Permissionless Startup Investing
How ICO token sales are changing for the better
While the beginning of every new technology curve is wrought with unsavory actors and questionable use cases, there is no way crypto currencies and blockchain based technologies are going back into a box, no matter what Jamie Dimon, CEO of JP Morgan, says.
The total market capitalization of cryptocurrency has grown from $3B to $150B in the last 24 months and so far in 2017, over $2.4B has been invested in ICOs, far more than what’s been invested by traditional venture capital firms in early stage startups. Not entirely surprising given so many early investors are playing with house money and many want to diversify within crypto without incurring tax liability.
In the past, if you wanted to invest pre-IPO in a Google or Facebook, you had to be in Silicon Valley, meet the team, and convince them to allow you to invest in their company. Public token sales change that. Thanks to cryptocurrency, Ethereum and the ERC20 specification, we now have Permissionless Startup Investing — You don’t need to know people to get into the early rounds of a great company. Once it’s a publicly traded coin, anyone can invest without permission.
But as more and more companies begin to tokenize their cap tables, there hasn’t been a great way for US companies to raise money in a token pre-sale in a legally compliant and tax efficient way, so most have domiciled in Switzerland or Singapore with clever untested structures. But the legal landscape is finally beginning to crystalize.
Marco Santori, FinTech lead at Cooley and Policy Counsel to Blockchain, a Lightspeed portfolio company, just co-authored the SAFT Project Framework, a 20 page position paper and sample SAFT agreement outlining an “emerging standard for how blockchain network developers can responsibly innovate”.
The SAFT (Simple Agreement for Future Tokens) is a framework and legal document based on the Y Combinator SAFE (Simple Agreement for Future Equity). The SAFT attempts to address the federal securities and money-transmitter laws while providing the greatest tax efficiency and seeking to apply both investor and consumer protections. It covers the important distinctions between “securities tokens” and “utility tokens” and the tax and consumer/investor protection implications of various forms of token sales.
The first popular token to leverage the new SAFT model is FileCoin, a project led by Juan Benet, founder of Protocol Labs. He and Naval Ravikant, founder of AngelList, unveiled a new platform for accredited investors called CoinList, which FileCoin recently used to raise ~$250M in a SAFT pre-sale earlier this year.
First, the SAFT requires the buyer to be an accredited investor in the eyes of the SEC. The SEC was created in the 1930’s post stock market crash to protect consumers against fraud. While this may run contrary to the decentralized characteristics of this entire ecosystem, if a company wants to sell tokens to US investors, they need to find a way to comply with US security/tax code. The goal of this project appears to get ahead of the curve of federal regulators and help craft the standard that allows for the greatest innovation still to occur. Lets not pretend that BananaCoin and ShitCoin are a good thing. They shouldn’t exist outside of a Comedy Central skit.
Second, the SAFT has a clear distinction from almost all token sales to date… investors won’t get access to the coin until a product/network goes live, which means there is no immediate liquidity. While technically this is for SEC/tax reasons, this will end PDF driven pump and dump schemes and protect unaccredited investors from the highest risk phase of a new idea.
Even if these new standards are widely adopted, early stage startups will still be accessible to the public market years prior than traditional venture backed startups. The past decade has shown us that high growth startups have waited longer and longer to reach the public IPO markets allowing only late stage funds access to that value creation, bypassing the retail investor. Thats about to change.
In traditional venture capital, a small team raises a seed round pre-launch from a small group of investors. If the company continues to show progress, they raise multiple additional rounds of capital correlated to their progress/growth/revenue/etc. In this new SAFT world, unaccredited investors will still miss out on the seed round of a future Facebook, but may have access to subsequent rounds. For an example, you would’ve missed the seed round of Facebook, but may have had the opportunity to participate in the Series A, which had a valuation of $100M. It later IPO’ed at $100B.
So the wild wild west of ICO mania may be coming to an end, but I applaud Marco and others for working to protect the core innovation here and providing a framework through which we can continue to innovate responsibly. Their whitepaper is a must read and addresses these topics in much more detail.