This article covers all there is to know about token warrants and includes a free token warrant template created by the team at Legal Nodes. In case you need help with customizing the template, request a demo of our platform or send us a message in chat. 

In this article, we’ll cover:

• What a token warrant agreement is and how it actually works
• When a token warrant agreement is typically signed
• Similarities and differences between the token warrant and the token side letter
• How to choose between a token warrant and a token side letter
• What the terms of the token warrant (and the token purchase right terms) include 

Before we get started, we’d like to remind you that everything in this article is for educational and informational purposes only, and is not legal advice.

What is a token warrant agreement?

A token warrant agreement, commonly referred to as simply a “token warrant” and also known as a “token purchase right”, is a document often used by Web3 projects to attract early-stage investments. It gives investors the right to purchase a portion of tokens during the initial token sale, as well as fixes the price of the tokens.

How does a token warrant work?

The concept of the token purchase right in a token warrant can be roughly reduced into its three main features:

1. it legalises a right but not an obligation of an investor: the investor is free to choose whether to proceed with the purchase or not;
2. the token warrant is not used for automatic (unconditional) issuances: the investor has to pay an additional consideration for tokens should they decide to execute their token purchase right; and
3. the price at which the investor buys the tokens in the future is fixed by the token warrant. It thus puts the investor in a better position when redeeming their tokens compared to purchasers during the initial token sale, as the actual price of the token at the time of the token generation event is typically much higher.

When is the token warrant signed? 

The token warrant is signed when:

1. Investors are interested in both tokens and shares and a supplementary document is needed to secure their interest and rights to the tokens.
   The main document of the investment deal is a convertible equity instrument, such as a SAFE. The token warrant is signed as an additional document, which, although autonomous, relies on the equity agreement in its conversion formula;
2. The tokens have not yet been issued, and, in most cases, the tokenomics is still in development; and
3. From the entire Web3 legal wrapper structure, only a single DevLab has been registered. Therefore, the token warrant is signed by this DevLab rather than by a Token SPV.

It’s important to note that these three circumstances apply to the signing of the token side letter too.

What do the token warrant and the token side letter have in common?

These two documents are used in pre-seed Web3 fundraising and share a number of similarities. In particular, both the token warrant and the token side letter:

• have the same signatory, the DevLab company;
• are supplemental to convertible equity investment documents, such as SAFEs (simple agreement for future equity) or convertible notes; and
• use the same formula for calculating the portion of investor’s tokens.

What are the differences between the token warrant and the token side letter?

Despite being related, appearing at the same point of the Web3 fundraising process, and having similar sounding names, the token warrant and the token side letter are sisters, not twins. In terms of issuing tokens, the way they function is fundamentally different.

For the token side letters, the same company that signs it, the DevLab, is also responsible for converting the document into tokens. To do that, it first receives the allocated  number of tokens from the token-issuing company, the Token SPV. It then makes transfers to investors who hold token side letters, as well as other core contributors to the project ecosystem such as developers, advisors, etc. who hold token options and either have contracts with the DevLab or are employed by it.

This is different from token warrants, which will usually be assigned from the DevLab to the Token SPV by the time the tokens are initially issued. This happens either when the Token SPV is registered or some time before the token generation event. The idea of that assignment is that the Token SPV then sells the tokens to investors at the price that has already been fixed in the token warrant. It is the Token SPV that will be responsible for the sale of tokens and will have also received regulatory approvals to organise the distribution.

The second important difference between the two documents is that the token side letter does not require any additional details of payments for tokens: the consideration is already included in the price of the convertible equity agreement. The token warrant, however, requires a discount or a discounted price as one of its substantive terms to function. Therefore, in some cases, the token side letter may look more appealing to investors compared to the token warrant, as it will not involve any additional payments to receive tokens later.

How to choose between the token warrant and the token side letter

When standing at the crossroads trying to choose the most suitable document for pre-seed Web3 fundraising, it’s important to consider any regulatory restrictions on token transactions that are imposed on the DevLab by a local regulator. If they are on the stricter side or if there is a high risk of regulatory uncertainty, such as in the U.S., it is probably best to proceed with the token warrant. 

Here’s why: in the case of the token warrant, its signatory is NOT responsible for the conversion event and thus does not sell tokens. Instead, it only confirms the right of investors to purchase tokens with a discount or at a predetermined price. Investors then buy tokens directly from the Token SPV, which is the actual issuer and has the right to sell them under a permit received from the regulator. This is possible thanks to the token warrant assignment by the DevLab to the Token SPV at the time it is created or before the token generation event. This, in turn, helps the DevLab (which may be registered in the US as an American company) to avoid any involvement with the process of selling and distributing tokens. As it is a separate entity, the Token SPV can handle these processes, shielding the DevLab from any involvement in the token distribution process. Therefore, all things considered, the token warrant is better suited for DevLabs incorporated in the U.S..

As for DevLabs registered outside the U.S., such as in Europe, Asia, or Latin America, they have more flexibility in choosing which fundraising document to use, be that the token warrant or the token side letter.

What are the terms of the token warrant?

As with any legal agreement, the token warrant comprises a number of terms and conditions. The most important of them are as follows:

1. token portioning: specifically how many tokens are reserved for the investor;
2. token generation event: for greater flexibility, you can specify a deadline over a specific date;
3. token purchase right: the investor's right to buy a number of tokens up to the allocated portion;
4. purchase price: a fixed price at which the investor will be purchasing tokens;
5. token transfers: what constitutes a transfer of tokens and what restrictions are imposed on the transer, e.g. a lock-up; and
6. exercising terms and rights: in other words, the process of how the investor can exercise their right to purchase tokens. Here, it is important to clarify that the project should warn the investor in advance about the exact date of the token generation event. Next, the investor is given a defined period during which they can exercise their right to redeem tokens. It is also important for the founders to include the investor in the Token Cap Table if they decide to proceed with the purchase.

As you can see from this list of key document details, the terms of the token purchase right  sit at the very core of the token warrant.

The token purchase right is the right to buy tokens in the future. In order to determine the best approach of how to structure it, it is necessary to assess the readiness of the project’s tokenomics. If the token economics of the project is not finalised, the way to address it is to agree on the discount, which will apply to the investor’s purchase. The number of tokens that they will be able to buy with the discounted price is then calculated pro-rata to the equity ownership of the investor. (In our template, available to download below, we chose to go with the pro-rata formula based on contributors’ allocation, meaning that the base for the calculation is not the entire token pool, but the part that is used for distribution to the core contributors. That being said, it is not the only way to structure the conversion formula, we chose this method as it is an industry practice we think will be most helpful to users of the document, as per our explanation below)

Download a free token warrant template from Legal Nodes

So, if your tokenomics is finalised, meaning, the price of the token at the time of its issue and the hard cap is already determined, you will be ready to specify in the token warrant details about the number of tokens available to the investors and their specific price. That price would, naturally, be lower than the standard price during the token generation event. Hence, this sale to the investor is also called a “pre-sale”. It is, however, rare for the tokenomics to be ready at such an early stage. Usually, one to two years may pass between the initial fundraising to the time of issuing tokens. During that time, the market conditions may change significantly, as it gives sufficient time even for new tokenomic models to emerge and be adopted. 

Therefore, for our template to work for more early-stage projects, we have decided to go with a discount-based model.

Another important point that deserves attention is the process of assigning the token warrant from the DevLab to the Token SPV. This could be done as soon as the Token SPV is incorporated. However, it could alternatively take place just before the token generation event. Either way, the important part is that the DevLab is excluded from any token matters to avoid any unnecessary regulatory risks.

When using our token warrant template, remember that it is jurisdiction- and protocol-agnostic. It does not take into account the specifics of all national frameworks and infrastructure of all existing blockchain protocols. As explained above, our template works with a discount and a core contributors’ allocation pro-rata formula, which is one of several methods suitable for a token warrant agreement. If you want your Web3 fundraising to go smoothly and just the way you envision it, Legal Nodes would happily help you customise the template to address your specific fundraising needs. 

Get started with Legal Nodes by downloading the free template on this page or filling out a form to find out how we can help you solve your legal needs.

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.

Legal Nodes does not assume responsibility for the contents of any templates or documents in any form that are provided on the Legal Nodes website. In addition, Legal Nodes does not assume responsibility for the consequence of using any version of the templates found on our website. You should consult with a legal specialist such as a lawyer, who is licensed in the country where the documents might apply. You can speak to the team at Legal Nodes to find out more about how we can help you use these documents.