Common SAFE Token Warrant Misconceptions
I invite you to collaborate on this community document, so that we can have a better overview of common practices in the space:
https://hackmd.io/mzbs3fGWTOaTc2BroJoVAw?view
Deprecated version below (from Jul 2024)
Background: SAFEs are a standard instrument for Seed and even Series A investments. In crypto companies, equity becomes often worthless if the company issues a token. To protect against that various instruments for future tokens have been developed.
The problem is this: equity clearly defines ownership of the company. Tokens don’t. Tokens can do all sorts of things, and many projects opt for large scale community token distributions. It is not uncommon to reserve 80-50% of the tokens to community airdrops or other incentivisation mechanisms that let you kickstart a network.
There are several major choices when drafting an agreement for future tokens:
Total token supply vs insider token supply
Ratio of equity to token (usually 1:1 or 1:2)
Here some common misconceptions.
Total token supply is the most common way of doing token warrants.
That's false. It is common, but it's definitely not standard.Anything less than total token supply means the valuation is proportionately higher. E.g. 50% community allocation at a 10M valuation SAFE, actually means 20M valuation.
That's false or at least it's rare to model tokens like this. If tokens were the same thing as equity, this would be the case. Yet, community allocations are not charity work. Community allocation performs important business functions.A related and weaker worry is that not having a clearly stated proportion (e.g. 20% investors, 20% founders, 10% ESOP, 50% community) prevents VCs from having a clear valuation that they come in at.
It also does not muddle the valuation. A 1:1 insider allocation at 10M simply means that the capital-venture market values the insider portion at 10M, no matter what the total token supply is. Does that make it incommensurable with deals that are total token supply? Maybe. Does it make business sense to do leave that undefined. Definitely!The warrant with insider token supply is a new instrument that’s 3-4 months old.
That's false. A16Z has been leading the effort for over 2 years now. All their deals are 1:1 or 1:2 insider allocation, including much later stage deals. There are many VCs who almost exclusively do these deals.The warrant with insider token supply is heterodox.
No, the proportion of the deals done this way is in the 50-70% from the VCs we talked to about this. ****A VC needs to be protected from extreme dilution in the case of large community allocation.
That's false. The worry here is that a VC about a 90% community allocation, leaving them with only 1/10 of the tokens. This worry has little substance, because the founders would dilute themselves the same way. In fact, this very mechanic aligns founders and VCs. There is no need for token astrology and trying to predict what the perfect community allocation would be. On top of this, A16Z leads an effort to go exactly the opposite way and defines MAXIMUM insider allocation at <50% (or a MINIMUM community allocation at >50%). There is NO minimum insider allocation in these deals, which clearly protect against the community dilution worry.