Initial Coin ‎Offerings (ICOs)‎ have raised nearly $4 billion in 2017, but ‎with some blockchain-based startups generating millions in a ‎matter of seconds, they have also raised concerns of ‎regulatory bodies.‎

Regulators around the world have banned the ICOs crowdsales to protect investors against fraud. However, ‎the recent flurry of digital fundraising, as well as the aura of ‎chicanery surrounding ICOs, have motivated the industry participants‎ to search for ways to ‎legitimize the process and ensure compliant ‎offerings.‎

In October 2017, a law firm in New York announced one of ‎the most interesting attempts to establish a legal framework that addresses the existing issues with the funding through ‎ICOs. Protocol Labs and Cooley LLP, with the participation ‎of those with vested interests in ICOs, ‎have developed the “simple agreement for future tokens”, aka ‎‎SAFT.

Structure overview ‎

For those not familiar with the term, SAFTs are legal ‎contracts used to raise capital from accredited investors for the ‎development of a virtual token. Typically, under the SAFT, an ‎investor obtains the right to a certain number of digital ‎tokens issued by the startup in exchange for an up-front ‎investment. The conversion rate, which is used to convey ‎investor’s rights in the token upon a triggering event, is usually ‎based either on discount or valuation cap.‎

For instance, if a startup wants to bring a token to market, instead of offering ‎an immediately available token, the founders can issue these SAFTs to reduce the complexity of early-stage raises, and in the meantime avoid ‎ complex areas of state and federal laws.

On the operational front, the SAFT is relevant ‎to a specific class of “utility tokens” designed to be used to purchase goods or services ‎on a distributed network platform. For example, a digital token ‎can be used on a blockchain-based decentralized cloud platform to purchase ‎computing or storage capacity.‎

If you have an investment background you can think SAFTs contracts as modelled as ‎something called a Simple Agreement for Future Equity (SAFE), which is a ‎contractual legal instrument that entitles its holders ‎the right to acquire private equity. ‎

Both the SAFE and the SAFT are similar in many respects, ‎except that the SAFT entitles the instrument holders with ‎the right to tokens rather than equity.

Now, let’s take a brief overview of the SAFT and ‎outline some features to be considered when planning to invest through ‎the instrument in pre-ICOs activities.‎

Regulatory compliance

As we discussed in a recent article, one key takeaway from watchdogs’ warnings was that ‎some tokens fall within the definition of securities. As such, when a startup ‎considers sale of digital coins, then that fundraiser must comply with relevant ‎securities laws. This means the token must either be registered as a security or that the token qualifies for an exemption from registration requirements.‎

For start-up entrepreneurs, the SAFT should help overcome the shortcomings ‎relating to the application of securities laws to digital ‎tokens, and could be useful to deal with some of the uncertainties around ‎regulation of these assets.‎

Aside from the regulatory issues, the SAFT was developed ‎in essence to finance young start-ups, and is also designed ‎to mature the fundraising process, particularly with some tokens ‎are nothing more than a website and promises of new ‎products.‎ Further, the SAFT typically ‎imposes a restriction on the investor’s ability to transfer or make use of the tokens until the virtual assets are vested.

The SAFT is also identical to VC funding, ‎since it does not have a maturity nor contain interest ‎provision, which arguably distinguishes it from debt. ‎Nevertheless, discount between the token issuance value ‎and the conversion rate could also be viewed as interest.‎

Moving from conceptualization and legitimization to ‎implementation, the SAFT helps crypto entrepreneurs get ‎investments without spending too much time on ‎negotiating complex legal terms with traditional venture ‎groups. For investors, compared to angel investing, it allows ‎them to share in whatever success the startup experiences while ‎potentially retaining the upside of converting the SAFT ‎instrument into utility tokens.‎

Finer points really matter

To be clear, SAFTs are not investments, nor they come ‎without cons. For instance, an ‎investor might never realize his investment by converting ‎the SAFT into tokens. At least, it could be a long shot ‎before the investor be able to cash in upon effective launch.‎

‎In addition, the contractual legal innovation does not ‎provide any governance rights, and in case the startup ‎‎‘gone with the wind’, the SAFT is likely to turn into an ‎unsecured claim. ‎Furthermore, investor doesn’t obtain the ‎right to participate in the token development or ‎management, so a start-up could face difficult dilemmas ‎and, sometimes, wrong choices, and a SAFE holder is ‎unable to control such decisions.‎

Despite advertising the SAFE as a brilliant solution to comply with laws, or at least obtain an exemption from ‎the registration, the regulatory treatment is not entirely clear and the ‎answer to this is likely to depend on particular ‎circumstances.

In short, SAFT is an interesting innovation, however, it is ‎not a “one size fits all” instrument and no one can assure it ‎would entirely replace the pre-token sales. The instrument ‎could be more interesting though should the startup founders ‎develop guidelines to provide the SAFT holders with a type ‎of engagement that is more strategic and more easily ‎evaluated.‎