Fundraising through the sale of digital tokens can unlock exciting growth opportunities for a web3 startup. It also gives investors a way to get in on the ground floor of a blockchain project, by placing a strategic bet on the future value and viability of that project’s native token. But how does a web3 startup actually go about the business of fundraising with digital tokens rather than traditional equity? One mechanism created specifically for this purpose is the SAFT.
A SAFT, or Simple Agreement for Future Tokens, is a token-based investment contract that an early-stage web3 startup can make with an accredited investor. In this guide, we’ll walk you through the basics of SAFTs, from how they work to where they could fit into your startup’s cap table.
- What is a SAFT?
- SAFT vs. ICO: What’s the difference?
- How do SAFTs work?
- How do SAFTs fit into my startup’s cap table?
- Simplify your startup’s token equity with Pulley
What is a SAFT?
SAFT stands for Simple Agreement for Future Tokens. If the name sounds familiar, that’s because the basic structure of a SAFT is based on a similar mechanism called a SAFE (Simple Agreement for Future Equity).
The startup accelerator Y Combinator launched the first SAFE in 2013. It was designed as a way for early-stage companies to raise money from seed investors, in cases where the company doesn’t yet have a formal valuation and doesn’t yet have shares to issue to the investors. Basically, a SAFE is an agreement that the investor will pay money now and receive shares of company stock at a later date.
A SAFT works similarly, with one major difference: the agreement is for tokens rather than equity (i.e. company stock). In a typical SAFT, an investor agrees to pay money to a web3 company upfront in exchange for a certain number of tokens later, when the company has launched its token network and achieved functionality.
SAFT vs. ICO: What’s the difference?
If you’re at all familiar with fundraising in the cryptocurrency industry, you may have heard of another mechanism called an initial coin offering, or ICO.
An ICO is essentially crypto’s answer to the stock market’s initial public offering (IPO). Early-stage web3 companies have used ICOs as a means of raising capital from investors, who buy in at a certain amount and get a certain number of tokens in return.
Because they often deal in “pre-functional” tokens that may never have any real value or any functioning network to run on, ICOs have been fertile ground for fraudsters. And until recently, they existed in a hazy regulatory area, where it was unclear whether the tokens offered in them constituted securities offerings and were thus subject to federal securities law. Recent comments and actions by the U.S. Securities and Exchange Commission (SEC) indicate that tokens sold in ICOs are likely to be viewed as securities.
The SAFT framework arose in part from the need for a compliant framework for token sales—one that would clearly define what is and isn’t a security. Remember: Whereas the investors who buy into an ICO get their tokens right away, investors who sign on to SAFTs don’t get any tokens until the underlying project or network achieves functionality.
How do SAFTs work?
The when and the what are both important elements of the SAFT framework. Let’s clearly outline what we mean by this:
- The when — Investors receive their tokens after the network is functional.
- The what — The SAFT framework distinguishes between “utility tokens” and “securities tokens.” Utility tokens are meant to have some kind of intrinsic utility on the blockchain network, i.e. they can be used to do stuff on the network once it’s functional. Securities tokens, on the other hand, are intended to serve as substitutes for traditional securities. Crucially, for a SAFT to pass regulatory muster, it must be an agreement for utility tokens and not for securities tokens.
The distinction between utility tokens and securities tokens is an important one from a regulatory perspective. Protocol Labs’ SAFT Project whitepaper states that a SAFT itself is a security and must be regulated as such. But it also states that, since the tokens are sold after the network is functional, the tokens themselves are already functional (i.e. utility tokens) and should not be considered securities.
This distinction is based on the Howey Test, named after a U.S. Supreme Court case from 1946. This test finds that an “investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” Since the crypto tokens sold in a SAFT contract are already functional, the argument goes, they are not securities under the Howey Test and are thus not subject to securities regulations.
Do SAFTs pass the Howey Test?
Whether the U.S. government actually agrees with the SAFT framework’s distinction of “utility token” vs. “securities token” is less clear.
The answer may depend on a case-by-case reckoning of the specific digital tokens and network in question, though several recent court cases suggest that the SEC may consider many SAFTs to violate federal laws governing the registration of securities.
For example: in 2019 the SEC filed an emergency action against the messaging service Telegram for failing to appropriately register their offers and sales of Grams, a token offered to investors in a SAFT. And in 2020, the SEC found that Kik Interactive Inc. was in violation of federal securities law for failing to register its offering of Kin tokens.
How do SAFTs fit into my startup’s cap table?
As with many things in the cryptocurrency universe, SAFTs exist in a fluid regulatory environment. Whether your startup opts to use a SAFT or some other token-based equity mechanism will depend on the particulars of your project—not to mention a healthy amount of input from your legal counsel.
If you do decide to move forward with a SAFT, consider the implications for your cap table. This is especially crucial if your cap table includes both traditional equity (RSAs, stock options, etc.) as well as tokens. We’ve seen web3 startups struggle to manage two separate systems for their equity and tokens, which is messy and runs the risk of noncompliance.
Simplify your startup’s token equity with Pulley?
Cryptocurrency may be reshaping the internet in fundamental ways, but Pulley understands that the startup funding ecosystem isn’t going to change overnight. Many web3 startups need an equity solution that balances tokens with traditional equity.
That’s why we’ve created a single source of truth that allows you to issue, track, and record all token agreements and token sales the same way you do with your equity agreements. You can even plan your tokenomics and future allocations directly on the Pulley platform.
To learn more about how Pulley can help you plan your tokens and simplify token ownership, schedule a call with us today.
