Token offerings and ICOs have gained publicity as an alternative to venture financing. However, they are increasingly being used to supplement traditional venture financing for startups who have already taken investment from angels and traditional venture investors .This "hybrid structure" raises new issues for companies and investors, particularly relating to choice of the token issuer, size of the offering and control of the token issuer. This presentation was part of a panel presentation the Global Corporate Venture Capital Summit in Monterey on February 1, 2018.

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OVERVIEW OF ICOS FOR GCVI
SUMMIT
Mark Radcliffe, DLA Piper, Silicon Valley Office
Louis Lehot, DLA Piper, Silicon Valley Office

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Naval Ravikant of Angelist:
Cryptocurrencies will create a fifth protocol layer powering the next
generation of the Internet
Where’s the protocol layer for exchanging value, not just data? Where’s the
distributed, anonymous, permission-less system for chatty machines to
allocate their scarce resources? Where is the “virtual money” to create this
“virtual economy?”
Blockchain: Fifth Layer of Internet Protocol

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Many fundamental Internet protocols of the Internet are two decades old and
were developed by academic institutions/governments
SMTP
TCP/IP
Open vs closed in social media: RSS vs. Twitter/Facebook
Closed won in social media because they had the money
Enable participants in networks to share in the value of the “networks” as
compared to “closed networks” like Facebook and Twitter
“Open” approaches now has new tools to fund development
Like investing in “Linux” rather than companies
ICOs: Opportunity to Invest in Protocols (a16z)

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ICO Statistics 2017 (Partial for Nov/Dec from
Coinschedule.com)

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ICO Category

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Outsourced processing power – each transaction (a block) is validated by third
party “nodes” in the network before it is added to the ledger (the chain) in POW
Transactions require consensus mechanism, no intermediaries (“trustless”) for
“permissionless chains” and different mechanisms for “permissioned” chains
Transactions are anonymous
Highly secure – complex cryptology, significant stake to be a validator or miner
Transactions are immutable, irreversible once on the blockchain after certain
number of blocks
What is blockchain?
Blockchain is a “distributed ledger” technology – a ledger maintained by the
consensus of a network of unrelated parties who are rewarded for their efforts.
Key features of blockchain technology are:

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Sale of tokens or right to purchase tokens
Early 2017, crowdsale primarily, but in August shifting to two phase sale,
Simple Agreement for Future Tokens (“SAFT”) and then token issuance
Most are based on Ethereum blockchain
On Ethereum blockchain, tokens use the ERC20 standard
ICOs

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What instrument is being sold?
Tokens that are and will remain “securities” (“Security Tokens”)
– Token VC fund or tokens that mimic equity or debt
Tokens that may qualify as non-security assets (if properly structured) (“Utility
Tokens”)
– Network is built, tokens have immediate and meaningful use in purchasers’
hands
“Locked” tokens that may qualify as non-security assets (if properly structured)
– Network not built yet, but when it launches tokens will “unlock” and have
meaningful use in purchasers’ hands
Simple Agreements for Future Token (“SAFT”)
– Right to acquire tokens in the future following launch of the issuer’s network
– SAFTs likely sold as a security, but underlying tokens are intended to be
non-security assets following network launch
Simple Agreement for Future Token or Equity (“SAFTE”)
– Basically a SAFT with an equity conversion feature if a priced equity round
occurs prior to the network launch

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Many complicated questions
•Is the token a “security” under US securities law? Triggers issuer, broker-dealer,
exchange, investment adviser, investment company, and other considerations.
•Financial reporting/disclosure – how are tokens shown in financial statements?
Securities
•Receiving value to be delivered to another location can trigger FinCEN and US state
licensing obligations for “administrators” and “exchanges”
•Currency exchange regulations
Money
transmission
•Is the token a future, swap, or other contract subject to CFTC regulation?
•Triggers advisor, exchange, “commodity pool” compliance (exemption for sales to
“qualified eligible participants”), and other commodities issues
Commodities
•Is the token a security or an asset? Can its character switch?
•International structures (where to put IP, token issuer, etc.)
•Tax planning (NOLs from building network, tokens to be issued in future)?
Tax
•Anything to patent? Planning to open source any IP? Where to house IP?
•Data transfer issues – user consents and data transfers
•Cybersecurity – drafting “smart contracts” to avoid hacking ($50m hack of The DAO)
IP
•KYC requirements, transactions with restricted persons
•BTC-e (2nd largest token exchange) shut down by FinCEN, seized, $110m fine
AML/Sanctions
•US corp, Singapore or Swiss foundation, or another entity to oversee public network?
•Fiduciary duty considerations associated with how blockchain is monetized
Corporate

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Utility token vs. security token
First part of the year, most ICOs were issued as “utility tokens” based on
optimistic views of the securities law
Howey test for securities (US Supreme Court, 1946)
Invest money
Common enterprise
Expect profit
Profits based solely on efforts of others
Significant Regulatory Uncertainty: SEC

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SEC, The DAO, July 25, 2017
The DAO was a decentralized “venture firm” raised $150M from 10,000
individuals but the smart contract was flawed and a hacker diverted $55M
Found that The DAO was an unregistered security even though TheDAO
had shut down
September 25: SEC announces creation of a Cyber Unit inside the
Enforcement Division to address cyber-related misconduct including “market
manipulation,” and “[v]iolations involving distributed ledger technology and
initial coin
Security Law Regulatory Activity

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SEC Requires Munchee Offering to return money (December 11, 2017 )
Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token
from being a security. Determining whether a transaction involves a security does not turn on
labelling – such as characterizing an ICO as involving a “utility token” – but instead requires an
assessment of “the economic realities underlying a transaction.” Forman, 421 U.S. at 849. All of
the relevant facts and circumstances are considered in making that determination. See Forman,
421 U.S. at 849 (purchases of “stock” solely for purpose of obtaining housing not purchase of
“investment contract”); see also SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 352-53 (1943)
(indicating the “test . . . is what character the instrument is given in commerce by the terms of the
offer, the plan of distribution, and the economic inducements held out to the prospect”).
SEC Chairman issues general warning on cryptocurrencies and ICOs
https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11.
SEC Chairman issues warning to securities lawyers about ICO advice
https://www.sec.gov/news/speech/speech-clayton-012218
State regulators become active
Texas: Texas State Securities Board ordered emergency halt of certain operations of U.K.
cryptocurrency marketplace BitConnect, saying “its cryptocurrency offerings are opaque and
promises to investors are unrealistically rosy”
Massachusetts files Administrative Complaint against Bensenoff and Cavier
More Security Law Regulatory Activity

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October 15: Against Tevos, $230M offering from a Swiss Foundation, styled
as a “donation”
December 13: Against Centra, $30M offering promoted by Floyd Mayweather
January 4: Against Giga Watt (which included a Singapore entity), a $20M
offering
Private Actions

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PRC: Banned all ICOs
Singapore: Singapore Monetary Authority suggests that some “token
offerings” may be securities rather than “currency”
South Korea: Banned all ICOs
Spain: The Spanish Markets Supervisor (the National Securities Market
Commission, "CNMV", for its acronym in Spanish), together with the European
Securities and Markets Authority ("ESMA"), published on 13 and 14 November
2017 a warning to entities and investors regarding ICOs and the possibility that
the issuance of certain types of tokens may constitute a regulated activity
Gibraltar: Gibraltar Financial Services Commission issues DLT regulatory
framework effective on January 1, 2018
Other Countries

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Under the Commodity Exchange Act (CEA), the CFTC has jurisdiction over (i)
retail commodity transactions, (ii) commodity futures and option contracts and
(iii) swaps.
To the extent a token or SAFT constitutes a swap or commodity futures or
option contract, it will be regulated by the CFTC under the CEA unless the
SEC successfully asserts jurisdiction.
Under the CEA, unless an exception or exemption is available, it is illegal to
enter into swaps or commodity futures or options unless those contracts are
traded or executed on a contract market, swap execution facility, board of
trade, exchange, or market that is registered or otherwise subject to regulation
by the CFTC.
Each token or SAFT should be assessed independently as to whether it
constitutes a futures contract or swap, whether an exemption exists and
whether any CFTC registrations are required.
Additional Regulatory Regime: Commodities
Trading

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– Coinflip (2015) -- CFTC determined that futures contracts and commodity option
contracts in virtual currencies such as Bitcoin are commodity futures and option
contracts and accordingly are regulated by the CFTC under the CEA
– Bitfinex (2016) -- Enforcement action for offering illegal off-exchange financed retail
commodity transactions in Bitcoin and other cryptocurrencies, and for failing to
register as a “futures commission merchant”
– Gelfman Blueprint -- Enforcement action charging fraud, misappropriation, and
issuing false account statements in connection with an alleged Ponzi scheme in the
solicitation of Bitcoin
– My Big Coin Pay, Inc.(January 16, 2018) -- Enforcement action charging commodity
fraud and misappropriation related to the ongoing solicitation of customers for a
virtual currency known as My Big Coin
– Coin Drop Markets (January 18, 2018) -- Enforcement action charging fraud and
misappropriation in connection with purchases and trading of Bitcoin and Litecoin
CFTC Enforcement Actions

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Protocol Labs
– Blueyard Capital, Digital Currency Group, Haystack, Boost VC, Working Lab
Capital, Union Square Ventures
– Venture Funding: $3.73M (May 2016)
– ICO (July 2017): $250M
Kik
– Tencent Ventures, Union Square Ventures, Foundation Capital, Blockchain
Capital, Polychain Capital
– Venture Funding: $218M (over time)
– ICO (September 2017): $100M
Reverse ICOs (ICOs for companies with venture
investors), new name “Hybrid Token Offerings”

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Telegram proposes to raise of $1.2B to create the Telegram Network
Telegram Messaging Service
– Telegram is a messaging app with a focus on speed and security, it’s super-fast, simple and free. You can use
Telegram on all your devices at the same time — your messages sync seamlessly across any number of your
phones, tablets or computers. With Telegram, you can send messages, photos, videos and files of any type (doc,
zip, mp3, etc), as well as create groups for up to 50,000 people or channels for broadcasting to unlimited
audiences. You can write to your phone contacts and find people by their usernames. As a result, Telegram is like
SMS and email combined — and can take care of all your personal or business messaging needs. In addition to
this, we support end-to-end encrypted voice calls.
According article in November 2017
– 100M users
– 15B messages/day
ICOs as IPOs: Telegram

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Fiduciary considerations for directors in approving an ICO
– Do they understand the deal structure?
– Do they understand the implications to future revenue?
– Ready for the compliance obligations?
– What approvals are needed in the resolutions?
Is shareholder approval needed?
– Sale of substantially all assets?
– Trigger protective provisions?
Does the ICO trigger preemptive rights?
– Best interest of legacy shareholders (who invested on a non-token strategy)?
Does the ICO trigger anti-dilution adjustments?
Corporate law issues for Hybrid Token Offerings

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Does it trigger traditional protective provisions in NVCA form of Certificate of Incorporation?
create, or authorize the creation of, [or issue or obligate itself to issue shares of,] any additional
class or series of capital stock [unless the same ranks junior to the Series A Preferred Stock with
respect to the distribution of assets on the liquidation, dissolution or winding up of the Corporation,
the payment of dividends and rights of redemption], or increase the authorized number of shares
of Series A Preferred Stock or increase the authorized number of shares of any additional class or
series of capital stock [unless the same ranks junior to the Series A Preferred Stock with respect
to the distribution of assets on the liquidation, dissolution or winding up of the Corporation, the
payment of dividends and rights of redemption];
create, or authorize the creation of, or issue, or authorize the issuance of any debt security, or
permit any subsidiary to take any such action with respect to any debt security[, if the aggregate
indebtedness of the Corporation and its subsidiaries for borrowed money following such action
would exceed $_____] [other than equipment leases or bank lines of credit] [unless such debt
security has received the prior approval of the Board of Directors, including the approval of [at
least one] Series A Director];
Answer: Probably not, unless modified
Traditional Structure: Protective Provisions

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Add new protective provision requiring approval of token offerings
Define “token offerings” broadly to include sales by “affiliate entities” (some
ICOs are structured as sales by “foundations” or subsidiaries)
Other potential issues:
– Control over governance of “affiliated entity” issuing tokens
– Access to tokens by company
– Possible exchange of preferred stock for tokens
– Limit on token sales to officers through special Board approval in the
Investor Rights Agreement
Solution to Potential Token Issuance

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Investments in ICOs and the acquisition of tokens can create issues under the
governing documents of investment funds.
– SAFTs and comparable investment contracts will likely be defined as
securities but do not have equity attributes.
– Tokens themselves are structured to not be securities but may be
considered commodities
– Accordingly, fund investment focus and purpose may not be broadly defined
to encompass tokens, SAFTs or other assets that are not equity securities
– Fund investment restrictions may limit the amount of capital invested by
funds in non-equity securities.
– Fund restrictions on commodity trading should be considered.
– Tax consequences, both US and foreign, of acquiring and trading tokens
must be addressed—in particular if the tokens are illiquid.
Issues for Funds

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Business purpose
Capped vs. uncapped number of tokens
Special rights for “pre-sales”
Vesting, if any
Use of funds
Reserving tokens for future offerings
Issues in Token Offerings: Part 1

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Token issuer: company, affiliated entity or foundation
Tax issues
Sales price
Bonus structure (company, officers, service providers)
Who can change governance rules
Ownership and control of code
Vesting
Issues in Token Offerings II

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Evolving financing option
Many open issues on terms
Regulatory issues remain unclear
Great deal of confusion and bad information on legal issues
What does 2018 hold?
Valuation of “tokens” in M&A exit
Major companies seek to find role for tokens (Kodak announcement of
Kodakcoin and Kodak share price doubles)
Follow on ICOs
Conclusions

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Novum Insights: Blockchain Insights https://www.novuminsights.com/
Coindesk: www.coindesk.com
Pitchbook: https://pitchbook.com/news/reports/4q-2017-blockchain-market-
map
Chain Letter (MIT Technology Review):
https://www.technologyreview.com/newsletters/chain-letter/
Resources on Blockchain and ICOs

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Mark Radcliffe

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Background
– B.S. Georgetown University
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Practicing in Silicon Valley for over 12 years
Corporate securities from venture capital to IPO, ICO & M&A
Co-Chair, Emerging Growth and Venture Capital Group
Chambers Rated in Capital Markets
Louis Lehot