An outward glance at ICOs. Current trends in structuring of token offerings.

Following upon my article on EOS offering (https://steemit.com/cryptocurrency/@mazilinig/what-are-you-buying-when-investing-in-icos-lawyer-s-perspective-on-eos-token-offering) below is an attempt to summarise current approaches to ICO transaction structuring. It is too early to say that there is some sort of market practice in this industry. In fact, it is the opposite. In an environment with very little to none regulation legal practitioners are still trying to figure out their positions.

Jurisdiction of token issuer incorporation

• Choice of jurisdiction of incorporation of token issuers is primarily driven by tax and attitude towards cryptocurrency capital raisings
• No safe haven jurisdiction for conducting ICO exists as of now. No country has yet implemented a detailed set of guidance re dealings with crypto assets (including capital raisings)
• Regulatory attempts so far mostly related to alerts on relevance of AML compliance to operations with cryptocurrencies and necessity to respect financial industry regulations (currency, commodity and security) with more concerns voiced than answers given
• United States, Japan, Isle of Man, Singapore, Gibraltar and Hong Kong are in neutral to permissive camps with their financial regulators attempting to bring ICOs under the established regimes for financial transactions and securities offerings
• China and South Korea are primary examples of a restrictive camp  
• Most commonly used jurisdictions are zero tax zones as Cayman (EOS, Tierion, BAT), BVI (Storj), Gibraltar (Gnosis, Coindash, Brickblock) which allow for zero tax leakage of proceeds and for simplified accounting of crypto tokens  
• Delaware incorporated companies are also commonly used in high profile offerings (eg. Filcoin, Blockstack). ICO proceeds from these offerings are likely exempt from profit tax as most Delaware offerings are done under SAFTs which are considered securities
• Switzerland became a posh and well advertised jurisdiction at the start of ICO mania due to FINMA relaxed approach, availability of such legal form as the foundation, possibility to negotiate tax exemptions and early benchmark projects such as Etherium and DAO incorporating there. FINMA approach to ICOs since then has changed to cautious and investigative and no regulations have so far been implemented despite press announcements. Such notorious projects as Bancor, Tezos and Status have also chosen to implement a Swiss foundation structure in their capital raisings  

Types of corporate structures

• Corporation (two-tier economic) structure
• Structure is under control of equity holders of a corporation which develops the project
• Corporation issues tokens to finance the project
• All intellectual property sits on a corporation balance sheet
• Token holders are participating in the token economics within a framework of the project, hence are dependent on the will of equity holders to continue with the project in a shape initially presented
• Equity holders are theoretically capitalising on the success of the project through their equity holdings in a corporation
• Filecoin and Blockstack and, particularly, EOS are examples of such structure but equity holders risk is mitigated by the fact that software once open sourced and a decentralised platform once launched should lead to equity holders losing their leverage on token holders as the platform would detach from the team that developed it

• Foundation (non-profit organisation) having contractual relations with operational company
• Tokens are issued by the foundation
• Foundation is independent of the project development team
• Foundation employees a board of directors that manages and supervises use of proceeds and token distribution
• Project development team is employed by the operational entity
• Operational entity commits to using tokens issued by the foundation in a product that it develops or undertakes to open source the software or transfer the product to foundation once it is developed
• Structure allows project development team to keep control of its operations while the project is developed and cash out (eg. Tezos) at the time of project transfer to the foundation. At the same time it provides more comfort to token holders that at least the use of funds and token distribution are supervised by the board that is independent of the development team  
• Examples of such structures are Tezos and Bancor. KIK and MobileGo also declared that they would implement some sort of foundation type structure.

• Foundation acting on its own
• Foundation conducts the token offering and uses its proceeds to hire team of developers to develop a project
• Once project is developed and launched foundation keeps promoting it
• Foundation’s activity is charitable as it gains no profit out of project
• Etherium is the best example of such structure

Legal form of token issuer incorporation

• Private corporation
  • Filecoin and Blockstack (Delaware)
  • EOS, Tierion and BAT (Cayman)
  • Storj (BVI)
  • Gnosis, Coindash and Brickblock (Gibraltar)
  • TenX (Sinapore)  
• The most utilised form of legal entity in ICOs
• Examples include
• Founders maintain control over ICO proceeds and token distribution
• Risk of founders circumventing the ICO use of proceeds and token distribution representations persists
• Operations could vest in the token issuing entity
• Corporate and capital gain tax may apply to ICO proceeds and tokens kept on the balance sheet unless registered in a zero tax offshore jurisdiction
• Having an issuer entity incorporated in offshore jurisdiction may result in much longer KYC clearances with banks and crypto exchanges  

• Foundations / Non-profit organisations
  • Etherium, Tezos and Bancor (Switzerland)
  • KIK (Canada, though not officially disclosed in the offer documents)
  • MobileGo (place of incorporation is not disclosed)
• Used in a number of high profile ICOs
• Most notable examples include
• Although Switzerland is the most widely marketed jurisdiction any other civil law jurisdiction could theoretically be used (eg. Dutch stichting)
• Founders lose control over ICO proceeds and token distribution
• Eliminates the risk of founders circumventing the ICO use of proceeds and token distribution representations
• Usually tax exempt unless involved in business activity (Zug requires tax exemption to be negotiated with tax authorities)

Use of proceeds

• Varies from declarations that all proceeds will be spent at the sole discretion of the token issuer (eg. EOS) to commitments to allocate all proceeds to fund operations and develop the project (eg. Filecoin)

Governance over use of proceeds and token distribution

• Governance procedure are rarely disclosed in detail in white papers and offer documents
• Most projects have not implemented any governance procedures except for commitments in their offer documents with respect to use of proceeds
• Some projects employed (eg. Tezos) or claim that they will employ (eg. KIK and MobileGo) foundation structures with independent boards to take management of the use of proceeds and supervise token distributions.

Tokens offer structure

• Depends on a set of jurisdictions where tokens are offered to
• US is the most feared because of US persons tendency to litigate and SEC enforcement reputation
• From the perspective of sales into US it should be assumed that tokens are securities unless the platform is launched and purchasers could utilise tokens at the time of the offering
• Some high profile issuers (eg. EOS) chose to exclude US persons from their token distribution to mitigate the risk of US litigation
• Those who wish to offer into US are invited to use SAFT offering structure whereby options to purchase tokens are offered to qualified investors instead of tokens. SAFT structure nevertheless leaves the question on whether tokens themselves are securities unanswered, hence pushing issuers to keep close ties with their lawyers all the way through project development stage to have them finally opine on when the risk of requalification is mitigated. Examples of SAFT offering are Filecoin and Blackstock. Others who conducted token sales into US with no MVP in place at the time of the offering face a risk of SEC prosecution  
• Other jurisdictions such as Singapore, France, Hong Kong, Switzerland also voiced concerns and warnings regarding potential applicability of their securities laws. However, in the lack of clear guidance from regulators in those jurisdictions and perhaps a more formalistic approach to defining what a security is they are being considered of less risk  

KYC / AML

• Approaches to KYC are polar varying from no practical KYC steps taken at all (eg. EOS) to strict KYC requirements of submission of copies of identity documentation and proof of professional investor status (eg. KIK, Filecoin, Brickblock)
• Projects that employed KYC compliance usually require the verification of ID (passport, driving licence, ID card), biometric facial verification by means of comparison of selfie vs ID picture, verification of supporting documents (such as bank statements and/or utility bills)

Disclosure

• It is not market practice to provide for clear disclosure of corporate structure, names and places of incorporation of various group entities

Development team liability

• In most examples, teams seek full release of liability and reserve the right to terminate the project
• General approach is that no funds are returned in case of failure or termination of the project with few exception (Filecoin documentation provides for return of all investments in possession of Protocol Labs in the event the Filecoin project is abandoned)
• No obligations to report on team being on track with the project milestones are usually contained in the offer documents

Documentation

• WP is usually a technical document that describes the project. Some WPs describe the offer structure however usually this is done in such documents as terms of sale, token sale agreement or SAFT
• In addition to WP some issuers have been preparing marketing brochures
• FAQs sometime provide additional disclosure that is not contained in WP and offer documents
• Legal documents used (depending on the offer structure) are terms of sale,  token sale agreements, SAFTs
• Privacy Policy and term of use are also prepared for the website from which the ICO is launched
• SAFT structures also use additional disclosure pack consisting of private placement memo and a number of other documents