How Does A SAFT Work

Disclaimer

Simple Agreement for Future Tokens

A SAFT is an offshoot of another structure known as a SAFE -- Simple Agreement for Future Equity.   For what it's worth, I'm not much of a fan of SAFEs.

IN GENERAL

In any case, a SAFT is generally issued before a network goes live when it would be impossible to sell actual Tokens (because the blockchain is not live and no one could be assigned a private key).  In its simplest form, an investor buys a SAFT for a fixed price and the SAFT provides that on the date the network goes live ("Network Launch Date"), the Investor will receive a fixed number of Tokens.  Sometimes, where the total number of Tokens in the Network is not predetermined at the time the SAFT is issued, the SAFT will provide that the holder will get a number of Tokens calculated as a percentage of the total number of Tokens in the Network on the Network Launch Date (i.e., the maximum number of Tokens including all unmined and unassigned Tokens).

VARIATIONS

     A. VARIABLE PRICING.  Some SAFTs also provide that if the market value of the Tokens on the Network Launch Date is less than some multiple of the original issue price (e.g. 125%), the Investor will receive Tokens equal to the amount invested divided by a discounted fair market value (e.g., 80%).  There are many different formulas for determining fair market value (closing price, weighted average price on a given day, and where the SAFT settles after the Network Launch Date, weighted average price over a period of days).  Given the volatility of crypto currencies, it is important to understand the valuation methodology.  This structure is similar to the structure of SAFEs or convertible debt with a conversion cap.  The SAFT converts based on a discount to the price at Network Launch, but subject to a Cap determined at the time the SAFT is issued.

     B.  VARIABLE PRICING WITH A FLOOR.  Another variant on the above is to have a floor as well as a cap.  E.g. the a SAFT issued at 5 Tokens for a dollar might provide that if the Discounted FMV on the conversion date is less than $0.20, the Investor will get additional Tokens, up to a maximum of 6 Tokens.  This feature can give the SAFT issuer confidence that a temporary market disruption won't result in an enormous outflow of Tokens.

     C.  VESTING/LOCK UP.  Many SAFTs also provide that Tokens will be issued on some schedule beginning with the Network Launch Date (e.g. 24 months).  The longer the delay, generally, the greater the discount offered to the Investor.  Delaying conversion of the SAFT has two benefits (1) it reduces the risk that the conversion of SAFTs will cause a flood of Tokens to hit the market and overwhelm demand, and (2) it has at least a chance that it will delay the recognition of income by the SAFT issuer until the conversion date.  However, the income recognition delay probably is only achievable if there is genuine variable pricing.  Sometimes SAFTs with these features are called "Laddered SAFTs", although not all Laddered SAFTs have variable pricing (which, as I say, may limit their benefits).

OTHER COMMENTS

Since there have been no cases or administrative rulings on SAFTs, it is not clear whether an issuer will be taxed on the day a SAFT is issued, the Network Launch Date or the conversion date.  Where the SAFT is for a fixed conversion price with the only variable being the timing of the Network Launch Date, I believe the IRS will claim the issuer is taxed on the issue date.  (Remember, the IRS has not yet decided what it really thinks about crypto currency and will likely take the position that income must be recognized early and often.)  There is an argument that an issuer should not be taxed with respect to a SAFT before the Network Launch date, but as I have discussed elsewhere, I think that argument creates a risk that the issuer will be taxed on unsold Founder Tokens on that day as well.


Where the SAFT provides for genuine variability as to the number of Tokens issuable to each Investor (i.e., a spread that is material given likely volatility and the length of time before conversion), then I believe the issuer has a good argument that it should not be taxed with respect to the SAFT before the conversion date.  The IRS has generally argued that where an option (or a conversion right) is so far in the money that the holder of that option is "economically compelled" to exercise the option/convert the right, such exercise or conversion will be deemed to have happened on the issue date.  As a result, it is important that the spread between the highest number of Tokens issuable and the lowest number of Tokens issuable be large enough that there is a reasonable possibility that the actual number issuable will differ materially from projections.

One other note.  Where the issuer hopes to delay recognition of income past the Network Launch Date, it may be important that the issuer populates a "genesis block" on the SAFT issue date, even if all the terms of the block chain have not been determined.  Otherwise, it is possible that the IRS will require the SAFT to be tested on the Network Launch Date to see if the variability in the number of Tokens issuable is still significant.  E.g., in the example above, if on the Network Launch Date Tokens are trading at $20/Token (100x the price at which any variability comes into play) the IRS might say that the variability is illusory and require the SAFT issuer to recognize income on the Network Launch Date.  If the Tokens were already in existence on the SAFT issue date, the risk that the IRS would be successful with this argument is reduced (as opposed to where the Token springs into existence on the Network Launch Date).





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