Issuing equity grants is easy. From Silicon Valley giants like PayPal and Google to new entrants, equity is usually a part of early employee compensation. It’s common and the process is well documented. Issuing token grants instead of equity grants is complicated.
Tokens are not equity, but many early teams are treating them the same. That’s oversimplifies the complexity of uncertain regulation, expensive taxes, mixed incentives, vesting considerations, and the transparent nature of public ledgers. There is not enough precedence to understand the future risks, but I outline many of the known considerations below.
The good news is there is a equity-token structure that provides an elegant solution. It’s gaining in popularity and aligns employee incentives with token appreciation, but provides the benefits and simplicity of equity incentives.
Company Owned Token Model (Co-Own)
The Company Owned Token Model (Co-Own) links employee upside to token appreciation and uses established equity grant best practices. Instead of issuing token grants to employees, the tokens are all owned by the corporation. Employees then get equity grants in the Corporation, but never token grants directly.
Open Garden, a mesh networking platform best known for it’s FireChat app, uses the Co-Own model. CEO Paul Hainsworth said investors were always surprised to know he doesn’t own any of the company’s tokens. He said this model works better to align incentives with the long term success of the project, investors, and teams.
In their model, Open Garden will have 20% of tokens in the network, so if they appreciate, it will increase the value of the company equity. It’s a 2–4 year commitment for teams. Co-Own better aligns the team and the company’s success. No early cash out option which he said was important for the team.
Let’s look at the Co-Own model further downstream. When an employee leaves, vests, or trades on the c-corp company stock, it gets the tax benefits of equity but is correlated to the success of the token. The company stock is then liquid one of three ways: when the c-corp goes public, sells in an M&A transaction, or when the c-corp manages it’s own liquidity, either by buying back equity or issuing dividends from revenue or token sales.
I think we’ll see more companies adopt the Co-Own model. The original purpose of equity grants was to tie employee upside to the overall success of the business. This model serves that mission better than giving individual grants to employees. Companies that did token sales in the past had less insight into the new regulatory hurdles and may decide to switch to this model as they bring on more employees.
Still Considering Token Grants? Things to Consider.
I believe there will be better models as the token-backed business ecosystem evolves, but it is still early days. If you are considering setting up employee token grants, below are some of the considerations I’ve heard from lawyers, accountants, engineers, and founders in the space.
Employee Tax Burden: If you issue tokens to an employee, they are responsible to pay income tax is the year they receive them. Lockups do not solve this problem if you issue tokens in 2018 but they can’t sell until 2020, they will still pay income tax in 2018 on the tokens granted in that tax year. If you earn tokens on a vesting schedule, you will be paying tax on the price when issued, which could fluctuate if it’s publicly traded. Tokens don’t currently benefit from full regulation as securities, so the same tax benefits from getting public company stock aren’t currently getting the same treatment. Yes, 83B’s can help but there is still uncertainty on how.
Strike Price: If you receive equity in a company as shares, you have to pay tax, but you may benefit from a low share price that may appreciate over time. If you receive tokens after an ICO, they will be issued at the recent price, which may be priced at a future valuation, not what it’s currently worth.
Options & RSUs: Many VC-backed startups switch from issuing equity to issuing option grants or RSUs to delay employee tax burdens until they exercise the shares. The company can also benefit from options instead of equity grants. These structures do not currently exist in issuing tokens.
Employer Tax Burden: Tax guidance on tokens is not set in stone. The company may have an additional income tax burden for issuing tokens to employees, in addition to the taxes employees own on receipt of the grant.
Accreditation for US Employees: If your token is a security, can you only give it to accredited US employees? There is still a lot of uncertainty in how security tokens can be issues, sold, and traded in the US, but as it stands, there is a chance you could only provide securities to accredited, which may eliminate many of your employees.
Short v. Long Term Capital Gains: Holding equity for long periods of time before selling qualifies it for lower cost, long-term capital gains instead of short-term capital gains, or income tax. Tokens may not qualify for capital gains or long-term if the time form issuance to sale is short.
Incentives and Vesting:
Employee Participation in the Network: Issuing tokens means your employees now have assets they can use in helping to share your ecosystem, but wouldn’t it be better if all employees had equal incentive to participate in the ecosystem, even if they have smaller compensation of tokens?
Vesting Schedules: Long equity vesting schedules, from 2–6 years, helps keep people at a company long enough to add value. Exercising at the end of the vesting schedule is usually a future bet that the stock will become liquid. You have to double down on your beliefs with cash. Tokens have a different dynamic. Once vested, you could sell your tokens immediately. Faster path to cash, but maybe less incentive for long term token valuations.
Short v. Long Term Token Upside: Tokens are liquid in the short term, equity is not. Once an employee has vested tokens or they’ve come off lock up, it could could create an optimization for the employee to maximize the value of their tokens, not the overall token price over the long term.
Public Record of Employee Trades: When employees buy, sell, or trade tokens, there is a ledger entry on a blockchain. More transparency can be a good thing, but may require more messaging if an employee suddenly sells all of their tokens in a public manner vs. private manner of equity secondary.
Attracting Talent in a Dip: If your token price takes a hit, perhaps from a crypto-wide dip (like the one we see now), does it hurt your ability to hire talent and attract them with token grants?
Encouraging Employee Participation: Employees may need tokens to test being a participant in the network. Should they be price sensitive when using tokens to test? If they are granted tokens but they haven’t vested yet, do they have to buy tokens in the ecosystem to participate?
Sharing Best Practices Benefits the Blockchain Ecosystem.
I want to hear your input, examples, and feedback. I write to learn. Better discussion can lead to better outcomes. Please leave a message in the comments or tweet @br_ttany.