Company investment strategies: ICOs and Beyond
In mid-2017, the cryptocurrency market started a dizzying climb, spurred by the seemingly unassailable benefits of blockchain technology and the instant success of one homerun ICO after another.
Coin offerings faced an uncertain regulatory landscape—and they still do—but they seemed to hold wild promise for startups looking for capital. Now it’s 2018, the marketplace is evolving rapidly, and several major crypto currencies have lost value in recent months.
So the question remains: When it comes to startup funding options, are ICOs still worth the risk? And if not, are replacements available? Here are some thoughts on current market practice for the issuance of tokens and other crypto currencies.
SAFT: Simple Agreement for Future Tokens
Some companies are starting to raise millions using this pre-sale method that targets accredited investors. With SAFTs, investors accept promises of tokens—not actual tokens—until the project or company gets off the ground.
We are not fans of the SAFT. The SAFT carries too many unanswered questions, particularly from a tax perspective. When the SAFT converts into the token, is there a tax realization event? If an employee receives a SAFT that vests over time, are they able to file a Section 83(b)? Is the SAFT (which is just a promise to convert into tokens) “property” for purposes of Section 83(b)? How defensible is the typically low valuation on the SAFT that companies are using to replace the illegal pre-sales that were taking place in 2017?
Then of course there are several lingering and unanswered questions about the tokens themselves. Once the SAFT converts into the token, does that token retain its status as a security? If it remains a security, then it will be subject to the myriad of resale restrictions and other prohibitions on tradability that govern all U.S. securities. So what exactly will that token be worth if it can’t be traded?
The SAFT is the purported “best” option in a sea of terrible answers out there. We strongly encourage our clients to avoid SAFTs and to really consider the risks -- both legal and tax -- associated with purchasing one.
Securities Token Sales
Some companies are attempting to fund crypto currency and/or blockchain development by issuing two different types of tokens: one, a security token used to fundraise, and then a second, different crypto currency that the security token will convert into at some date in the future.
We believe this approach carries many of the same legal and tax risks associated with the SAFT. We have doubts that a company can really issue two different tokens, “convert” one token into another, and then maintain tradability of a non security currency thereafter.
Traditional fundraising combined with currency issuance
Perhaps the safest approach under the securities laws is for a company to do a traditional equity or debt raise (such as a sale of Preferred Stock sale, or convertible note raise) and then to use that financing as general proceeds that can go into the development of a bona fide, tradable crypto currency. Holdings of that currency could be held as any other asset of the company.
We believe this is the soundest approach under the current securities laws for companies that are looking to raise money in order to fund currency development.
Direct currency issuance
Our office is exploring with several clients the possibility of directly and immediately issuing tradable, programmable money, as the fastest way to achieve the goal of general tradability of the new crypto currency. Much of this work is confidential, but we would love to explore these issues with serious founders who want to develop a bona fide, tradable programmable money.