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How to set up an ICO – Part 2: The Corporate Structure

Flag Theory Weekly Letter – Friday, June 1st, 2018

In the first chapter of How to set up an ICO, we discussed the fundamental aspects to consider before deciding to launch an ICO. If you missed it, you can read it here.

Today we will talk about another key aspect and one of the most important when launching your ICO: the corporate structure.

As always, remember that this series of articles is considering a utility token issuance and are for illustrative purposes, they are not, nor intend to be legal or tax advice.

Before taking action, always speak with an attorney to assess your individual situation. We have a global network of attorneys and accountants that we can refer you to in the relevant jurisdictions and can give you the proper advice according to your specific circumstances.

An ICO corporate structure is a must

To begin with, a corporate structure is an essential tool for any type of business. This also applies for ICOs.

Launching an ICO is currently somewhat risky due to regulatory uncertainty. ICOs are relatively new and there is not much experience and jurisprudence to support your decisions. So your first goal should be to minimize that risk and a powerful corporate structure can help.

Not using a legal entity for your token issuance would mean operating as a general partnership, with general liability attached to each partner, jointly and severally. Essentially what this means is that you and your co-founders are all responsible for any actions – either your own or theirs – with relation to this business. If this doesn’t scare you, it should.

Conversely, a legal entity will limit your personal liability and provide you a corporate veil for more protection.

While many ‘traditional’ businesses operate within the brick and mortar confines of a particular state or country, most projects launched ICOs have a global reach. Going international from day one, or operating without a physical office, brings advantages such as a broad range of options when choosing the jurisdictions where to establish. However, there are also disadvantages: for instance, the compliance burden and you may be subject to the laws of different countries. This is just one reason why the legal support of a qualified international firm is important.

Now it’s time to choose the pieces and put the puzzle together. What entities will be part of this corporate structure, what will be its functions and in what jurisdictions you will establish them?

ICO Corporate Structure: Divide and rule

Normally, we recommend separating the structure that will issue the tokens from the structure that will be responsible for the ongoing operations and develop the project.

In this way, you not only separate the legal liability from the sale itself from the ongoing operations of the network. This also brings flexibility: you can choose different types of legal entities that are more adjusted, advantageous and effective for each of the phases, establish operations in several countries without the legal burden that an ICO entails, easy access to banking services, tax optimization, among others.

For instance, many of the most successful ICOs have been carried out by a structure where one entity conducts the token sale and another entity is tasked with ongoing operations and of building the software.

What entity is right for me?

Typically projects must decide whether a foundation or a company is a better entity type.

Unlike a company, a foundation does not have shareholders or owners. They are hybrid in nature and contain characteristics of the corporation (legal personality) and the trust (created for a purpose or benefit).

Although it has been a legal entity popularly used for token issuances, a foundation may not be the ideal vehicle to carry out an ICO, since Foundations are not entities created to engage in commercial transactions.

Projects using Foundations to issue tokens have done so on the basis that token purchasers made donations. Anyone who calls a donation to a token sale is lying to himself (and his token sale participants).

People who participate in a token sale get something in exchange for their contribution: tokens, so considering it as a donation is not accurate, nor recommended.

So for the purpose of the sale, it may be more advisable to establish an entity suitable to perform commercial activities, such as an LLC.

An LLC is an entity type with significant legal flexibility. The governance of certain LLCs is dictated by their operating agreement. This is a key feature that makes any legal entity much protective. You can even combine the issuing entity with a Trust for more protection.

A Foundation, although it is not an ideal tool to carry out the token sale, can be a powerful vehicle to manage the proceeds and tokens that are accrued by the ICO.

A Foundation may have assets in its own name for the purposes set forth in its constituent documents and its administration and operation are carried out by the Members of the Board in accordance with the Foundation’s by-laws.

Foundations can be a non-profit organization, they can be established solely to carry out a purpose and not for the benefit of persons and can enjoy a very advantageous tax status.

The Foundation can be established solely for the purpose of developing an ecosystem or software and not for the benefit of people and it can make grants to the operating companies to perform work on its behalf establishing operating an arm’s length agreements for tax and legal reasons.

Choosing the right jurisdiction for your ICO

Choosing the right jurisdiction(s) to set up your corporate structure can make a difference.

There are jurisdictions more prone and interested in attracting business and investments developing new innovative technologies such as blockchain companies. Some have even launched a Regulatory Sandbox so that these projects can be regulated and therefore reduce legal uncertainty.

You must also take into account their reputation, political and economic stability, transparency and make sure that the time of incorporation, costs and bureaucratic procedures required are adjusted to your priorities.

You may want to choose a jurisdiction where the tax laws for cryptocurrency are efficient and well defined. Proceeds received by the ICO, regardless if they are in cryptocurrencies, may be subject to income tax or V.A.T. in most jurisdictions.

Whether or not your token will be considered a currency, property, or security, could be determined not only by where you set up the legal entity, but also by the jurisdiction where the token buyers are located. This is because the laws (such as securities laws) vary by jurisdiction.

Generally, however – you’ll want your base of operations in a friendlier jurisdiction with a clear and delimited definition of a security – ideally one that your token does not fall into if you are selling a utility token. Other laws to consider include but are not limited to commodities, money transmitters or crowdfunding laws.

In the next article of this series, we will go into more detail in the corporate structure specifically established for the issuance of tokens and some jurisdictions to consider for this purpose.

If you are planning to set up an ICO, we can help you. We assemble teams to help with all of the legal, tax, compliance and banking issues you need to be aware of for both your company and its officers. You can contact us to schedule a consultation call.

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