Tokens and/or equity: Crypto projects' recipes for raising funds

Popularised from 2015 onwards with the famous ICOs (Initial Coin Offering), fundraising in tokens has gradually established itself as an essential means of financing for crypto start-ups.

Of course, their scope has evolved (primary sales are now rarely accessible to individuals), but their success with business angels and specialist investment funds is unproven.

For project holders, the benefit is obvious: tokens give access to a global audience of investors and therefore to more funding. "A major asset for federating a community", says Luc Jodet, partner for the French venture capital fund XAnge, which is very active in this field.

But for investors, there are also many advantages, as long as you know what you're getting into.

A seductive asset for investors

Unlike a traditional fundraiser, the token does not represent the share of a company but rather a right of governance within a decentralised autonomous organisation (DAO), in charge of the future management of the project.

For investors, attention must be paid to the usefulness of the token and above all its meaning: is it essential to the operation of the project? "Most of them don't actually need it," warns Luc Jodet.

However, funds that are familiar with Web3 are keen on projects with tokens. In many cases, they are synonymous with a faster return on investment than via traditional equity.

"As soon as the token is distributed on the markets, investors who have had access to primary sales at a preferential price can start generating profits," explains Ivan de Lastours, Lead Crypto & Blockchain at Bpifrance. "There are often vesting periods (time before you can sell your tokens, editor's note), but this is generally much shorter than with equity," he insists.

In fact, vesting periods rarely exceed two years for tokens whereas you have to wait five to seven years with equity.

"Once on the secondary market, funds have a much more liquid asset whose price can soar very quickly in a more or less rational way," continues Ivan de Lastours.

In addition, tokens offer professional investors a way out if the adventure turns sour: they can limit the damage by selling the token on the secondary market, whereas they are often locked in if they only hold shares. It is therefore a way of hedging at a minimum.

Three types of agreement have emerged

Over the years, 3 types of agreement including tokens have emerged.

👉 The "Single Agreement for Future Tokens" (SAFT). This is an over-the-counter contract allowing investors to acquire tokens that the project undertakes to issue.

👉 The simple OTC or secondary market purchase. Here, investors will simply buy back tokens that have already been issued. The deal is going to be over-the-counter.

👉 The token combined with equity. In this case, the equity investment will give access to a share of the tokens that the company undertakes to issue.

This last arrangement is currently the most fashionable. It was popularised by Uniswap Labs from 2020 and has seen the US start-up raise funds in equity and UNI tokens from venture capitalists (VCs).

"Combining equity and tokens allows investors to have an influence on the protocol but also on the company, which could launch other products," deciphers Pablo Veyrat, CEO of Angle Labs behind of the Angle stablecoin protocol. In fact, this is the choice he himself has made.

In the case of Uniswap, the decentralised exchange protocol (DEX) has a lot of potential value because it is recording record trading volumes (over $2,000 billion since its launch). However, it is not yet generating any revenue.

This is because US regulation does not allow the wealth generated to be redistributed to the holders of the UNI token (otherwise it could be requalified as a financial security).

It was therefore appropriate to also offer shares in the Uniswap Labs company, as it is remunerated via an interface developed on top of the protocol and which charges fees. The token/equity balance thus offers a source of profit for investors depending on the legal conditions, especially when the project is of American origin.

"While most major projects have launched tokens with no other use than to exercise governance, more ambitious models should soon emerge," anticipates Ivan de Lastours. "We are only at the beginning of the development of this type of investment", he stresses.

In this area, Europe has been innovative with MiCA (Market in Crypto-Assets), the European regulation designed to regulate crypto-assets at EU level from 30 December next. In particular, this incorporates an exemption for decentralised finance projects.

Some have already taken this route, such as Paraswap (a DEX aggregator), which shares revenue from its protocol with PSP token holders.

Morpho: the 100% token example

For other projects, the value of what is developed is concentrated solely around the protocol and not the company. It therefore makes sense for the investment to be made solely via the tokens that will be used to govern it.

This is notably the case with Morpho, which has raised $18 million in 2022 from several specialist funds, such as Andreessen Horowitz and Variant. "When you're building a totally decentralised network, I think it's the token that offers the most value," explains its creator Paul Frambot. "Our priority is to develop the best lending protocol, nothing else," he insists.

Morpho does have a structure to onboard its designers, but this is a not-for-profit association. "Morpho Labs acts as a simple proxy for the DAO," details Stéphane Daniel, a lawyer at d&a Partners, the firm that handled the fundraising for the French start-up.

As every project is different, Morpho's choice will not suit everyone. "There is no canonical way to proceed," Paul Frambot reminds us. "You can choose to offer equity, tokens or both, but that choice depends on the founders, who must have an extremely clear vision of what they want to build," he insists.

Some projects have the sole ambition of developing a network (like Morpho), while others have developed a front-end on top and have varying degrees of regulatory constraints (like Uniswap).

How to value the tokens?

Now it remains to define the value of the tokens when the funds are raised. Here, nothing is set in stone, even if valuation models are beginning to take hold.

"For projects that only offer tokens to investors, we will look at the total value immobilised, the costs that the protocol may generate or even the blockchain on which they are deployed," says Ivan de Lastours. "A decentralised finance project that launches on a blockchain like Ethereum will naturally be worth more because that's where most of the capital is," he points out.

On the other hand, it's more complex for those offering a combination of tokens and equity. "In many cases, the total value of the tokens issued corresponds to twice the value of the company after the fundraising," blows out an entrepreneur working on an operation of this type.

"When we raised $5 million in 2022, we agreed to issue tokens equivalent to $50 million," illustrates Pablo Veyrat of Angle Labs, meanwhile. If we follow this principle, Angle Labs would have been valued at $25 million at the time of this transaction (which Pablo Veyrat has not confirmed).

"Investing in tokens is something very new," explains a US-based investor. "Only a few funds with solid experience in the field like Andreessen Horowitz (which has invested in Uniswap and Angle, editor's note) are now able to draw up relevant valuation models", he huffs.