As the U.S. Securities and Exchange Commission (SEC) becomes less and less "friendly" to cryptocurrencies, SAFE + Token Warrant / Token Side Letter gradually replaces SAFT (Simple Agreement for Future Tokens, Simple Agreement for Future Tokens) and becomes the investment and financing platform for Web3 projects. The most common transaction models and legal documents in .

Specifically, if a token is used for fundraising purposes, it may fail the Howey Test — the standard by which the SEC judges securities. In order to solve this problem, cryptocurrency venture capitalists and start-up companies are increasingly favoring investment and financing methods that combine equity and Token. In theory, these tokens are granted nominally and have no value.

This transaction model is especially suitable for early projects, that is, Token SPV (Token Special Purpose Vehicle) has not yet been registered, responsible for the issuance and distribution of the initial Token, usually in jurisdictions where legislation allows Token issuance and provides clear rules for Token sales and transaction taxation registration), and have not established a complete Tokenomics (economic model and theory based on blockchain and cryptocurrency technology to achieve economic incentives, value exchange and community governance) projects.

0****1 SAFE

SAFE (Simple Agreement for Future Equity) is a contract and a financial instrument commonly used in startup financing for transactions between investors and startups. It allows investors to provide capital to companies in exchange for future issuance of equity. Unlike traditional equity financing, the SAFE agreement links investors with an interest in the company, but does not immediately give investors shares.

Traditional equity financing may involve complex equity structures and legal documents in the early stage, such as SPA (Share Purchase Agreement), SHA (Shareholders Agreement), MAA (Memorandum and Articles of Association), etc., and requires detailed legal due diligence. This has high economic and time costs for start-ups and investors. SAFE provides an easy way for investors to back startups at an early stage and secure future equity. It was introduced by the well-known startup incubator and venture capital firm YC (Y Combinator) in 2013 to simplify the financing process, reduce the complexity of legal documents, and improve the speed and efficiency of transactions, providing an easier way for early-stage startups , flexible and fast financing.

1. Core Terms

• Investment Amount: The agreed amount of funds provided by the investor to the start-up company.
• Conversion event: A trigger condition is stipulated. When the condition is met, the SAFE agreement will be converted into the company's equity according to the agreed ratio. Common conversion events include the next round of financing, a company sale or listing, etc.
• Conversion ratio: Determine the ratio of the investment amount to equity that can be converted into equity in future financing rounds.

2. Optional terms

(1) Valuation Cap

Valuation Cap is used to constrain the company's valuation ceiling in future financing rounds. It provides investors with a protection mechanism to ensure that they can perform equity conversions on favorable terms when they raise funds in the future. Valuation Cap is a set maximum valuation limit used to determine the price at which investors will receive equity in future financing rounds. When the valuation of a company in a certain financing round in the future is lower than or equal to Valuation Cap, investors will convert their investment amount into equity according to a predetermined ratio. This enables investors to enjoy more favorable equity conversion conditions as the company's valuation grows.

For example, suppose an investor invests a certain amount when signing the SAFE agreement, and sets the Valuation Cap to be 10 million USD. If the company raises funds at a valuation of US$50 million in a future financing round, the investor's SAFE agreement will be linked to this valuation according to the agreed conversion ratio, thereby determining the amount of conversion of the investment amount into equity.

The main role of Valuation Cap is to protect the rights and interests of investors, especially when the company's valuation increases rapidly. If the valuation of the company in future financing exceeds the Valuation Cap, investors will perform equity conversion according to the valuation cap, so as to ensure that they can obtain equity at a relatively low price and enjoy investment returns.

(2) Discount

Discount is used to determine the discount rate for investors to convert equity at preferential prices in future financing rounds. Discount is the preferential discount that investors enjoy when converting the SAFE agreement into equity. It is expressed as a discount rate, usually expressed as a percentage. The discount rate is generally between 10% and 30%, and the specific value is determined according to the negotiation between the two parties.

For example, suppose the investor invested a certain amount when signing the SAFE agreement and agreed on a 20% discount. When the company conducts financing at a price of US$10 per share in a certain financing round in the future, according to the agreed discount, investors can perform equity conversion at a price of US$8 per share. This means that investors receive equity at a lower price, enjoying a discount compared to investors who did not sign up for the Discount.

The main purpose of Discount is to reward early investors and reflect their early commitment to the company's risk. Given the higher risk faced by early-stage investors and the company's typically lower valuation, giving them a share conversion discount is an incentive to attract more early-stage investment.

(3) Most Favored Nation (MFN)

MFN (Most Favored Nation) aims to ensure that investors receive the same treatment as other investors in future financing rounds. The role of the MFN clause is to protect the interests of investors and prevent them from being unfairly treated in subsequent financing. According to the MFN clause, if the company conducts other financing after signing the SAFE agreement, giving other investors more favorable terms or conditions, then the investors have the right to request that these more favorable terms or conditions be applied to their SAFE agreement.

For example, assume that the investor and the company sign a SAFE agreement, agreeing on the investment amount, conversion ratio and other terms. Later, the company raised its next round of financing, offering other investors more favorable terms, such as a lower share price or higher equity. If an MFN clause is included in the SAFE agreement, investors can request that these more favorable conditions be applied to their SAFE agreement in accordance with the agreement of the MFN clause to obtain the same treatment as other investors.

The existence of the MFN clause helps to ensure equal treatment among investors and promotes consistent and fair treatment of all investors by the company in subsequent financings. The purpose of this clause is to prevent investors from being subjected to unfavorable conditions or the risk of being diluted in subsequent financing, thereby protecting their rights and interests and investment returns.

Valuation Cap, Discount and MFN are not necessarily included in all SAFE agreements, and their use is related to the specific design of the investment agreement and the negotiation between the investor and the company. Different investors may have different requirements for Valuation Cap and Discount settings. Therefore, when formulating a SAFE agreement, both parties need to fully negotiate and clarify their respective interests and expectations.

In addition, in addition to the above three common optional clauses, additional clauses such as priority rights and information disclosure requirements can also be added according to specific circumstances.

3. Advantages of SAFE

(1) DELAYED PRICING

The SAFE agreement delays equity pricing to future financing rounds, avoiding the initial troubles with company valuation. When signing a SAFE agreement, investors do not directly receive shares, but instead link the investment amount to a valuation ceiling for future financing rounds. This delayed pricing feature allows both parties to more accurately determine the value of the company.

(2) Simple and efficient

Compared with the traditional form of equity financing, the document structure of the SAFE agreement is relatively simple, which reduces the complexity and time cost of the transaction. This enables startups and investors to close deals more quickly and efficiently.

(3) Investor Protection

SAFE agreements usually contain some clauses to protect the interests of investors. For example, valuation caps can ensure that investors can obtain a corresponding proportion of equity when the company's future valuation exceeds a certain level. Additional clauses may also involve priority rights, information disclosure requirements, etc., in order to protect the rights and interests of investors.

(4) Flexible

The SAFE agreement is relatively flexible, allowing both parties to negotiate and adjust the investment amount, conversion conditions and additional terms to meet specific investment needs and conditions.

4. Points to note when drafting and reviewing SAFE

(1) Determine conversion event

Clearly define transition events in the SAFE agreement, such as the next round of financing, company sale or listing, etc. Switching events should be specific, quantifiable, and easily verifiable, such as funding amount, valuation reaching a certain level, or a specific date. This avoids ambiguity and controversy, and ensures that investors can convert to equity under certain conditions.

(2) Determine conversion ratio

The ratio of the agreed investment amount to equity convertible in future financing rounds. This ratio should be negotiated based on the company's needs, investor expectations and risks. A high conversion ratio may have an impact on the equity structure of start-up companies, so it needs to be carefully considered.

(3) Understand the terms of investor protection

SAFE agreements usually contain some clauses to protect the interests of investors. These clauses may relate to valuation protection, priority rights, disclosure requirements, triggering events, etc. Ensure that the impact of these terms on the distribution of interests between the company and investors is clearly understood and assessed.

(4) Assess the impact of financing structure on equity

When using the SAFE agreement for financing, it is necessary to carefully evaluate the impact of the financing structure on the company's equity. High conversion ratios and valuation caps can have important implications for a company's ownership structure, especially in subsequent financing rounds, which can lead to investor dilution. Therefore, it is necessary to comprehensively consider future development, equity allocation and investor expectations to determine the most suitable financing structure.

02Token Warrant / Token Side Letter

Since SAFE mainly involves equity investment and future equity conversion, it only deals with legal arrangements related to equity. Therefore, if investors want to obtain the relevant rights and interests of Token subscription, both parties need to arrange matters related to Token subscription, and often need to sign Token Warrant or Token Side Letter.

First, certain projects or specific Token issuances may require additional terms and conditions to meet specific needs and agreements. Token Warrant or Token Side Letter can provide more specific and customized terms to suit the needs of the project and the requirements of investors.

Secondly, the risk factors and regulatory requirements involved in Token issuance may be different from traditional equity investment. Token Warrant or Token Side Letter can contain specific risk disclosures and legal terms related to Token issuance to ensure that investors have a clear understanding of risks and comply with relevant regulatory requirements.

1. **What is Token Warrant? **

Token Warrant is a document often used by Web3 projects to attract early investment. It gives investors the right to buy some tokens during the initial token sale and fixes the token price.

(1) Core Terms of Token Warrant

• Allocation of Tokens: How many Tokens are reserved for investors.
• Token generation event: For more flexibility, a deadline can be specified.
• Token Purchase Right: Investors have the right to purchase Tokens that do not exceed the specified limit. Token purchase right is the right to purchase Token in the future. In order to determine the best way how to structure it, it is necessary to assess the Tokenomics readiness of the project. If the Tokenomics of the project has not been finalized, it is possible to negotiate with investors a discount rate for their purchase of Tokens. Then, according to the investor's equity ratio, calculate the number of Tokens they can buy at a discounted price.
• Purchase price: The fixed price at which investors will purchase Token.
• Token transfer: Various restrictions on Token transfer, such as lock-up period.
• Exercising terms and rights: First, the project team should inform investors in advance of the exact date of the Token generation event. Second, investors are given a definite period within which they can exercise their right to purchase tokens.

(2) Features of Token Warrant

• It legalizes investors' rights rather than obligations, and investors can freely choose whether to purchase Token.
• Token Warrant is not used for automatic (unconditional) issuance, if investors decide to exercise their Token purchase rights, they must pay additional consideration for the Token.
• The price for investors to purchase Token in the future is determined by Token Warrant. As a result, investors are in a better position to purchase tokens than buyers during the initial token sale, as the actual token price is usually much higher when the token generation event occurs.

2. **What is Token Side Letter? **

The Token Side Letter is a document representing the right (but not the obligation) to receive or purchase future Tokens, and is signed together with convertible equity investment documents such as SAFE.

(1) Features of Token Side Letter

• The exact date of conversion to token is not specified.
• The price of Token is not fixed.
• The purpose of Token is not defined.

(2) Advantages of Token Side Letter

• The Token Side Letter protects project development companies from any risks associated with the regulatory uncertainty of specific Token status in various jurisdictions by stipulating that future Token issuance will be conducted from an independent Token SPV.
• Token Side Letter allows founders to avoid making specific commitments for their Token in the early development stage, it allows them to flexibly conduct Tokenomics experiments, and at the same time serves as a guarantee for investors to obtain Token in the future.

3. What are the applicable scenarios of **Token Warrant/Token Side Letter? **

• Investors are interested in both tokens and stocks, and need a supplementary document to ensure their rights and interests in tokens. The main document for an investment transaction is a convertible equity instrument, such as a SAFE.
• Tokens have not yet been issued, and in most cases Tokenomics are still undetermined.
• The project team registered only one product development company. Therefore, the Token Warrant/Token Side Letter is signed by this product development company rather than a Token SPV.

4. What do **Token Warrant and Token Side Letter have in common? **

• Have the same signatory, the project development company.
• Supplementary to convertible equity investment documents, such as SAFE or Convertible Note.
• Use the same formula to calculate the Tokens that investors can get.

5. What is the difference between **Token Warrant and Token Side Letter? **

First, the way Token is distributed is different. For Token Side Letter, the project development company that signed it is also responsible for the distribution of Token. To do this, it first receives the Token that needs to be distributed from the Token SPV. Then, it will be transferred to investors holding Token Side Letter, as well as other core contributors to the project ecosystem, such as developers, consultants, etc. who hold Token options and sign contracts with or are employed by project development companies . For Token Warrant, Token SPV will be responsible for the sale of Token. When establishing a Token SPV or a Token generation event, the project development company distributes Tokens to the Token SPV. Then, the Token SPV sells the Token to investors at the price already fixed in the Token Warrant.

Second, the Token Side Letter does not require any additional Token payment details: the consideration is already included in the price of the convertible equity agreement. However, Token Warrant often requires an agreed transaction price to take effect. Therefore, in some cases, a Token Side Letter may look more attractive to investors than a Token Warrant because it does not involve any additional payments.

6. How to choose between **Token Warrant and Token Side Letter? **

When a Web3 project selects the appropriate financing documents for itself before the seed round, it is important to consider any regulatory restrictions on token transactions imposed by local regulators on the project development company. If they are strict, or there is a high risk of regulatory uncertainty (such as in the US), then it is better to use Token Warrant.

Because, in the case of Token Warrant, its signatory is not responsible for the conversion event. Therefore, the project development company does not participate in the sale of Tokens, it only confirms that qualified investors purchase Tokens at discounted or predetermined prices. The project development company assigns Token authorization to the Token SPV when the Token SPV is created or before the Token generation event. Investors then purchase Tokens directly from the Token SPV, which is the actual issuer and has the right to sell Tokens subject to regulatory approval. This helps the project development company avoid getting involved in the process of selling and distributing tokens. An independent Token SPV can handle these processes, thereby shielding the project development company from any participation in the Token distribution process. Comprehensive consideration, Token Warrant is more suitable for project development companies incorporated in the United States. As for project development companies registered outside the United States, their options are more flexible.

The transaction model of SAFE + Token Warrant / Token Side Letter combines the advantages of traditional venture capital tools and blockchain technology. It simplifies the investment process, reduces transaction complexity and costs, and provides investors and startups with more flexibility and options. However, it is important to note that the specific terms and conditions of this deal structure may vary depending on the particular circumstances of the project and transaction. Before conducting any investment activities or signing relevant documents, it is recommended to consult a professional legal advisor for specific legal advice and protection.