How to hold an ICO in 2018 and beyond

If your interested in learning how to hold an ICO (Initial Coin Offering) while reducing your chances of potentially getting #rekt (wrecked) by the SEC (Securities and Exchange Commission) then you might want to read this post.

Over the past year we’ve explored multiple paths and options for raising capital for our project. This post covers what we learned over that time along with the pros and cons of each approach. Perhaps one of these methods might work for you if you are so inclined to launch an ICO in the future.

Before we get started you should know that the SEC chairman Jay Clayton recently warned cryptocurrency investors to exercise “extreme caution” when backing ICOs — especially the ones that claim to be registered with the SEC.

Jay Clayton states in his warning that “investors should understand that to date no initial coin offerings have been registered with the SEC. The SEC also has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies. If any person today tells you otherwise, be especially wary.”
U.S. Securities and Exchange Commission

Quick boring legal disclaimer in italics before we proceed

The materials available in this blog post is for informational purposes only and not for the purpose of providing legal advice. You should consult professional legal counsel to obtain advice before holding an ICO.

This blog post may contain forward-looking statements, subject to risks and uncertainties that could cause actual results to differ materially.

This document is for informational purposes only and does not constitute an offer or solicitation to sell shares or securities in EtherSportz, LLC or any related or associated company. Any such offer or solicitation will be made only by means of a confidential offering memorandum and in accordance with terms of all applicable securities and other laws.

Realize the ICO wild west days are gone

We originally intended to have a traditional ICO open to everyone using smart contracts to fund the continued development of our project but with the regulatory uncertainty we pushed pause and started our legal research. Over the summer of 2017 the SEC issued an investigative report concluding digital tokens were in most cases a security. We took this report very seriously which started us down the path of finding a way we could hold an regulation offering within the framework that's currently available for raising capital. For our project and timeline we ultimately decided to move forward with a private Regulation S offering for non-U.S. investors only.

Even more recently the SEC issued a cease and desist order to a California based ICO “Munchee” for securities violations. You can read the SECs overview here. Apparently Munchee missed the memo? The main problem with Munchee’s approach was that their tokens (securities) were available for sale to the general public (anybody) for purchase by individuals in the United States and worldwide without following any SEC guidelines for raising capital or validating the investors status.

With all of that in mind, there are many ways to legally raise capital for your token based technology company but they should fall into one of the preexisting methods for raising capital like Regulation Crowdfunding, Regulation A+, Regulation D, and or Regulation S.

SAFT (Simple Agreement for Future Tokens)

Before we talk about ways you can raise capital, you should understand the type of agreement most token based companies are using called a SAFT (Simple Agreement for Future Tokens). A SAFT is similar to the SAFE “Simple Agreement for Future Equity” framework popularized by early stage investor Y Combinator.

The SAFT is the commercial instrument used to convey rights in tokens prior to the development of the tokens’ functionality. In the U.S., the SAFT itself is a security, so it could be offered in a private placement to accredited investors. The tokens that are ultimately delivered to the investors, though, should be fully-functional, and therefore not securities under U.S. law. Outside of the U.S., the need to limit SAFTs or tokens to accredited investors will depend upon the laws of the local jurisdiction. Learn more about SAFTs by visiting The SAFT Project.

Okay lets jump into the ways to raise capital now.

1. Regulation Crowdfunding (Reg CF)

Regulation Crowdfunding is a new law that rolled out on May 16th, 2016. For the first time in 80 years, it’s legal for the public — not just the rich — to make investments in private companies. Businesses can raise capital from their friends and local communities instead of just banks or venture capitalists. Its basically Kickstarter with Equity (or Debt) instead of board games.

Example Crowdfund ICO: Indeco

Reg CF Pros:

  • Non-accredited investors can participate
  • U.S. investors can participate

Reg CF Cons:

  • Restrictions on Resale. Probably the worst part of a regulation crowdfund is that securities purchased in a crowdfunding transaction generally cannot be resold for a period of one year, unless the securities are transferred.
  • Only $1,070,000 can be raised from a Regulation Crowdfunding offering each year. However, you can raise unlimited dollars by running a concurrent Regulation D, Rule 506(c) offering for accredited investors.
  • A Form C must be filed with the SEC before fundraising can begin. You’ll need to disclose up to two years of GAAP financials, along with other items, like number of employees, officers & directors, stakeholders with more than 20% voting power, past fundraising rounds, use of funds, all material risks. This will normally cost anywhere from $3k-$10k to have a CPA prepare your GAAP financials and of course legal counsel who will copy-paste your company name into various boiler plate documents.
  • Ongoing reporting. Each year, you are supposed to file an annual report with financial statements updating your investors. If you neglect to do so, you will be unable to fund-raise with Regulation Crowdfunding again until you file the annual report (however, you may still raise funds from accredited investors with Regulation D).

2. Regulation D, Rule 506 (Reg D)

Regulation D, Rule 506 is how startups have been financed for the past 30 plus years. If you’ve already received money from an angel investor or venture capital firm, you likely have already done a Reg D fund-raise.

Example Reg D ICO: Filecoin

Reg D Pros:

  • Its easy — This is the easiest, oldest, and most-used fundraising exemption. There are no public disclosure or ongoing reporting requirements other then one simple notification called a Form D.
  • There is no limit to the amount you can raise.
  • Reg D, 506(c) offerings permit general solicitation and advertising. You can even have a celebrity promote it — so long as the compensation paid to the celebrity is disclosed in accordance with Section 17(a) of the act. The JOBS Act lifted the restriction against general solicitation under 506(c).

Reg D Cons:

  • Only accredited investors — i.e., rich people — may invest in your company.

3. Regulation S (Reg S)

Regulation S is a commonly used exemption for US companies that want to sell their stock (securities) to foreign investors. This could be a path for a US company to use a private placement memorandum and SAFTs offered exclusively to non-U.S. persons (foreign investors).

There are two key parts to the Regulation S exemption:

  1. The sale of securities must be an offshore transaction (foreign investors).
  2. There must be no directed selling efforts that target the US market.

Offshore Transactions
A sale of securities counts as an offshore transaction if two conditions are met. No offer is made to a person in the United States; and One of the following is true:

  • At the time the securities are purchased, the purchaser is physically outside the US or the seller reasonably believes that the purchaser is physically outside the US; or
  • The transaction is executed on a foreign exchange and the seller is not aware that the transaction has been arranged with a US purchaser. (I recommend you not go for this one.)

There are a couple of further caveats: If the sale of securities is targeted at US citizens abroad, the sale does not count as an offshore transaction, and conversely, offerings may count as an offshore transaction if they are made to people physically present in the US who are not within Regulation S’s definition of a “US person.” The US person definition includes US residents, US companies, and US trusts and estates, among others.

Directed Selling Efforts
An action does not qualify as exempt under Regulation S if any actions are taken in connection with the offering for the purpose of “conditioning” the US market for the sale of the securities. Offerors cannot do any of the following: advertise the offering in the US, mail printed materials to US investors, have promotional seminars in the US, or make offers to US citizens. However, companies can initiate selling efforts from the US if the efforts are directed abroad.

Reg S Pros:

  • Raise as much as you want from an unlimited number of people — Sell securities offshore without regard to the sophistication or number of purchasers in the offering or the size of the offering. Similarly, unlike Rules 505 and 506 of Regulation D, Regulation S does not contain specific information requirements.
  • You can advertise — Regulation S permits issuers and distributors to advertise an offering offshore (consistent with the prohibition against directed selling efforts and the offshore transaction requirements) in a manner that would not be consistent with the prohibition against general solicitation in a private placement in the United States.
  • You can use the internet — An issuer that chooses to effect an offering via an Internet website may do so without jeopardizing its exemption by including prominent statements on the applicable web pages indicating that the offer is directed only outside the U.S., and by implementing means to preclude sales to U.S. persons.
  • Private Placement Memorandum is not required for a Regulation S offering, but it would be prudent to provide one to ensure the foreign investors understand the structure, risks and conflicts associated with an offering.
  • No SEC filings are required for a private Regulation S offering.
  • Regulation S and Regulation D Offerings can be combined — Regulation S may be conducted concurrently with a Regulation D offering to U.S. accredited investors without the offerings being deemed as integrated.

Reg S Cons:

  • The USA is blocked — U.S. persons cannot participate. The US person definition includes US residents, US companies, and US trusts and estates, among others.
  • Resale Restrictions — Securities sold under Regulation S are subject to resale restrictions. The nature of the restrictions depends on a number of factors including: whether the company selling the stock is foreign or domestic; whether the issuer is a public company; the types of securities being sold; and whether there is a “substantial US market interest.” The securities being sold must contain a legend stating that the securities may not be resold to US investors for a restricted period of time.

4. Regulation A+ (Reg A)

Regulation A+ is a newer fundraising exemption that became active in late 2015, designed for companies who want to raise more funds publicly, but don’t want to do a full-blown IPO yet. It’s like a mini-IPO.

Example Reg A+ ICOs: FCFL and GAB

Reg A+ Pros:

  • You can raise up to $50 million per year from anyone. You can advertise your fundraising and solicit investors. You can also “test the waters” and solicit investors before filing with the SEC.

Reg A+ Cons:

  • It’s expensive — Before you can start fundraising and collect funds, you need to pre-file an offering placement memorandum (OPM) with the SEC. An OPM is like a business plan wrapped with a whole bunch of legal disclaimers, and can cost up to $50,000 to $100,000+ in legal fees.
  • It’s time consuming — Getting qualified for your Regulation A+ offering can be both tedious and take significant time. Here is a breakdown of the timeline. 30 Days to compile the required documents. 30 Days to complete and submit the forms. 30–45 Days to get SEC appeal.
  • It has to be reviewed and qualified by the SEC. According to the SEC, the estimated Burden Hours is 608 hours.

ICO Funding Platform Options

Here are some platforms that are friendly to ICOs that offer most of the above methods for raising capital. This is easier than going it alone but you will end up paying 6%-8% of what you raise to the platform for facilitating.


Final Advice: Talk with the SEC

Don’t be afraid to email or, even better, to call the SEC directly and talk with them about what you are trying to do and ask them for guidance.

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