Optimizing your structure further


I had a new thought the other day about setting up vehicles for promoters of new token networks.

As a starting place, assume there are 3 places that Tokens in your network can go:
  1. You can give them back to your founders / early investors;
  2. You can sell them through SAFTs or Token sales for fiat or other crypto currencies that you then use to fund operations and possibly distributions to your shareholders; and
  3. You can give them away either in an airdrop, to miners, to some kind of non-profit or simply to early adopters.
I have been focused on maximizing the value to the founders and early investors -- which is why I've generally proposed that you set up an LLC HoldCo and deposit with it ~30% of the tokens (see http://cryptoblog.duncanpc.com/2017/09/2c-llc-holding-company-structure.html).

However, I have realized that there is an opportunity to increase that value further.

First (and simplest), you could retain a larger percentage of the network tokens in the LLC HoldCo.  That way, if it turns out that you are able to launch your network successfully, with optimal distribution and adoption before you've needed to sell as many tokens as you might have thought (i.e., 2 above), or without having to give as many away to users and nonprofits as you might have anticipated (i.e., 3 above), you can deliver those tokens to your LLC shareholders free of corporate level tax.  But if you needed those Tokens, you could always transfer them to Corporate OpCo at the time they were needed.  (This is compared with the situation where you transferred all 70% to Corporate OpCo on day one and had to pay corporate level tax on any excess token distribution back to LLC HoldCo.)

Previously I had thought that if you were satisfied with your share of [30%] of the tokens, these extra tokens were an unanticipated benefit and tax costs were not significant.  However, when I thought further (particularly with respect to the second point below), I realized that the vehicles should keep as many tokens at the holding company as possible.

But why did I have the change of heart?  That's my second point.

If instead of having the Corporate OpCo transfer the tokens to the nonprofit, we had the LLC HoldCo make that donation, the benefits grow enormously (but see discussion below regarding the fact that it may be impossible to set up a Network Specific nonprofit).

When Corporate OpCo donates tokens to a charitable entity, it may get a deduction for the value of the tokens, but it can only use that deduction to offset 10% of its income.  And even that deduction is not certain because there are a myriad of rules and limitations related to corporate donations.  Corporate OpCo can claim that the transfer is for business purposes, and deduct 100% of the value of the tokens transferred, but then it has an offsetting income item for the built in gain represented by the tokens.

However, if the LLC makes the donation, the tax deduction flows up to its members who can use that deduction to offset (best case) 50% of their income.  Furthermore, if LLC has held the tokens for more than 1 year, the LLC members shouldn't have to pay tax on the built in gain in the tokens.

So, for example, compare Alternative A with Alternative B:

Alternative A: LLC HoldCo owns 30% of the tokens and contributes 70% to Corporate OpCo, which then sells 30% for operating costs, gives 25% away to early adopters and miners and donates 15% to a charity (so that after deduction of the charitable donation it has taxable income equal to 27% of the value of the Tokens sold -- 30% less 10% of 30% -- pays taxes on that 27% at 21% or more, and keeps the value of no more than 24.33% of the Tokens).  LLC HoldCo then distributes the 30% of the Tokens it holds to its investors and founders who ultimately pay tax on whatever they sell those tokens for.  When those investors sell, hopefully they pay long term capital gains tax and keep value equal to up to 24% of the Tokens.

Alternative B: LLC HoldCo owns 45% of the tokens and contributes only 55% to Corporate OpCo, which then sells 30% for operating costs and gives 25% away to early adopters and miners.  OpCo pays taxes on the full 30% and keeps the value of 23.8% of the Tokens.

If LLC HoldCo then waits a year and donates 15% of the Tokens to a charity and then distributes the 30% of the Tokens it holds to its investors and founders, those founders and investors will pay tax on only half the value of the tokens they receive (valued on the date of the donation to the charity).

So if Investors in the LLC pay $1 per Token to invest, and sell those Tokens on the day they are distributed by the LLC for $11, they have $10 of gain.  In Alternative A, they pay at least $3.50 of tax, and keep gain of $6.50.   But in Alternative B, they have a $5.50 tax deduction, so they only pay tax on $4.50 of gain ($1.58) and keep $8.42 of the gain -- all at the cost of having the Corporate OpCo pay an extra $0.21 tax per Token sold (less if they are sold at a lower value).

Furthermore, by keeping 45% of the Tokens at LLC HoldCo, the Sponsor can decide that it doesn't need to give all 15% to the Charity and the investors and founders will get more tokens without having to fund the corporate level tax Corporate OpCo would have to pay on a corresponding distribution.

Now, of course there are a lot of details to be managed here, and some of them may be insurmountable (I certainly have no view on any securities law complications), but the benefits here seem worth more thought.  The biggest hurdle I am working on is the difficulty of setting up a nonprofit to operate your network and getting tax exempt status for that non-profit (particularly if it's going to be run by people with significant positions in the relevant token).  In fact, I think that would be impossible.  However, it may be that you could get under an existing nonprofit's umbrella or could find people to run the nonprofit who don't own the relevant tokens.

In any case, this crypto currency rabbit hole I've fallen down continues to present interesting questions.


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