Structuring Web3 Funding Agreements: Equity and Pro-Rated Insider Token Allocation Percentage

In 2017, there was a boom in initial coin offerings (ICOs). These crypto projects would pre-sell a token and then promise to bring a product to market. Most of these projects were unable to deliver and the token value dropped to zero. That same year, an estimated 80-90% of all ICOs failed, with only 8% of projects succeeding. Additionally, 90% of capital raised in 2017 ICOs was lost, according to an April 2019 report from Boston College.

Web3 builders and investors have learned some hard lessons from the ICO boom of the past. As a result, they design their projects differently now. Instead of simply issuing a token, the modern Web3 project seeks to build and validate a product through engagement with its community before issuing a token. This method of project development helps ensure that the project is supported by a strong and engaged community, and that the token itself is likely to be more valuable and viable in the long term.

In many cases, Web3 companies raise pre-seed, seed, or even Series A funding rounds before issuing a token. This leads to an important question: how should these seed funding deals be structured? Are they similar or different from a traditional seed funding round?

The short answer is that the best offer includes equity and gives investors a pro-rated percentage of insider token allocation.

In any start-up business, a number of shifts and pivots can occur, many of which are unplanned. As a result, investors want to be sure that however the business chooses to organize and grow, they will be able to see some sort of return on their investment. If the business remains centralized and follows the traditional start-up route, the value will be in the stock of the business. However, if the company decides to decentralize and issue a token, the value will be in the token itself. For this reason, it's important to structure your Web3 funding deal in a way that provides both opportunities: equity and tokens. This way, you can ensure that whatever path the business takes, there will be a return on investment for investors.

The equity portion of the Web3 deal will either be in the form of a simple agreement for future equity (SAFE) or a priced equity round based on standard Seed series documents or the National Venture Capital Association. Dealing points will reflect a standard seed funding cycle and should be structured so that all parties involved are aware of the risks, rewards and expectations of the investment. Nothing exotic or new should be included in the equity portion of the deal.

The startup promises investors the right to tokens if and when they create and distribute tokens, with the number of tokens awarded to an individual investor often difficult to determine. Indeed, many of these transactions are completed before a startup has done any work on its tokenomics and has solidified the token's supply, attributes, and monetary policy.

For the startup to get the most out of its token distribution, it needs to ensure that the number of tokens granted to each investor...