This article is the second part of a guide created by Nestor Dubnevych, co-founder and COO at Legal Nodes, for Web3 founders into the ins and outs of creating a Legal Roadmap for their project. In the first part, the guide covered why Web3 projects need a Legal Roadmap, how to approach creating one and how Legal Nodes helps with it.
More articles about Web3 legal issues you can read in Legal Nodes blog.
The need for legal structuring of Web3 projects
In most venture projects, the need for legal structuring arises when such projects begin to attract the first investments. At this point, founders of such projects begin to receive questions from investors about whether the project company is registered, whether intellectual property is protected, whether team members have contracts with the company, etc.
Unlike traditional venture-backed startups that solve such tasks by registering a classic shareholding company, Web3 startups have more tasks to solve by creating a proper legal structure. Such tasks include:
- issuing not only shares for investors but also tokens (or only tokens);
- the possibility of further transformation of the project into DAO with the capitalization of tokens, not shares;
- creating a reliable legal wrapper around the Web3 project to protect the participants of such a project (developers, investors, DAO members, etc.) from unlimited liability for DAO activities.
Legal Roadmap for legal structuring of Web3 projects
Since the legal structure has to solve more business tasks for Web3 startups compared to Web2 startups, it implies much more legal work in the Legal Roadmap. Such legal tasks include registering a group of companies, conducting legal analysis and obtaining Token Legal Opinions, solving the issue of financial compliance, etc.
Implementing such a Legal Roadmap will help Web3 founders create the proper legal wrapper for a decentralized app (DApp) operations that underlie every Web3 project and provide an opportunity to attract venture capital. Therefore, Legal Roadmap for the Web3 project should be divided into several stages, each of which helps solve the project’s relevant business tasks.
Stage 2: Start of early-stage fundraising and registration of a Token company
Once the Web3 project team has reached the proof-of-concept of the DApp, they begin to fundraise. At this stage, the Web3 project usually does not issue tokens, but investors who plan to invest in it are interested in receiving tokens for their investments in the future. At the same time, given the early stage of the project, investors understand that token issuance plans and the tokenomics model of the project may change in the future. Hence, as an additional guarantee for their investments, they count on receiving shares in the project.
This approach of investors in the early stages of fundraising requires founders to register a separate company that will sign investment documents and issue tokens in the future (let’s call it a “Token company”). Most projects need a separate company at this stage because:
- this company must be registered in a jurisdiction that is acceptable for investments (where venture instruments operate and where investors can protect their rights); and
- this jurisdiction must also have special regulations for the token issuance to avoid regulatory barriers to future liquidity of tokens.
Stage 3: Launching the product and preparing the necessary legal documents
After attracting investments and bringing the DApp to a new stage of development, Web3 founders face the question of how to correctly launch their product on the market and begin to attract users legally. The complexity of this process is that DApps are a set of smart contracts that virtually and completely autonomously “live” and operate in a blockchain network. At the same time, to create the ability for users of such DApps to interact with them, Web3 founders develop interfaces to such DApps in the form of websites, mobile applications, and browser plug-ins.
To host websites or list mobile applications in application stores, Web3 founders need to analyze the business model of their DApp carefully to:
- obtain necessary authorizations/licenses for the DApp operation;
- ensure that all details of the DApp are properly reflected in the Terms & Conditions and Policies posted on the website/mobile application of the DApps.
Stage 4: Token launch and preparation of legal documents for token distribution
After launching a DApp on the market, Web3 founders begin to issue their tokens. In most DApps, the purpose of such a token is to increase users’ engagement, namely to create additional motivation for users to use the DApp more actively, recommend the product to friends, spend more time using it, etc. Also, Web3 founders can significantly expand their user base by airdrops or by launching tokens on launchpads. Attracting additional investments can also be done via selling tokens to investors in new rounds of investments.
Each token distribution method requires certain legal works:
- listing tokens on an exchange requires obtaining a Token Legal Opinion;
- selling tokens to investors requires a Token Sale Agreement;
- distributing tokens through airdrops or as the token incentives requires appropriate policies;
- the project might need token approval from regulatory authorities to issue tokens in some cases.
Stage 5: DAO launch and structuring a legal wrapper for it
After launching a DApp, attracting customers and issuing tokens, the project enters a stage of active growth. The nature of DApps suggests that this type of project is completely decentralized and autonomous, meaning it has no centralized administrators or final beneficiaries. Therefore, at some stage in the development of a DApp, many Web3 founders think about “transferring” the project to the full disposal and management of the project community.
This transition involves the organization of decentralized governance and decentralized treasury management. Such rules of decentralized project management are programmed in a smart contract and allow DAO members to participate in voting for changes to the rules of smart contracts operation, as well as for ways to manage the DAO Treasury. The main legal works in this process are to create a proper Legal Wrapper for such a community of people. In other words, founders need to register a DAO company which will protect DAO members from unlimited liability for DAO activities, allow for a legally binding voting process and ensure compliance with the procedures in the process of DAO Treasury management.
Getting started with a Legal Roadmap
Each business task of the Web3 project, which involves the interaction of virtual and autonomous DApp with the real centralized world of application stores, payment systems and venture funds, requires Web3 founders to do legal work to build “bridges” between the two worlds (centralized and virtual decentralized). Each stage of Web3 project development has such tasks, so for Web3 founders to plan their business activities and project budgets, it is essential to prepare a detailed Legal Roadmap in advance.
And given that Web3 regulation is at an early stage of development and there is a high level of regulatory uncertainty in the industry, a well-thought-out Legal Roadmap becomes even more relevant as it will allow Web3 funders to avoid many troubles and risks in the future.
Usually, founders think about creating a Legal Roadmap when the need to interact with a centralised world appears or when they plan to raise funds for the project. It is best to start with a consultation with a crypto expert who understands the crypto market and recent regulations and also has information on the most crypto-friendly countries and best practices of Web3 project structuring.
At Legal Nodes, we provide such Legal Discovery Sessions, where Web3 founders can discuss the best way to structure their project with our Web3 legal expert and get:
- an intro to crypto-friendly countries – specifically which ones may be the best jurisdictions for your project;
- an intro to token legal design to better understand all the implications of issuing a token; and
- a checklist of all the tasks to structure your Web3 startup legally.
Disclaimer: the information in this article is provided for informational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice.
Written by Nestor Dubnevych, co-founder & COO of Legal Nodes
