Originally published as The art of the SAFT: How to improve the terms of your pre-ICO investment on Venture Beat on January 7, 2018
This article does not constitute legal advice.
Unregulated initial coin offerings (ICOs) stormed onto the scene in 2016 and early 2017, raising the collective eyebrows of the entrenched VC community. It was in this context that SAFTs, simple agreements for future tokens, were introduced. SAFTs have been hailed in the U.S. as a solution to the murky regulatory status of ICOs and their tokens. Some people in the blockchain community even argue that VCs brought in SAFTs to retain control over the startup-funding ecosystem.
Controversy aside, SAFTs do appear to be gaining traction as a workable option for conducting ICOs in the U.S. markets. A company raising funds via an ICO, where its tokens relate to a product under development, would likely be in violation of U.S. securities laws. However, that same company, if its tokens are properly crafted, may be free to raise funds via an ICO once the product has been deployed and is active. So how can an ICO issuer avoid selling tokens before product launch yet still raise the funds they need to develop the product? Via a SAFT, a written promise a startup can give to accredited investors, such as VCs, to grant them tokens in a post-product-launch ICO in exchange for immediate funding.
In other words, a SAFT lets an ICO issuer raise sufficient funds to develop its project while conducting an ICO free of securities regulations after product launch.
Professionals in the cryptocurrency field generally recognize the SAFT published by Cooley LLP in October 2017 as the industry standard (the basic SAFT). Let’s look at the ways the basic SAFT can be supplemented and improved to protect investors.
The basic SAFT is less than five pages in length. It’s intended for use in a “paper and ink” transaction rather than for the terms and conditions of an online sale. As such, depending on how much leverage a particular investor or fund has on its ICO issuer, there should be an opportunity to improve the terms prior to signing and funding.
Here are five areas investors can look at to improve the terms of their SAFT investments.
1. Describe the Token
At its core, a SAFT gives purchasers (investors) the right to be issued tokens upon the issuer’s product launch. However, the basic SAFT fails to describe the rights associated with the tokens to be issued. Without such a description, investors may find they’re not getting what they expected when tokens are finally issued. By incorporating language about token rights into the startup’s white paper and referencing those rights into the SAFT, you can set out your expectations in advance. Alternatively, you can drop a description of the token’s rights and obligations directly into the SAFT itself.
2. Usage of Proceeds
Depending on the SAFT project, you may want to include an obligation about how proceeds will be used. You can accomplish this with a set of issuer covenants in the SAFT. Also, if the investment is sufficiently large, it may be appropriate to include negative covenants that restrict certain activities of the issuer without the consent of SAFT buyers.
The issuer’s representations and warranties in the SAFT should benefit the investor. The basic SAFT doesn’t do a lot in this respect. Investors should consider adding to the SAFT any key assumptions they have about the investment. This may include warranties about the financial status of the issuer and the state of development of the project.
4. Control the Timeline
A key aspect of the SAFT is that tokens are not issued until product launch. However, if the product launch is delayed, accredited investors may become concerned. Investors could, therefore, demand that tokens be issued prior to the launch in certain circumstances. If regulatory restrictions no longer apply to the resale of the SAFT or the underlying tokens, if some exemption is found to such regulations, or if a token can no longer be considered a security, investors should have the right to demand token issuance, irrespective of the project’s launch date. These types of provisions can provide an extra layer of protection to SAFT purchasers looking to exit their investment.
5. SAFT as Part of the International Markets
ICOs are part of an international ecosystem, and the SAFT is generally only needed to address U.S. domestic regulatory concerns. Still, investors may want to consider adding language to the SAFT that deals with the international aspect of the ICO. For example, if a U.S. accredited investor is permitted to resell the SAFT rights or the underlying tokens under U.S. law, and such resale does not contradict the regulatory environment of the intended buyer, the SAFT should explicitly permit such transactions.
Note that the above is a summary of general suggestions. In practice, each project and accompanying SAFT needs to be considered on its individual risks and merits and in the legal environment applicable at the time. This article does not constitute legal advice and is designed for general informational purposes only.