Crowd funding is all the rage these days, especially among crypto-projects. For the first time in history we have a easy way to crowd fund on a global scale and everyone is doing it. It takes significant money to build, deploy, and maintain a new crypto-ledger and developers don’t work for free. Few developers have the resources necessary to support themselves for the years it takes for a crypto project to gain ground. BitShares had one of the largest crowd funding campaigns and has had an opportunity to learn a lot from it. Our conclusion: don’t do it.
When a project attempts to raise money from the public through a straight sale of tokens it invites all kinds of regulatory uncertainty that is difficult to measure. A project needs a firm legal footing to protect its founders and uncertainty can be a cloud over an otherwise successful project. Even though we have not received any letters from regulatory bodies, we still have people bringing up concerns and spreading fear, uncertainty and doubt.
I am not a lawyer, but have paid over $100,000 to lawyers, accountants, and tax advisors. What I am about to relay is just my opinion.
The primary issue with crowd sales is whether or not you create a security and how should the money received be taxed. It seems like most countries have sales tax, income tax, and/or VAT tax along with capital gains. The exact rates may be different, but if you live in a country without any of those kinds of taxes then let me know so I can move there! Almost the only way to accept funds without owing taxes on them is if you are claiming to sell equity in a startup and treat the funds as a capital infusion.
If you sell your tokens as digital property then chances are you owe income tax and/or sales tax. To avoid the income tax you need to make sure your expenses occur in the same tax-year as your crowd sale. In other words, start raising money Jan 1st and spend it all on legitimate business expenses by Dec 31st. Be sure to pay any sales / VAT tax as necessary. What ever you do, don’t start raising money in December.
If the value of the tokens (BTC) you receive from your crowd sale fall between the time you receive them and when you spend them then you may face a tax liability that you are unable to pay even if you sold all of your tokens (BTC). In other words you have to sell your BTC immediately upon receipt of your crowd sale so that you can make sure you have enough money to pay taxes.
We didn’t do this with AngelShares because we wanted to keep our funds invested in the crypto space. As a result we faced paying taxes on BTC received at $800 but spent at $350. The taxes amount to almost 80% of the value that remained. Fortunately we had other income sources from BTS capital gains that could offset the BTC capital losses. You may not be so fortunate.
Security Issuance Issues
If you don’t sell your tokens as digital property but as shares in your business then you could potentially fall under SEC guidelines. This is why we didn’t sell our tokens and insisted that there were no strings attached to the funds we raised under AngelShares. We went so far as to claim that we could simply walk away with the money if we felt like it and that you shouldn’t give us a dime unless it was truly a gift. To this day this is how we respond to any complaints about how we spend the money.
Even if you attempt to sell your tokens as a pre-sale, a pre-sale becomes a liability and a debt. Liabilities and debts are technically securities which you will soon discover if you never deliver a working product. I do not recommend going into debt to the public via a crowd fund. You will only create a demand for transparency and a tendency toward public criticism of how you use the funds.
A crowd sale, especially a large one, places a lot of trust on those that receive the funds. This is a massive target for government confiscation and or theft. All of the money raised could be lost in a single attack. It is very difficult to provide full oversight into how the money is used and if the management team is bad you cannot fire them and select some else.
Public Perception Issues
There have been hundreds of crowd sales and the default perception is that they are scams until proven otherwise. Projects that don’t have crowd sales avoid a whole lot of negative PR issues. In some cases the PR issues can be enough to kill a project or at least outweigh the value of the funds received. Nxt suffered from this issue to some extent.
People that participate in crowd sales have learned the hard way that their “investment” is not liquid and that it will remain that way for an indefinite period of time. This lack of liquidity hinders your ability to raise funds and creates unnecessary stress if your project is delayed.
Long live Crowd Funding!
Fortunately there is a new approach to bootstrapping a project that allows for greater transparency and oversight while avoiding all of the legal issues. Launch a proto-chain based on BitShares. Every BitShares network is self funding through 101 delegate positions that receive income just like Bitcoin miners. This income can be scaled as a percentage of the total issuance depending upon the project and allow an arbitrary amount of incentives to fund development.
The initial allocation is done at a cost-basis of zero. This means that who ever you share-drop on has no taxes to pay until they sell. Delegates must pay income tax on the value of the tokens they receive in compensation, but this is individualized to the jurisdiction of each delegate and is not a systemic risk of a single party.
Pay as You Go
When you do a crowd sale on day one you end up selling all of your stake at its lowest possible market price: prior to any product existing. When you have delegates paid over time your project can raise far more money as the project matures. This also means that you do not commit to any one developer, but can switch as necessary by firing one delegate and hiring another. The developers must continue producing to keep their paycheck and their job.
The pre-allocation of stake to be sold on the market after launch is a better legal/tax position to be in that the pre-sale of stake to be issued at launch. The pre-allocation give the issuer a cost basis of zero and the first buyer a cost basis at their buy price. This has tax advantages for everyone. The issuer pays capital gains rather than income tax and the first buyer has a non-zero cost basis and potentially pays no sales tax or VAT depending upon their jurisdiction.
Avoid Large Concentrations of Tokens
If a company has any small group of stakeholders that have a “controlling influence” then that represents a risk and liability for the entire system. Crowd funding should air-drop on a large number of users as the initial stakeholders which then vote on policy. This has the effect of making the entire process democratic and shielding everyone involved from liability. If you pre-allocate 50% or more to any one individual then that individual carries almost 100% of the liability. Ideally no single individual should have more than a few percent of the initial stake. For this reason I highly recommend to avoid any pre-allocation of stake to anyone other than a share drop on a large widely distributed chain.
Stop the crowd sales, pre-sales, IPOs, ICOs, and instead launch a product directly and fund upgrades to the product through the delegate pay. If you must pre-allocate, make it a small stake for the developers. In this way we can put an end to many potential regulatory risks for new projects and ensure that our best and brightest developers are shielded from legal risks.