Marrying Your DAO to A Legal Entity — Why It Matters and What It Looks Like

TLDR:

  • A legal structure is important for DAOs to provide individual legal protection, access to the legal system for business operations, and rules around governance control.

Introduction

When choosing a model for their organisation to be based on, one of the considerations for the founders to contemplate is the jurisdictions the tokens are going to be issued and offered in. In this article, we are outlining why a legal structure is important for DAOs and some of those that our readers could refer to, to build their own organisation. Please keep in mind that this list is not exhaustive and we encourage our readers to consult with their own legal and tax counsel to understand which structure would work best for them.

Why is a legal structure a pivotal touchpoint for DAOs?

There are three main reasons why a legal structure is important for DAOs. First, a proper legal structure can protect individual members and organisers of the DAOs from individual liability. Second, it helps these organisations have meaningful access to the legal system for contracts, bank accounts, and whatever else they might need. This makes it possible for the organisation to enter into an agreement with a third party, especially if the former party wishes to exchange cryptocurrencies, protect their IP, and legally hold assets. Last but not least, a legal structure helps create rules surrounding member entry and exit, governance voting, control liquidation of the DAO. A current court case in California could set a precedent for unincorporated DAO members having unlimited liability. Elsewhere, key members of a protocol have been sued. Without a legal structure that clarifies how these entities are governed from a legal perspective, jurisdictions will find ways to govern them regardless.

A guide for ideal structure for certain DAO category, inspired by the Andreessen Horowitz’s flowchart

The DAO LLC structure in Wyoming (U.S.) and in Delaware (U.S.)

Wyoming has earned the first seat at the table to bring a more formal legal structure to DAOs. Being the birthplace of the LLC structure, it almost seems like a natural fit for Wyoming to have this be a sub-category. This jurisdiction has been working on legislative clarity at a state level for a few years now surrounding digital assets.

The Wyoming’s DAO LLC structure works because of how they have legislatively divided the criteria for digital assets based on: 1) what that entity can do with them; 2) member transparency requirements; and 3) the property rights associated with them. On the contrary, this jurisdiction has also been criticised for not being technology agnostic enough as it has yet to build clear regulations for all the aspects evolve around DAO (governance, legal, token issuance, etc.).

Similarly, the Delaware DAO LLC structure allows the organisation to hold all the ownership rights and be a (partial or entire) beneficiary of the funds raised in their token sale. This structure is meant to limit members’ liabilities and fiduciary obligations to the permitted extent by the corresponding law. In practice, what we have seen is that most DAOs in the U.S. are avoiding incorporating on-shore in the U.S. because of security law and other regulations.

The Limited Cooperative Association (LCA) structure in Colorado (U.S.)

The LCA provides the creation of a statutorily defined entity and is an unincorporated association of individuals or businesses that unite to create an enterprise to meet their mutual interests. It is created on the basis of empowerment: the users of a LCA enterprise’s products/services should also own and govern it. Colorado is traditionally very open to the cooperative structure, which is the basis for the creation of the LCA.

It is typically known to be member-driven, pro-member benefits and allows a variety of membership classes to be created so members could become both the consumers and workers in the same entity. Registering under this structure also enables the organisations to own real estates and equipment and be held accountable for reporting to the state’s Secretary. Most importantly, LCA provides a new and unique form of cooperative organisation that allows outside investors to be admitted as members with voting rights and participation in the financial gains and losses of the organisation.

Colorado governors and agencies are working on the formation of legal entities so they could become more familiar with the crypto and web3 concepts. They have also vouched for some projects that combine the cooperative model and a web3 layer.

The Foundation Company structure in Cayman Island

Cayman Islands has legislation in place that provides certainty around how the tokens are going to be treated and what the organisations are allowed to do with them. Although many token issuances are not regulated, the DAO leaders can still see where the line is between what will be and not be regulated under the Foundation Company structure. Cayman Island is considered a jurisdiction that has all of the familiar types of legal structures, such as limited partnerships, trust structures, and the newly introduced foundation company.

The Foundation Company structure is special to the Cayman Island jurisdiction as some places do not recognise this as a form of a legal company. It is, in essence, a hybrid of a company and a trust, which means it allows the tying entity to enter into contracts, protect and hold its assets, be a member of the trading exchanges, etc. Although having limited liability and being managed by its directors like a normal company would be, the key difference is that this structure does not have to have members or shareholders. It was not intentionally introduced with DAO in mind but ends up being perfectly designed for DAOs.

Although there is virtual assets legislation in place for tokens, tokens will rarely be considered a security under this jurisdiction. The person carrying out activities in relation to the tokens could be regulated depending on what they are doing in relation to the distribution of their tokens, or virtual assets in this case. This regulation clarity combined with the avoidance of the U.S. Securities laws are the key points that make Cayman Island ideal for many decentralised organisations to establish their foundation structure here.

The Unincorporated Nonprofit Association (UNA) structure in The Republic of Marshall Islands (RMI)

The UNA is a non-profit version of an LLC, where two or more people join together to pursue a common non-profit purpose. This Non–Profit Entities (Amendment) Act 2021 has been passed particularly in the MRI to help organisations around the world easily transform into DAOs. It is typically formed without any legal paperwork and has no separate legal existence, which exposes its members to personal liability for its debts. Furthermore, a typical unincorporated nonprofit association in the U.S. cannot purchase, hold property, or sign legally binding contracts in its own name. These two downsides will likely make the stakeholders shun away from participating and are the catalyst for the recommendation of eventually registering with the Secretary of State.

However, the Marshall Islands has established a new law for DAO recognition, offering this kind of entity similar privileges to an LLC’s. This allows them to incorporate personhood and the ability to hold real estate, which is done through a modification to the nation’s Non-Profit Entity Act. DAOs that are incorporated as non-profits in the RMI also do not have to register a separate LLC, are not subject to U.S. federal laws, and yet still have access to some of the states’ services (e.g.: postal).

Conclusion

We are seeing improvements on the recognition and improvements on DAO regulatory in existing and new jurisdictions. Although minor and have yet to be introduced, Tennessee (U.S.) has also passed a new DAO LLC Act recently; Australia is also considering the creation of new legal entities to accommodate the new business structure implemented by such organisations. A lot more improvement and iteration of regulatory aspects is expected to be integrated into DAOs. Before we can figure out more efficient ways to grant such entities certain protective rights for borderless and trustless activities, the regulated corporate legal structures should suffice for now.

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Replacing Companies with DAOs Globally