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What is a Simple Agreement for Future Tokens (SAFT)?
A simple agreement for future tokens, or SAFT, is an investment contract offered to accredited investors by cryptocurrency developers. These legal documents are an alternative to future equity and allow cryptocurrency companies to fundraise without state, federal, or international violations. The US government classifies cryptocurrency tokens as a type of security, requiring the parties to follow all applicable rules and regulations.
A SAFT is a security since accredited investors offer financing without expecting a future, guaranteed return. When an investor invests in a project, they expect the project’s tokens to sell for a higher price, which allows the investor to profit. The SAFT is used to complete the investment, which satisfies the fundamental requirements and is subject to federal securities regulations.
This website will show you a SAFT sample via the US Securities and Exchange Commission’s (SECs).
What is a Token Purchase?
A token purchase is an investment transaction, typically activated by an initial coin offering (ICO), the cryptocurrency’s version of an initial public offering, or IPO. Token purchases are a vehicle for cryptocurrency companies to raise many through accredited investors. These transactions are governed through contracts, such as a token purchase agreement or a private token sale agreement.
How SAFT Agreements Work
SAFT agreements compensate accredited investors for early financing. The cryptocurrency company will issue tokens at a discount or liquidation scenario’s value, similar to convertible notes. The discount price is a single token’s value multiplied by the discount rate during a triggering event.
A SAFT essentially allows the company to defer the valuation of the token. Certain SAFT agreements may have a valuation cap. Thus, when parties raise capital through a SAFT with a valuation cap, they essentially negotiate a valuation.
SAFTs do not need to fall under the balance sheet as a debt. However, suppose the company fails before the cash converts to tokens. In that case, it typically offers to pay the investor an amount equal to the capital investment before paying its shareholders.
What’s Included in a Simple Agreement for Future Tokens (SAFT)?
Negotiating three terms before signing a SAFT is critical, including triggering events, valuation caps, discounts, and pro-rata rights. SAFTs are not all created equal, which means that the terms can make your investment sink or swim. An experienced startup lawyer can assist you in negotiating and drafting these terms.
Here is what you should know about each one and how they affect the investment:
- Trigger Events. Upon triggering an event such as a company sale, initial coin offering (ICO), or merger, future tokens convert to tokens. If the company goes bankrupt or the triggering events never occur, the SAFT is worthless. A future token investment can serve as the trigger. The SAFT investor receives the same number of tokens as prospective investors.
- Valuation Caps. A seed-stage investor takes a significant risk in the early stages. For the investor, a valuation cap resolves this issue. A valuation cap establishes a maximum token value to determine the investor’s ownership percentage. Without a cap on the token’s valuation, the percentage available to the SAFT investor continues to decline as the company’s value increases.
- Discounts. A discount rate provides a deal to the SAFT investor on the value of the tokens at the time of the triggering event. It is a discount from the anticipated price in the future. For example, a discount rate of 80 percent means that the SAFT investor receives their future tokens for 80 percent of the price paid by future investors as an early investment reward.
- Pro-Rata Rights. Pro-rata rights allow the SAFT investor to participate in future fundraising rounds. While this benefits the accredited investor, the company could face issues with future investors if they want the round to themselves. This issue could be exacerbated if the company has granted pro-rata rights to multiple SAFT investors.
SAFT vs. SAFE
A simple agreement for future equity (SAFE), or SAFE agreement, is different from a SAFT. Instead of future tokens, this investment contract entitles investors to future equity upon triggering a qualifying event, such as a merger, acquisition, or financing round. SAFE notes were invented by Y-Combinator, a San Francisco-based startup incubator, and are viewed as a more founder-friendly alternative to convertible notes.
SAFT vs. ICO
SAFTs often work in conjunction with initial coin offerings (ICOs). An ICO involves a project selling its tokens to regular, pre-approved users during the launch. On the other hand, SAFTs deal exclusively with accredited investors.
Accredited investors are those who can legally conduct securities transactions. In addition, they meet certain income, net worth, and professional experience requirements. Investor class distinctions enable SAFTs to be classified as a security that satisfies the fundamental requirements of US federal laws.
Image via Pexels by David McBee
Pros and Cons of SAFT Agreements
There are pros and cons of SAFTs for both investors and startups. On the one hand, SAFTs offer the stability and transparency that fiat markets have come to expect. On the other, this level of control could make the industry bristle since it bases its existence on decentralization and freedom from control.
Below, we’ve created a few pros and cons for your consideration when it comes to using SAFT agreements.
3 Pros of SAFTs:
- Potential Standardization. SAFT contracts could result in industry standardization, which would make regulators happy. It would also allow startups to continue using digital token sales to fund the development of their offerings.
- Increased Security. ICO scams would significantly decrease, as SAFT contracts are securities that must go through a vetting process. In addition, the SEC would subject the transactions to regulatory oversight at every point in the process.
- Wider Investor Base. The advantages of SAFT agreements alone could help expand the investor base for token sales. Not only would they provide some level of security for investors, but they also offer transparency that the public wants.
3 Cons of SAFTs:
- Limited Investors. The primary disadvantage of SAFT contracts is that they are only available to accredited investors. This means that small private investors must wait until the token becomes tradable on the secondary market.
- Perception. SAFT contracts may appear to work against the crypto movement. The entire premise of crypto and digital currencies is to move toward independence and freedom. Some people may push back against their becoming a standardized element.
- Limited Reach. SAFTs were based on the federal laws of the United States. Therefore, they may not gain as much global participation due to a lack of international applicability.
SAFT agreements are a new investment vehicle that assures compliance with US securities laws. They are both simple and effective but should be negotiated and considered carefully with a startup attorney. Regardless of your role, your lawyer can assist you in negotiating and understanding these terms so that it is a meaningful transaction for both parties.
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