We’ve shared a few blogs recently on the topic of cryptocurrency and ICOs (initial coin offerings) as a potential source of capital for growing startups. Conducting an ICO can provide a meaningful fundraising opportunity under the right conditions.
But of course, cryptocurrencies represent a new, unproven, and as-yet mostly unregulated foundation for a sustainable business. So before investing in or presenting a coin offering, founders would be wise to research potentially applicable law and regulation, and they need to be ready to reassure potential investors that the reasons behind the ICO are sound. If your fundraising decisions can withstand careful scrutiny and regulatory audits, that’s great.
…Unless something goes wrong. Despite the most carefully laid foundations and scrupulous planning, entrepreneurs who rely on crypto funding may find themselves on the defense if those who placed their faith in a struggling currency have reason to believe the offering was illegal. Similarly, investors who purchase coin may not gain the returns they expected, and may later find out that their chosen coin offering did, in fact, violate applicable securities laws. Most likely, the coin in question may have been presented as a “utility” token, when in fact, the coin better fits the definition of a “security” or investment vehicle.
If you’d like to include an ICO in your fundraising efforts, but are concerned about legal backlash in the event of misunderstandings or downturns in the cryptomarket, here are a few things to keep in mind.
You’re wise to be concerned.
This recent lawsuit filed on March 1, 2018 against CoinBase shows that people are realizing that cryptocurrencies may be subject to scrutiny and oversight from state and federal judges through litigation. CoinBase is being accused of insider trading and misrepresentation, allegations that would classically apply to the trading of securities. Because it is abundantly clear now that many (perhaps the majority) of cryptocurrencies will be subject to securities laws, we should absolutely expect to see an explosion of securities-based litigation brought by holders of crypto currencies, against issuers and intermediaries.
As with traditional securities litigation, savvy litigators will be looking at offering documents for ICOs and thinking about issues related to misrepresentation, insider trading, and failure to disclose material information related to the offering.
You can still move forward...carefully.
This concern shouldn’t stop you from pursuing your chosen path; it’s just one of the calculated risks you’ll need to take as you look for sustainable funding. In a sense, offering an ICO is just as risky as issuing any other form of security…but in different ways. For one thing, in a classic private offering, a company may only issue securities to a dozen or so purchasers, perhaps a few dozen at most. Many current ICOs are structure to issue coin to thousands of purchasers. As there are more holders, the potential for litigation from any one holder increases dramatically. Your offering documents need to be carefully vetted, and the risks explained to you, about the securities pitfalls that can befall a poorly-planned ICO.
Honesty and full disclosure can prevent a host of problems.
As with any securities offering, full disclosure is essential. All parties should be well-informed about the nature of your blockchain-based currency model, how it works, its stage of development, your future plans, and essential risk factors associated with holding the offering.
Documentation is essential.
Our recommendation to our clients at this stage is to be extremely conservative with legal documentation, to over disclose, and to assume that every single document related to the ICO will be later scrutinized. Accordingly, we generally advise that every ICO should have a well prepared suite of offering documents, well vetted risk factors, and a purchase agreement that borrows heavily from the securities framework. The ICO also needs to internally vetted to ensure compliance with applicable securities laws and to ensure that there is an appropriate exemption from registration under the Securities Act.