Founders Urged to Avoid Predatory Token Deals in Early Financing Rounds

Founders in the cryptocurrency space should exercise caution when structuring token rights during early financing rounds to avoid potentially predatory deals and unfavorable investor terms, according to a16z crypto.

Beware of Fixed, Non-Dilutable Token Interests

Granting investors fixed, non-dilutable token interests or unsustainable percentages of the network can severely limit a project's flexibility and growth potential. If development companies provide existing investors with non-dilutable rights to a substantial portion of the total token supply, they may face challenges in raising additional capital without extending the same terms to future investors. Such conditions can constrain a company's financing options, leading to an imbalanced token distribution that forces founders to sacrifice token incentives for builders, including those from the community or the development team.

Risks of Token Payments to VCs

Founders should also be cautious of venture capitalists who demand tokens in exchange for assistance with token launches. These arrangements are often a red flag, indicating that the VC may be more interested in extracting value and dumping tokens early rather than contributing to the project's long-term success.

Proportionate and Dilutable Token Rights

To avoid locking early-stage projects into problematic allocations, token rights should be proportionate to equity ownership and subject to dilution. This approach ensures that token allocations remain flexible and aligned with the project's long-term development goals. Consequently, projects can raise additional rounds of financing as needed, rather than rushing a token launch due to a lack of options.

Structuring Token Rights: Two Options

The a16z crypto deal documents offer two distinct ways to structure token rights. Option 1 entitles investors to a portion of the total token supply equivalent to a fraction of their equity percentage interest in the company at the time of token creation. This method provides clear expectations regarding investors' token allocations.

Option 2 entitles investors to a pro rata portion of the tokens allocated to the development company and its employees, consultants, investors, and other stockholders, provided that this allocation meets a minimum percentage of the total token supply. This option offers greater flexibility by allowing the project to determine the stockholder allocation versus the community allocation prior to launch.

Sample Language for Token Rights

Option 1: If the Company (or any affiliate, foundation, or nominee thereof) creates any Crypto Tokens, the investor will be entitled to a pro rata portion of the total possible token supply for such Crypto Token that represents half of its fully-diluted ownership at the time of the token generation (for example, representing [X]% following the contemplated financing).

Option 2: If the Company (or any affiliate, foundation, or nominee thereof) creates any Crypto Tokens, the investor will be entitled to a pro rata portion of the Crypto Tokens allocated to the Company and the Company’s officers, directors, employees, shareholders, and other investors (collectively, “insiders”). The amount allocable to the Company and Insiders shall be no less than [X]% of the total amount of Crypto Tokens ever to be created.