Assessing Crypto-Native Companies
CROs (Cryptonative Remote-First Organizations) are sexy… but do they provide value for startups in the near term?
Short answer: YES, given some conditions.
Creating a legally compliant business fully on-chain sounds sexy, but who and why would someone want to get involved in a system that is experimental? What benefit exists to incentivize the participants of such an entity?
This is research. Check with your attorney.
These CROs are essentially the same as LAOs.
Cryptonative remote-first organizations refer to companies that do business in crypto, hand work across boarders. There are two distinct levels of CROs:
- Accounting mostly or fully on-chain (cashflow, contracts, revenue, etc)
- Equity, dividend, revenue, and governance distribution on chain (security tokens)
After much examination, the prospect of utilizing CRO2 today adds more friction than it solves for startups getting off the ground.
The most tangible benefit early startups experience involves international cashflow as mentioned in CRO1 (essentially just a paired down CRO2 structure). These kinds of transactions are increasingly common in the emerging remote organizations built within the Ethereum and blockchain ecosystems.
This post takes a stab at evaluating all of the above by summarizing thoughts about US entity types, short term benefits, and long term benefits.
What and how?
If you plan to distribute most or all profits made by the company, then utilize an LLC. Partners of the LLC owning profit rights are all taxed on income made by the entity regardless of distribution thus distribution is prioritized rather than reinvestment for R&D.
If you plan for the equity shares of the company to capture and store value then move with a corporate structure.
The reasons for moving with an LLC:
- Corporations are taxed on income and shareholders are taxed on dividends, whereas partnerships are only taxed once (on profits).
- Governance is more flexible (no amorphous fiduciary duties).
- Series LLC may provide a path with lower overhead for new entities to form if the DAO Factory becomes an important aspect of the business.
The reasons moving with Corporate Structure:
- Profits can be reinvested w/o tax.
- Securities terms can be more flexible because they may be hybrid debt/equity instruments (like preferred stock) rather than pure equity instruments
- Tax structure is slightly simpler (no need for K-1 for each partner each year, only 1099 on actual dividends paid).
- The structure is familiar to investors.
Early Stage Token Distribution Restrictions
For startups interested in getting into the tokenized equity game, but want to avoid scrutiny by the SEC, here are a few pointers for managing distribution.
- Limited distribution to accredited investors (Rule 506(c)), and individual core contributors (those actively managing and building the business) (Rule 701) [Note: only natural persons, not entities, qualify for Rule 701].
- Need to define limits in selling tokens on secondary markets.
- A vesting period will apply to all token holders, though this might also remain configurable for each individual.
If the target user and partnership base for the product encompasses an international community, doing business crypto-natively means savings on fees.
Displacing Wire-Transfers (for contracting): crypto native organizations will save fees using cryptocurrency as opposed to lengthly (5 day) wire transactions. This provides an advantage in payment of international contract work / salaries.
Displacing Wire-Transfers (for revenue or profit share): utilizing smart contracts to determine and distribute profits on a consistent cadence would theoretically provide a more fluid accounting system than is available today. This would require a few factors to be true in order to execute:
- Revenue is all (or nearly all) in crypto. Having crypto and fiat would require costly ramp transfers to distribute shares.
- Profit can be automatically calculated on some consistent cadence (weekly, monthly, quarterly or annually). A short cadence is preferred for token holders (money now > money later). Calculating this would look like subtracting expenses from total revenue in a given timeframe. Invested capital should be left aside as an operational budget.
Displacing Credit Cards (for subscription access): credit cards charge a range of fees that vary between different regions. There is also a limited population of individuals able to access credit cards due to banking restrictions. Crypto accounts, on the other hand, may be opened and utilized by anyone with internet access. Thus, only allowing for payment in crypto eventually increases the target population of the product.
The following are added benefits as a tokenized CRO structure becomes easier to deploy.
Being a crypto-native business must simplify collaboration through tokeneconomics. This collaboration manifests in an ease of distribution to partners or ease of liquidity for shareholders compared to traditional investment and contribution practices. An added benefit is increased transparency of asset management.
Fluid & Permissioned Crowdfunding
ICOs simplified crowd funding by providing highly liquid assets representing value of a certain network open for anyone to participate in without friction. In contrast, the CRO model allows for a highly permissioned scheme in order to limit speculation and increase the quality of partnerships.
Ease of Deployment
Deploying a CRO should hit an inflection point where scaling becomes fluid (similar to the ICO model). There are visions of a DAO Factory that allow for developers to create entities through the push of a button. It is undetermined whether these entities will be able to find higher efficiencies than say the Clerky model today. Currently, there are two entity types that could be this easy to stand up, either grant-giving Moloch-like structures or tokenized networks. Anything in between (requiring a legal entity) is not fluid enough to scale.
If these companies are to become easy to stand up, the ecosystem must dogfood the model to provide example implementations and reduce unknowns.
Ease of Partnerships
The primary assumption with tokenized CROs lies in partnership agreements being standardized to the extent that distributing tokens and legal commitments occur simultaneously (or nearly simultaneously).
The formation of secondary markets would increase the value of these security tokens through speculation. Due to the fact that much ground needs to be broken in order for these tokens to launch, and it will take time to overcome the added friction of operating in this new system, it is unclear when secondary markets will occur.
The prospect of CROs becoming a viable mass entity structure is growing in potential. Early adopters will have some questions to answer: (Do we *need* a bank account? How to expense minus credit card? How to handle volatile assets? What tools make these things possible?) but they will also break important ground to define usable patterns to be reimplemented by others.
Many thanks to Gabe Shapiro and the team at ZeroLaw for their assistance in mapping out the legal restrictions associated with security tokens in the US.