The rapid evolution of Web3 signifies a major shift in technology and finance, requiring innovative fundraising approaches distinct from traditional startups. While early-stage Web3 projects may rely on conventional equity financing, many transition to token-based models as they develop. This progression mirrors broader Web3 trends, where tokens serve multiple roles—from governance to utility—within decentralized ecosystems. This guide explores the key stages of Web3 project financing, analyzing the characteristics, legal requirements, and structures for each phase, along with the relevant documentation.
Stages of Web3 Fundraising
Web3 fundraising involves multiple stages, each with unique investment sources, documentation, and legal entities. Below, we break down the primary phases.
Angel Round
In the initial stage, founders seek capital to build a team, validate ideas, develop concepts, and find product-market fit. Investors typically expect equity and token rights, particularly in companies holding intellectual property. Key legal tasks include:
- Registering a development company (DevLab) owned by founders and an option pool, with all IP assigned to this entity.
- Executing convertible instruments like SAFEs (Simple Agreement for Future Equity) or convertible notes for equity investment, convertible in future rounds.
- Signing a token side letter, granting investors the right to receive tokens if the project issues them.
Strategic Round
At this stage, projects have a minimum viable product (MVP) with core functionalities and validated user interest. Founders focus on tokenomics, launching a native token, expanding the user base, and advancing decentralization. Strategic investors—such as blockchain protocols, crypto exchanges, and DeFi platforms—often participate to gain resources and partnerships. Legal work includes:
- Registering a token company (Token Co) for initial token issuance and distribution.
- Creating a token cap table (similar to an equity cap table) outlining sale prices and distribution phases.
- Obtaining legal opinions on token classification to anticipate regulatory constraints.
- Using SAFT (Simple Agreement for Future Tokens) or SAFTE (for combined token and equity rights) agreements to formalize terms.
Private Token Sale
By this phase, investors expect a tested token economy and a clear public distribution plan. Pre-minted tokens are sold under lock-up conditions (typically 12–36 months) to prevent market manipulation. Legal considerations involve:
- Assessing whether the token company requires specific licenses (e.g., VASP, securities registrations like Reg D/S in the U.S.).
- Signing private token sale agreements to transfer locked tokens to investors.
- Converting earlier SAFTs into tokens for previous investors.
Public Token Distribution
This stage prepares for public token sales through marketing, community building, and partnerships with exchanges or launchpads. Common distribution methods include:
- ICO/Token Generation Events (TGE): Direct sales via the project’s website, with Token Co receiving proceeds.
- Liquidity Bootstrapping Pools (LBP): Deploying assets in DAO liquidity pools to optimize tokenomics.
- Intermediated Sales (e.g., IEO, IDO, Launchpad): Using third-party platforms to handle sales, KYC/AML checks, and compliance.
Legal requirements vary by method and jurisdiction, often involving VASP licensing, securities compliance, and AML procedures.
Future Token Distribution
After public distribution, token holder communities may evolve into DAOs (Decentralized Autonomous Organizations). Subsequent token issuance or treasury management decisions are made via on-chain voting under DAO governance rules. Founders often become DAO members, sometimes retaining executive roles.
Overview of Financing Types
Web3 projects blend traditional equity financing with token-based models, creating hybrid approaches. The choice depends on project type, regulatory environment, and investor expectations.
Equity Financing
Projects focused on infrastructure or technical support may opt for pure equity financing, using standard documents like:
- Share Purchase Agreements (SPA) + Shareholder Agreements (SHA): Detailed contracts for later-stage rounds, covering valuation, option pools, vesting, and call/put options. Token mapping clauses may be added for future token issuance.
- SAFE (Simple Agreement for Future Equity): Simplified instruments for early-stage funding, converting to equity in future rounds. Common in Web3 due to smaller deals and faster execution.
Token and Hybrid Financing
Many Web3 projects use tokens as primary or supplementary assets, offering flexible exit options. Key documents include:
- SAFT (Simple Agreement for Future Tokens): For projects with defined tokenomics, granting future tokens upon development completion. Designed to comply with U.S. securities laws by emphasizing utility.
- Token Purchase Agreement (TPA): Direct purchase of pre-created tokens, similar to SPAs, with terms on price, delivery, and restrictions.
- SAFTE (Simple Agreement for Future Tokens or Equity): Hybrid instrument allowing investors to choose tokens or equity based on project progress.
- Token Warrant: Grants the right to purchase tokens at a predetermined price, often paired with SAFEs. Useful for U.S.-based DevLabs to mitigate regulatory risk.
- Token Side Letter: Supplements main agreements with token rights, offering flexibility without fixed prices or deadlines.
- Private Token Sale Agreement (TSA): For direct sales of issued tokens to institutional investors, with lock-up periods and compliance controls.
Selecting the Right Financing Documents
Choosing appropriate documents depends on project stage and type.
By Project Stage
- Early Stage (No Token SPV, Undefined Tokenomics): Use SAFE/convertible notes + token warrants/side letters.
- Mid-Stage (Defined Tokenomics, Token SPV Registered): Employ SAFTs with detailed token economics and distribution plans.
- Mature Stage (Tokens Issued, Distribution Ongoing): Opt for TSAs, supplemented by equity documents if DAO governance isn’t implemented.
By Project Type
Web3 projects fall into categories like:
- Web2 Solutions with Utility NFTs: Primarily equity-based, with NFTs enhancing functionality.
- Centralized Web3 Projects with Ecosystem Tokens: Use hybrid models (e.g., SAFTE) for dual equity-token returns. Examples include GameFi (Axie Infinity), SocialFi (Sweatcoin), and exchanges (Binance).
- Decentralized Web3 Projects with Protocol Tokens: Rely on token-based financing, often transitioning to DAO governance.
Ecosystem token projects often centralize profits while using tokens to boost engagement. Valuation combines traditional equity methods with token economics, though equity remains primary due to token volatility.
Frequently Asked Questions
What is the difference between SAFT and SAFE?
SAFE (Simple Agreement for Future Equity) converts investment into equity during future financing rounds, while SAFT (Simple Agreement for Future Tokens) grants tokens upon network launch. SAFTs are specific to Web3 projects with utility tokens.
When should a project use a token warrant?
Token warrants are ideal for U.S.-based projects seeking to avoid direct token sales by DevLabs. They allow investors to purchase tokens at a fixed price later, reducing regulatory exposure.
Are public token sales legal globally?
Legality varies by jurisdiction. Projects must comply with local securities laws, VASP regulations, and AML requirements. ICOs, IDOs, or IEOs often require legal opinions and licenses.
How do DAOs impact fundraising?
DAOs decentralize governance, shifting financing decisions to token holders. Post-public sale, token issuance or treasury management requires on-chain voting, altering traditional founder-investor dynamics.
What is a token side letter’s advantage?
It offers flexibility without binding pricing or deadlines, allowing founders to adapt to market conditions. It’s often used in non-U.S. jurisdictions with favorable crypto regulations.
Can equity and token financing be combined?
Yes, through instruments like SAFTE, which let investors choose tokens or equity. This suits projects uncertain about their final fundraising structure.
Conclusion
Web3 financing blends traditional equity with innovative token models, offering multiple exit pathways. Each stage—from angel rounds to public sales—requires tailored legal structures aligned with project goals and regulations. As DAOs and decentralized governance grow, fundraising will become more flexible and community-driven. By understanding these elements, founders and investors can navigate Web3’s dynamic landscape effectively.
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