
The key differences between the two are that the token side letter gives founders more flexibility in terms of whether they will issue tokens or not and what the token price would be. Unlike the token warrant, the token side letter doesn't specify token price or dates for token exercise.
📝 To read more about the differences between the token warrant and token side letter, and download a free token side letter template, visit this page.
When should a simple agreement for future tokens (SAFT) be used?
A SAFT (a 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 all of the above). There are a couple of reasons why a SAFT is usually not signed before these steps have taken place.
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 the 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 fully-fledged SAFT.
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, a DevLab may not always be the most suitable vehicle for token issuance. In this regard, many Web3 founders register a separate company (Token SPV) 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 a 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 SPV, 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
- a clearly defined date for 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, Web3 founders may wish to consider the SAFE + token warrant/token side letter option described above.
In cases where the investor expects to get not only the future tokens, but also the shares of the company, founders should consider using a simple agreement for future tokens and equity (SAFTE) instead of a SAFT.
📝 To read more about the SAFT, how to use it, and to get a free SAFT template from Legal Nodes, visit this page.
What is a private token sale agreement?
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) as a fundraising document.
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.
When should you use a private token sale agreement?
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.
Using a private token sale agreement for token-issuing Web3 projects that don't 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 SPV.
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 SPV shares to consolidate their 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.
🎥 Watch this clip from our "Fundraising for Web3 Projects" talk that covers token sale agreements and their use in more detail:
Using a private token sale agreement for token-issuing Web3 projects that do 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 the investor is likely to apply to participate in the DAO themselves.
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 the 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 a shareholders agreement in traditional Web2 investing.
📄 Visit our TSA guide to read more about using token sale agreements for Web3 fundraising and get a free template of the document.
Find the right fundraising document for your Web3 project
In summary, the choice of an investment document for Web3 projects is mostly influenced by the readiness of the tokenomic model. If it is not ready yet and depending on where the DevLab is registered, then, in addition to standard equity instruments, the DevLab can also sign a token warrant in the U.S. or can sign either a token warrant and a token side letter if the DevLab is a non-U.S. entity.
When the tokenomics is finalized, the Token SPV signs either a SAFT or a token sale agreement, where the choice depends on whether the tokens have already been issued before.
At Legal Nodes, we help Web3 founders to legally structure fundraising effectively via a single legal platform. That means there's no need for founders or in-house counsel to find lawyers in each jurisdiction where a company may be registered or operating. Instead, our Virtual Legal Officers (VLOs) source and manage all the different legal specialists. VLOs analyze all the legal tasks needed to structure the fundraising, prepare cost estimates and then select the best legal providers from the Legal Nodes Network for each task. After that, they manage the work, handling all communication with the service providers, quality-checking deliverables and ensuring that the fundraising and token launch are undertaken in a compliant way.
To get help with structuring a fundraising process and to learn more about how our VLOs could help you, request a demo with our team. We'll be glad to chat with you.
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.