Where should I incorporate our ICO?
This is the question most often received by our firm from entrepreneurs and companies wanting to do an ICO (or initial coin offering), or as it’s also known, crowdfunding via token sale.
We wrote over 5000 words and a flow chart about all of the legal considerations of a startup doing an ICO, from a legal perspective - the potential pitfalls and hurdles you will need to overcome.
Today we will jump straight to the point and talk about several common structures which could be used, as well as the pros and cons of these entity setups.
These link to a different article:The perfect ICO corporate structure?
There are several commonly used structures when you consider doing an ICO. Firstly, you should realize that most ICO’s operate through a separate and distinct issuer company (ICO-CO), and the operating entity (OPCO).
This is done for a number of reasons. Firstly, you separate out the legal liability. Secondly, you may want to have many OPCO’s in various countries to support payments to staff in fiat. Thirdly it will be very hard to get a bank account for the ICO-CO under certain circumstances. However, you can transfer the tokens received in the sale to one or more OPCO’s in various ways. (as a side note, when doing so you may have some arm’s length agreements in place for tax and legal reasons). Fourthly, there may be more advantageous business entity types (such as foundations and trusts) which allow for more effective ICO issuance but are not suitable for conducting ongoing business.
Note that this is a very high level diagram and not a detailed structure, but rather used to illustrate that there should be a separation and clear ‘Chinese wall’ between the two entities. Why you should use two entities (a dual structure) and what to consider
The Foundation / Operating Company Setup
- tax - by utilizing two entities, one can shop for the proper jurisdiction to setup with the lowest effective rate of taxation based on the activities of the entity. One has to be careful in doing so, as to prevent ‘treaty shopping’ however as new entities, it is likely not an issue.
- securities - securities laws vary from jurisdiction, and you may find a jurisdiction friendlier and with less constraints on what constitutes a security. However, typically what matters is where the investors are located and NOT where the issuing entity is located. (for instance, it makes only marginal difference to setup offshore if your primary investor is in the USA).
- liability - the liability laws in certain jurisdiction are more favorable to debtors as opposed to creditors. For instance, Wyoming is highly protective, whereas florida is not. Nevis is highly protective, Singapore is not.
- there should be a transfer pricing agreement (TPA) between the two and this should be setup with the help of lawyers and tax advisors in the relevant jurisdictions. If and when the operators of these two entities are the same persons - then this would be considered an ‘arms length transaction’ and from a tax perspective needs to be considered. This is not a huge issue, but there should be a TPA between the entities so that they trade at fair market value (FMV).
This is by far the most common setup for an ICO, with most notable ICO’s including Ethereum, Bancor, and many others operating this structure based on a Swiss foundation. However, it’s also possible this could be done through a company limited by guarantee. For instance:
What If my token offers some kind of residual income, dividend, % yield
- Hong Kong
- BVI / Cayman
Your token is starting to ‘smell like a security’. If you remember from our first article (have a read if you haven’t and come back) a security by any other name, will still attract the SEC. In other words if you can and do sell a token which violates the Howey Act and causes the SEC to take action, they can and will.What are the purchasers?
The purchasers are buying a product. They are NOT investors, and should never be called investors. They are not donors - as donors do not get something in return for making a donation. They are customers, who are buying a right to use your product. What are we trying to avoid?
We want to avoid giving the token purchasers any indication or privilege or right to shares in the business. Following the logic from the previous point if we do not want token holders as shareholders, it stands to reason that we do the fundraising through an entity that does not have any shares - an investor cannot reasonably ever make a claim to shares! LLC’s and companies are not suitable. Foundations and companies limited by guarantee and trusts are more suitable. What type of entity should an ICO be conducted under?
Foundations, trusts, companies limited by guarantee, potentially a society. Where do we form the entity?
So where do we form an entity? Well, if you want to compare jurisdictions, we have literally every jurisdiction neatly organized and full searchable (for free) at incorporations.io, soon we will be pushing an update to include both foundations and trusts, with specific filters for your unique type of business.CaveatsYou need a structure
Operating without a structure means that you will default to a general partnership, where you - and all of the other founders or proprietors - are operating with liability both jointly and severally. This means in plain english that you are completely responsible personally, without limitation, for all actions of both yourself and your partners, and you have no corporate veil protecting your actions. No structure is bullet proof
ICO’s and token sales are currently an unregulated activity under the eyes of every regulator we researched. This however, does NOT mean that your activities automatically fall outside their regulation or jurisdiction. There are a number of issues to consider in an ICO, including securities laws, tax, AML/KYC, commodities laws, general fraud and tort, and many more areas of the law, in possibly multiple jurisdictions. Being that ICO’s are inherently international - it becomes almost impossible (or very expensive) to receive a legal opinion in every country. Furthermore, legal opinions in and of themselves will not prevent regulatory action. Beware of Regulators and do not flaunt the law
It is the belief of many lawyers that I have spoken to in various jurisdictions that one of the main things you will want to avoid when doing a token sale is to classified as a security in the eyes of a regulator. This is because of potential fines and jail time which could be the enforcement or penalty from a regulator. Now, realize that regulators are very busy people and normally will not go after companies unless there is significant compliant or reason to.
Use your ICO for good, not evil. We will assume your ICO is well intentioned and provides a product or service delivers on what you promise. If you do an ICO that does not deliver on what it promises - that is fraud. We want to avoid the ICO being considered as a security. Therefore, we should never issue any guarantee of stock or future profits in any way.Final Points
Make sure there is an actual need for your token!
First and foremost, there should be genuine rationale for the issuance (and ongoing use) of your token. Is there a tangible reason for the token? How is it used? Do you really need to have your own native token, or could you ride on top of another already more established token. As smart contracts are generally public and open source, it’s quite possible for others to simply steal your code and “race you to the bottom” using ethereum for instance. These points need to be clearly considered and one should not be over-exuberant to race a premature idea out the door, at the risk of other people's money.
I will end the article with a point that probably should be raised first. We live in an incredible age where we have distributed computing systems, breakthroughs in cryptography, and incredibly powerful anti-sybil, immutable ledgers which make doing an ICO possible for the first time. There are riches to be made, as well as lost - in this disruptive and transformative period. However, what will stick with you is your reputation.
What matters is the output of your project, not how much money you initially raise. Furthermore - in order to do an ICO, you should carefully consider the economic design of your platform or application so that participants do not suffer a massive loss due to an oversight on your (or your teams) behalf. Be true to yourself.
In other words - make sure that: You have every element of your project figured out, have good intentions for yourself, your team, and your customers, and be true to yourself about these points.
ICO Report and Action Plan
If you are interested in doing an initial coin offering (ICO) and want to select a favorable jurisdiction for your headquarters, we will help you comparing and selecting a place to setup a company. We are experts in cryptocurrencies and understand the legal workings that underpin an ICO.
Based on some of the unique complexities and number of options available to your specific situation, a full work-up and report is the best course of action to ensure you have the optimal strategy to implement now, and grow with over the course of time.
We can manage the implementation of the entire structure for you, so you have a complete turn-key solution rather than a bunch of pieces to try and put together on your own. If not, we head back to the drawing board to find more.
Learn more about the ICO Report and Action Plan.