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How to Attract Venture Capital for Your Web3 Project

Many Web3 projects plan to attract venture capital to fuel their growth, and there is now an increasing number of Web3 funds within the venture industry. Consequently, the number of Web3 venture agreements is multiplying.

Each Web3 fund has its own internal startup selection process, which includes due diligence, such as checking legal documents, conducting background checks, and reviewing financial data before making an investment decision. Additionally, most Web3 funds have standard investment conditions, such as focusing on project tokens or investing in both tokens and startup shares.

This guide aims to provide Web3 founders with a comprehensive overview of all the activities they should undertake or consider if they plan to attract VC investment into their project.

Legal Due Diligence for Web3 Startups

A Web3 startup needs to prepare several legal documents and materials to successfully negotiate with venture capital firms (VCs). Having all critical documents in place will help quickly conclude an investment agreement through the due diligence process.

The Legal Due Diligence Process Includes:

  • Analysis of Token Documentation: Ensuring all token-related documents are in order.

  • Authorizations and Licenses: Verifying necessary licenses and authorizations for token issuance.

  • Statutory Documents and Intellectual Property: Reviewing the statutory documents and intellectual property of the token issuer company.

Token Capitalization Table Analysis

Before making an investment decision, a Web3 fund needs to clarify:

  • Token Issuance and Value: The number of tokens the project plans to issue and their value.

  • Token Distribution: How tokens will be distributed within pools and how many tokens an investor can receive.

  • Founder and Team Allocation: How many tokens founders allocate to themselves and the existence of a token incentive scheme for employees.

The Token Cap Table needs to include all these points. A well-designed tokenomics strategy ensures stable growth in token demand and provides the investor with a return on investment (ROI).

Obtaining a Token Legal Opinion

After analyzing the Token Cap Table, investors examine the token's legal status. They usually request a Token Legal Opinion from a qualified lawyer, which provides a legal qualification of the token.

This opinion ensures that the token's legal status and associated consequences will not hinder its liquidity in the future. It also guarantees that regulators will not ban the token.

Regulatory Compliance of the Token Issuer Company

Investors want to ensure that:

  • Crypto-Friendly Jurisdiction: The team chose a suitable jurisdiction for the Token Issuer Company (Token SPV).

  • Regulatory Requirements: The company has fulfilled all regulatory requirements before issuing tokens.

  • KYC and AML Policies: The company has implemented processes to verify token holders and their transactions.

Non-compliance can lead to severe consequences, including returning all raised funds, project closure, financial penalties, or even criminal liability.

Intellectual Property

If the Web3 fund invests in both tokens and shares, the investor's lawyers will request an Equity Cap Table and supporting documents proving that all intellectual property has been assigned to the company.

Taxes

In Web3 startup investments, the situation differs as investments are often in the form of token purchases. Although this transaction does not create tax consequences for the investor, it is crucial to ensure:

  • Tax Analysis: The team has conducted the necessary tax analysis.

  • Tax Obligations: They understand any taxes that may arise from token sales or have confirmation from tax advisors that no tax obligations will occur.

Investment Documents

After due diligence and signing the Term Sheet, founders and investors prepare investment documents based on whether the investment is in tokens, shares, or both.

For Token Investments:

  • Private Token Sale Agreement: Specifies the number of tokens, their value, and lockup conditions.

  • Simple Agreement for Future Tokens (SAFT): Used if tokens are issued in the future.

For Investments in Both Tokens and Shares:

  • Share Sale and Purchase Agreement

  • Shareholders' Agreement

  • Simple Agreement for Future Tokens and Equity (SAFTE): Used if both tokens and shares are issued in the future.

Conclusion

Fundraising for a Web3 startup differs significantly from a Web2 startup in legal terms. While having a highly liquid asset like a token attracts venture funds, it also requires extensive preparation:

  • Define Legal Status: Determine the token's legal status.

  • Distribution Model: Choose the best distribution model.

  • Regulatory Compliance: Obtain necessary authorizations/licenses.

Founders of Web3 projects preparing for fundraising must carefully perform all necessary legal work and prepare legal documents to avoid any deal-breakers that may hinder negotiations with Web3 funds.

If you're preparing your Web3 project for fundraising, Legal Nodes can help you build the right legal structure no matter what stage you're at– from incorporation to due diligence document preparation, we can help.

Fill out a form on our website to get started. The call will cover everything from how our legal platform can help you, to how we build a detailed Legal Roadmap for your project.

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.

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