Web3 Project Foundation Myth Founders Essential Guide to Avoiding Pitfalls in Token Issuance

Coinworld reported:
In the world of cryptocurrency, “foundations” are one of the most misunderstood and expensive products purchased by founders.
Written by wassielawyer
Translated by TechFlow
The Basics of Web3 Projects: What They Are, What They’re Not, and Why to Use Them
In the world of cryptocurrency, “foundations” are one of the most misunderstood and expensive products purchased by founders. It often feels like most lawyers don’t really understand them either.
Firstly, why do foundations exist in Web3? What problem are we trying to solve by setting up foundations?
The main reason for setting up a foundation is to address the issue of token issuance. But to understand why this is a problem, we first need a brief introduction to the structure of most Web3 projects.
Currently, most Web3 projects are typically set up as “LabsCo” or “DevCo” (development companies) in jurisdictions such as Delaware or Singapore.
These jurisdictions are very suitable for operating technology development companies. They have Y-combinator-style Simple Agreement for Future Equity (SAFE) that provides convenient banking services, high efficiency in corporate services, and a well-established legal infrastructure, among other things.
The founders of Web3 projects typically become shareholders of these development companies and raise funds through weighted SAFE agreements (we can discuss SAFTs separately).
However, there is one thing that should never be done, which is issuing tokens from Delaware or Singapore. Issuing tokens from the United States is absolutely not feasible, and Singapore’s virtual asset laws are not very friendly towards token issuance either.
In general, you shouldn’t make mistakes on your own turf.
This is a problem for Web3 projects because their business model essentially involves:
(a) raising funds for technology development (or hosting events),
(b) consuming the funds over a few years, and ultimately
(c) launching a token so that investors can profit and the team can make money.
Rarely can your development company generate significant revenue, let alone profit, before the token launch.
Therefore, you do need to launch a token. So, how do you do it without breaking the law or making tax mistakes? This is where the concept of a “foundation” structure comes into play. It is intended to serve as an offshore structure for token issuance and governance, purportedly transferring responsibility away from the founders.
The two most common forms are
(a) Panama Foundation plus company and
(b) Cayman Islands and British Virgin Islands (BVI) structures. The logic behind them is:
It is inappropriate to issue tokens from the development company (LabsCo) because the founders are all within LabsCo. We need a structure that is unrelated to LabsCo to issue tokens.
The best way is to issue tokens in a jurisdiction that
(a) allows token issuance,
(b) is unrelated to LabsCo, and
(c) is unrelated to the founders.
The reason for choosing Panama and BVI as token issuance jurisdictions is that Panama does not have virtual asset laws, and BVI’s virtual asset laws are very favorable for token issuance.
This solves the problem mentioned in (a).
Now, solving the problem in (b) is actually not difficult, although some lawyers may make mistakes in this regard. The key is not to issue tokens from the development company (LabsCo) and not to let your token issuer be controlled by LabsCo.
(c) is usually where many lawyers make mistakes.
If LabsCo does not own the token issuer, then who does? This is where the concept of a “foundation” comes into play. The foundation is considered an ownerless entity, making it an ideal choice to own the issuer.
It sounds good, just establish an ownerless foundation, right? If only things were that simple.
This is where the concept of Ultimate Beneficial Owners (UBOs) comes in. UBOs are the natural persons who ultimately own the assets of a legal structure or who are able to exercise ultimate control when no clear owner is present.
The importance of UBOs lies in the fact that these persons may (a) affect the tax treatment of the legal structure or be taxed on the activities of the structure, (b) bear personal liability for certain actions of the legal structure, (c) subject the structure to the jurisdiction of countries, and (d) be required to disclose to certain national registration authorities and/or business partners (such as exchanges, banks, financial institutions) as part of Know Your Customer/Anti-Money Laundering (KYC/AML) activities.
In regular corporate structures, UBOs are typically shareholders.
If the company generates profits, they not only benefit from the increase in share value but also indirectly control the company through shareholder rights, such as hiring and firing directors.
This is relatively straightforward.
But for a so-called “ownerless” foundation, how does this work?
Next, we will explore two common foundation structures.
The Panama Private Interest Foundation (PIF) is a structure commonly used for estate planning and has now been transformed into a low-cost structure for token issuance in Web3 projects. It is controlled by a foundation council composed of three individuals, who are usually randomly selected Panamanian nominees, sometimes including the founders. Control is exercised by the beneficiaries or executors who own the assets, who are often the founders themselves.
In the PIF structure, the UBOs may be beneficiaries or executors as they have the power to control these assets. In almost all Panama structures that I have seen, the UBOs are usually the founders themselves. Sometimes (interestingly), the founders even own all the assets of decentralized autonomous organizations (DAOs).
Next is the Cayman Foundation Company. The Cayman Foundation Company is established for a specific purpose and is managed by at least one director. For Web3 companies, the purpose is usually to “support the growth and development of the XYZ ecosystem.” Without members or shareholders, the power to appoint or dismiss directors lies with the “supervisor” who is responsible for ensuring that the directors act in accordance with the foundation’s objectives.
The law effectively prevents the distribution of assets or income to directors or supervisors. Therefore, the UBO of the Cayman Foundation Company is usually the supervisor. Due to the existence of distribution restrictions, the supervisor is typically a corporate service provider who charges between $5,000 and $10,000 per year to fulfill this role.
It is generally not recommended for founders to serve as directors or supervisors of the Cayman Foundation. To ensure integrity, the Cayman Foundation is usually used in conjunction with a BVI company as BVI’s token issuance laws are more favorable.
In any case, your main goal is to ensure that the founders are not the ultimate beneficial owners (UBOs). In comparison, it is usually easier to achieve this goal with a Cayman Foundation as they have professional directors and supervisors who are willing to assume the risks associated with being managers and UBOs.
Panama structures usually operate through nominees, which does not fully address the issue of UBOs. Just because you list someone else’s name as a member or executor doesn’t mean you’re not the UBO, especially if you ultimately control them through a service agreement.
In other words, Panama structures typically rely on opacity of information. They are effective because it is difficult to determine who is behind the structure, but once discovered, that person will be considered the UBO of the structure.
This does not mean that the Cayman structure is perfect. To make it work effectively, you need truly independent directors and actual third-party supervisors. You can’t just find someone to play these roles and expect it to work properly.
So, how do founders “control” the foundation? Does that mean directors can do whatever they want?
Not exactly. Directors must act within the objectives of the foundation (and its bylaws, if any). They cannot distribute assets to themselves, thus addressing the risk of a rug pull.
Since the founders are usually the ones who know the project the best, directors can consult with the founders, who can provide advice and other relevant services. As long as these suggestions are reasonable, there is no reason for the directors not to adopt them.
This does not mean that Cayman structures are always superior to Panama structures, as “superior” can have different interpretations. Sometimes, due to virtual asset laws, Panama is still used even when adopting a Cayman structure (which is another topic). But many times, founders choose Panama because of the lower costs.
The costs are quite high if you want to operate correctly. While it may not be as high as you imagine, if you are running a simple Cayman-BVI structure and hiring a professional director, you may need a budget of at least $50,000 to $70,000. The setup fees in Panama are approximately $10,000 to $15,000, sometimes even lower.
Therefore, sometimes founders consider cost to be more important and temporary obscurity to be acceptable.
Another major misunderstanding is the timing of setting up such a structure.
In fact, the best time is before your token generation event (TGE). While lawyers may try to sell you these schemes as soon as possible, you should not set up a foundation with seed funding.
As a founder, your primary focus should be on building the project itself rather than investing a large sum of money into legal structures. If you have achieved some success and plan to enter the market within three months, then it is time to consider setting up a foundation. I can provide further details (and I really want to), but I realize that this is already one of my longest discussions, and a comprehensive coverage of this topic would require a whole article (or over 100 posts).
If you have read this far, the key point is that the foundation structure is primarily about addressing the issue of ultimate beneficial owners (UBOs). You don’t want the founders to be seen as UBOs.
But if you think the cost of not making them UBOs is too high, you may find it acceptable as long as no one knows or cares.
However, make sure your lawyer has actually explained how this structure works so that you can assess the risks reasonably. Additionally, this decision typically needs to be made before the token generation event (TGE), not during the initial fundraising (although we need to discuss Simple Agreement for Future Tokens separately). I will end the discussion here.
I am sure I may receive many private messages, but if you want to discuss anything, you can contact @Vigil_eth to arrange a time to chat.
This is not legal or financial advice, it is for entertainment reference only.