For an ICO- The Invention of the “Toquity” (originally published 11.13.2017)
If you have been following the ICO (Initial Coin Offering) market, you know that it is heating up, exciting, and a bit frothy all at once.
You may also know that it is a bit of a moving target. The legal structures are constantly changing and ramifications of potentially doing it wrong, could be quite devastating.
There are different documents being created to allow the “contributions” to occur into the company.
Lexicon and terminology is very important. For instance, you notice in the sentence above I didn’t use the term “investment” and instead used contribution.
There is much weight and effort to not have your ICO labeled as a “security”. The goal, at least at this early stage, is to have your ICO token labeled as a “utility”.
What is the difference? Well, that’s still left to speculation, and we might try to address that in a future article.
For this one, we’re going to focus on some of the paperwork and structure to enable the “contributors” to help fund the company.
In the “real world” of startup up, there is a document that was create called a “SAFE” document.
It stood for “Simple Agreement for Equity”. This was a legal document that enabled early investors to contribute to a startup, without some of the complications. These were usually simple four to five page agreements, and often were without a specific valuation or share price, as that was to be determined at a later date.
For ICO’s, what has come along are now called a “SAFT”, or Simple Agreement for Future Tokens. This means you are agreeing to contribute to the ICO of the company in exchange for a future Token that the company has created.
The interesting part with a pure ICO is the contributor is a token holder “ONLY”. This means there is no equity for the contributor in the formation company. They are simply a token holder on the outside.
What is coming along next is being called a “SAFTE”, which as you might easily surmise, stand for Simple Agreement for Future Token and Equity”.
This is where a more traditional investor, Venture Capitalist, Hedge Fund etc., wants BOTH the protection of being an equity owner in the company, and the potential liquidity of the Token from the ICO.
Again, these are simple agreements and usually put in place for the initial rounds, or what is also often called the “Pre-ICO”.
If you were to correlate this to a traditional start up, the SAFT and SAFTE are at the Angel round, or perhaps the series A round. This means it’s the early capital contributions.
What’s coming next? It’s a term I created called a “Toquity”.
Again, you can probably surmise, this stands for “Token and Equity”.
I believe, as the ICO market matures, and as the ICO offerings move past theoretical white papers of some future technology that hasn’t even been built yet, and into funding of existing companies, or ones that already have investors and revenue, then a new structure will be needed.
This is what I call the Toquity.
If you were a company looking to raise perhaps $50 Million from an ICO. And, if your investor, or contributor opportunities were coming more from institutional investors, hedge funds, family offices, etc., then there would be a different appetite and risk profile.
How would a Toquity work?
1- There would be an investment in the Operating Company for an equity amount.
2- There would be a separate “warrant” coverage for the ICO.
NOTE- the term warrant can connotate a security, so a different word will probably have to be used.
Here’s an example.
(There is a lot of math and inside baseball terminology here, but if you have funded a company before, this will all make sense.)
I’m going to use start up number as well to keep the solution easy to follow.
Let’s say you have a company that wants to raise $1MM.
The Pre-Money Valuation on the Company is going to be $3MM.
Which means the Post-Money Valuation is $4MM.
And the equity given to the investor is 25%.
However, if the Company were to do an ICO, that same company could attempt to raise $10MM dollars through the ICO, and give away NO equity to the investors.
So, let’s address first How and Toquity would work, and then why one would do it.
First- the How.
The company would still raise $1MM.
However, the valuation for the company would now be $9Mm Pre-Money, and $10MM Post Money.
This means the investor gets a 10% equity stake in the Company.
Further, let’s say that initial round was done at $0.25 cents per share.
Then, a separate offer is made in conjunction with the equity, and an equal “warrant” coverage of 10% is offered in the ICO and the Token price is set at $0.25.
The warrant coverage (again the term warrant is for a security, so it may end up a different term), but the result is the same, in that the investor gets both equity and token.
This means the investor gets a double-sided investment.
What is the advantage to the investor?
First, on the traditional equity side of a company, the investor gets all of the legal protections, insights, financial controls, and shareholder rights that are long standing.
Second, on the ICO or Token side, the investor gets potential liquidity in a global market that runs 24X7.
Unlike a traditional investment, which may take 7–10 years before there is an exit or liquidity event, the ICO’s liquidity could come within a matter of weeks or months.
The Toquity investment gives coverage of both traditional equity (though at a lower valuation than has been customary) and the new opportunity with an ICO Token (which provides quicker liquidity).
The goal with the warrant is to set the price at the same value amount as the equity round. Additionally, if you are in discussions with an investment group, you as the entrepreneur now have two points of leverage to negotiate.
The higher valuation of the company allows you to protect your equity and the price of the warrant allows you to shift some of the risk/reward outside the company.
Let’s say you are in negotiations with an investor and you have set a high valuation on your company. Let’s say as well you have offered a warrant coverage on the investment. In the negotiations, you might be pressured to lower your valuation. However with the Token Warrant available, you might be able to offer to lower the price of the Warrant, which could provide you the movement you need with an investor.
The lower Token price for the investor provides more upside for them, while also helping to protect you and your equity on the parent side.
Further, if additional expansion capital is needed, a follow-on round in an ICO (Versus a traditional equity round), which save the dilution point for all equity holders in the company.
Thus, the ICO provides a better potential funding vehicle all the way around.
I hope that makes sense, as I said it was some finance terminology.
However, that is my prediction of where the ICO markets may be going.
We’ll see in the near future if I was correct or not.