SAFT: A New Legal Framework for Token Sales
By: David Lamb and Nick Scannavino | Founding Partners @ Scannavino Lamb LLP
If you’ve been paying attention to recent news surrounding token sales (also known as ICOs), then you may have come across the term “SAFT” and the emergence of the use of a SAFT in token sales (including in the recent Filecoin token sale). So, what is the SAFT? Why are companies using it? And what should you be aware of?
What is the SAFT?
Let’s start with the basics. The SAFT (Simple Agreement for Future Tokens) is a contract by which a purchaser acquires the right to a future distribution of tokens from a company upon a specified event. Think of it like a conditional IOU. The company takes in money now on the promise that it will distribute tokens to purchasers later at an ultimate crowdsale and token distribution set to occur upon what is commonly referred to as the “network launch” of the company’s token on the blockchain.
Inspired by Y Combinator’s SAFE (Simple Agreement for Future Equity), the SAFT is intended to streamline the process of raising early-stage capital by creating a simple, uniform standard for conducting token pre-sales, which can help companies save time and money that would otherwise be spent drafting one-off legal agreements.
Why use this structure?
The SAFT represents a pre-sale of the tokens that are ultimately to be delivered at the network launch. With such a pre-sale, companies can raise critical capital to fund development costs and finalize their technology for the network launch.
The use of the SAFT primarily came about as a result of securities law concerns surrounding token pre-sales. The pre-sale of tokens that are meant to be used on a network that does not yet exist seems more likely to fall within the definition of “security” under US securities laws, therefore requiring that such pre-sale comply with securities laws. (More on this later).
What are some key terms?
The purchase price of tokens under the SAFT is often based upon either a fixed or dynamic pricing model. Under the fixed pricing model, the purchase price is the same for all purchasers participating in the SAFT. Under the dynamic pricing model, the purchase price fluctuates based upon specific variables determined by the company. Companies can employ various dynamic pricing models under the SAFT. For example, a company may decide that the purchase price for each purchaser should be determined by the demand for the SAFT, such that the purchase price goes up after certain threshold amounts have been sold. A company may also decide to incentivize purchasers to purchase tokens earlier in the offering period by offering early purchasers lower prices.
Companies often accept both crypto (typically ETH and/or BTC) and fiat (USD) currency as payment under the SAFT. In either case, the value of the purchase price is usually stated in USD, with crypto valued based upon a specified volume-weighted average price of the specified crypto across exchanges.
Discount on Tokens
A basic premise of the SAFT is that it allows companies to raise capital before fully building out their blockchain technology. Therefore, the actual network launch and delivery of tokens may not occur until quite some time after the SAFT, or may not occur at all. To incentivize purchasers to take this risk and participate in the SAFT, a company may offer purchasers a discount on the price at which the tokens will be sold at the network launch. As with the actual purchase price, the structure of the discount on the purchase price can come in different forms. For example, a company may elect to tie the discount to the total amount raised in the offering or to the vesting period specified in the offering.
Companies may place a general prohibition on a purchaser’s ability to sell, transfer, spend, exchange or otherwise make use of the tokens after the network launch until they are vested according to a defined vesting schedule in the SAFT. In addition, companies may allow purchasers to choose a range of restricted periods that come with a range of discounts on the purchase price of the tokens as an incentive for purchasers to lock-up their tokens for a longer period. These vesting schedules are intended to incentivize long-term support by purchasers and to provide stability to the token supply.
When are the Tokens Delivered?
As mentioned above, the actual distribution of tokens is usually tied to a network launch. Unfortunately, there is often very little certainty around the timing of a network launch following the SAFT offering. It could be weeks, months, years, or never.
Assuming a network launch occurs, purchasers will receive their tokens either at the time of the network launch or at some time following the network launch based upon a vesting schedule (as described above). There is no one-size-fits-all approach here, but each SAFT should clearly lay out the framework around the timing of the token distribution.
SAFTs typically include a deadline date upon which purchasers are entitled to a refund of their purchase price if the network launch has not yet occurred. However, this date is typically several years after the SAFT offering (and subject to extension by the company) and assumes the company will have enough money to issue a refund at that time (which is unlikely).
What About Those Securities Laws?
As part of its goal to streamline the token pre-sale market, the SAFT was developed to provide a clear and conservative path to compliance with current US securities laws and regulations when it is utilized in conjunction with an accredited investor verification process.
Keep in mind that the body of law surrounding token sales (both pre-sales and ultimate crowdsales) is very undeveloped and, therefore, the analysis below is subject to change. The law will mature as regulators and courts continue to review the application of traditional securities laws to blockchain technology, and the approach taken by companies and their lawyers with respect to token sales may change accordingly.
The SAFT is structured as a security
The SAFT cuts through the debate of whether the pre-sale of tokens prior to a network launch constitutes the sale of a security, as the SAFT itself is structured as a security instrument. Under US securities laws, the sale of securities must be either registered with the SEC or fall under an exemption from registration. In order to avoid the monumental requirements of SEC registration, the SAFT utilizes an exemption (Rule 506(c) under Reg D of the Securities Act) that allows companies to raise an unlimited amount of money and generally solicit and advertise the offering so long as the purchasers are all verified “accredited investors.”
In general, an accredited investor includes (1) individuals who earned income exceeding US$200K individually or US$300K jointly with a spouse in the two years prior to the offering with the reasonable expectation for the same in the year of the offering, (2) individuals who have a net worth north of $1 million (either alone or jointly with a spouse, and excluding the value of a primary residence), (3) entities with over $5 million in assets, and (4) entities in which all of the equity owners are accredited investors.
To comply with the verification requirements, companies cannot just rely on purchasers’ self-certification that they are accredited investors. Instead, Rule 506(c) requires that companies take additional steps to independently verify the accredited investor status of each purchaser, which could entail reviewing tax returns, bank and brokerage statements, credit reports, and other documentation. In the context of a SAFT offering, companies are generally advised to partner with third-party verification services in order to satisfy this requirement.
Although this structure closes the door to many people looking to participate in the token pre-sale, this conservative approach is being adopted to account for the complexity of early-stage investing and the uncertain regulatory landscape surrounding token sales.
Companies must file a Form D with the SEC
Companies relying on the Rule 506(c) exemption must file a brief notice called a Form D with the SEC after they first sell their securities. The Form D includes the names and addresses of the company’s management and promoters as well as some details about the offering, such as the amount of the offering and the number of purchasers.
Purchasers generally cannot transfer the SAFT
Securities offered pursuant to Rule 506(c) are “restricted” securities, which generally means that purchasers may not resell the SAFT in the public marketplace for at least one year without registering the SAFT with the SEC. Moreover, the terms of the SAFT typically prohibit transfer of the SAFT, requiring purchasers to hold the SAFT until network launch and token distribution or until termination or expiration of the SAFT.
Availability of other securities law exemptions
Other securities law exemptions may be available to companies offering SAFTs that could potentially open up the pool of possible purchasers, including Reg S and Reg A+. While the use of these exemptions may allow companies to expand their offerings beyond verified accredited investors, these regulations come with different disclosure, solicitation, qualification, and administrative requirements that, when analyzed comprehensively, may not be economically viable for most companies.
The status of the token at network launch
A key question with the SAFT model is whether the token underlying the SAFT is itself a security, such that the later public crowdsale of the tokens would also be deemed a sale of securities and therefore trigger U.S. securities laws. This requires a highly fact-specific analysis under a very undefined regulatory framework, so companies are advised to seek legal guidance before making any such assessment.
For now, it appears that the use of the SAFT may become the norm in the token pre-sale market. While this is a step forward towards providing uniformity in this dynamic sector, companies and purchasers should continue to work closely with their legal and business advisors to evaluate each SAFT and to monitor the shifting regulatory landscape surrounding token pre-sales and token sales as a whole.
Stay tuned for additional articles by Scannavino Lamb LLP on the SAFT and token sales.
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