Handling your company’s capital structure is integral to long-term success. There is no replacement for a well-developed business model, but well-managed capital formation can be the difference between a startup that scales and one that stalls. This chapter covers the full arc of capital formation for crypto startups: from structuring founder and employee equity, through navigating the federal exemption landscape, to the specific considerations that apply to token-based capital formation. I would hope that this goes without saying, but if you are new here, please THIS GUIDE DOES NOT TAKE THE PLACE OF ENGAGING COMPETENT LEGAL COUNSEL. It is important for all businesses, but particularly for those building on the edge of new and emerging technology and regulation, to consult with legal counsel early and often. The easiest way to solve a problem is to avoid it in the first place (I promise).
Founder and Employee Equity
Founder Issuances
Founders need to be compensated for their work in building the company. Most founders receive a substantial equity issuance during the company’s earliest stages. The terms of this issuance, including transfer restrictions, vesting schedules, repurchase rights, and any lock-up provisions, should be negotiated carefully and memorialized in a stock purchase agreement or restricted stock agreement.
Because every shareholder must pay adequate consideration for their shares, corporations typically issue shares to founders at par value—the lowest permissible price. Founders should consult with tax counsel regarding the tax implications of any issuance below fair market value. An alternative approach is for founders to pay for their shares with the value of intellectual property or other assets contributed to the enterprise, though valuation in this context requires careful documentation.
It is important that founders retain independent counsel during equity negotiations, particularly where the interests of co-founders or early investors diverge. The terms set at inception (board composition, protective provisions, anti-dilution protections) compound over time and become very difficult to renegotiate later.
Employee Stock Plans
Stock plans allow employees to acquire ownership in the company over time, aligning their incentives with the company’s performance. Employees typically contribute through payroll deductions that accumulate until a designated purchase date, at which point shares are purchased at a discount. Beyond the retention incentives, equity-based compensation enjoys favorable tax treatment compared to equivalent cash outlays, making it an efficient tool for startups operating with limited cash reserves.
The board must determine how many shares to reserve for the employee equity pool and approve the plan, which then requires written consent from the stockholders. The size of the equity pool is a negotiation point in every funding round: investors want it large enough to attract talent but small enough to limit dilution.
Stock Option Agreements
Stock option agreements grant employees the right to purchase shares at a specified exercise price for a defined period. If the share price appreciates above the exercise price, the employee realizes a gain upon exercise. Options are the most common form of employee equity compensation in venture-backed startups because they provide meaningful upside without requiring employees to invest capital upfront.
Two varieties dominate: Incentive Stock Options (ISOs), which receive favorable tax treatment under Section 422 of the Internal Revenue Code but are limited to employees and carry annual exercise limits, and Non-Qualified Stock Options (NQSOs), which can be granted to employees, advisors, and consultants without the same restrictions but are taxed as ordinary income on exercise.
Token Plans
Many crypto companies reward employees with tokens in addition to or instead of traditional equity. Functionally, token plans operate similarly to stock plans—but the regulatory analysis is different. Because the SEC does not treat all tokens identically, and because the securities classification of a given token may depend on the state of the network at the time of distribution, companies issuing tokens to employees must consult with counsel to determine whether the issuance triggers registration requirements or qualifies for an exemption.
The CLARITY Act’s proposed taxonomy—distinguishing digital commodities from investment contract assets—may eventually provide clearer guidance for token-based compensation. Until formal rules are finalized, companies should err on the side of compliance and document the basis for their classification decisions.
Vesting
The Purpose of Vesting
Vesting allows the company to stagger or delay equity issuances according to how long an employee or founder has been with the company. The standard structure is a four-year vesting schedule with a one-year cliff: no shares vest until the first anniversary of the commencement date, at which point 25% of the granted shares vest, with the remainder vesting monthly or quarterly over the subsequent three years.
Vesting serves two purposes. It incentivizes retention—the longer an individual stays, the more equity they earn. And it protects the company: unvested shares can be forfeited or repurchased (typically at cost) if the individual departs, preventing former employees from retaining a disproportionate share of the company’s equity.
What Investors Expect
Investors will expect founders to vest their shares. The rationale is straightforward: vesting ensures that founders remain incentivized to continue building the company, rather than walking away with a large equity stake. It is customary for founders to begin vesting from the date of incorporation, which provides credit for the work already invested in getting the company off the ground.
Acceleration Clauses
Founders should negotiate for acceleration provisions that accelerate vesting upon the occurrence of specified trigger events. Single-trigger acceleration vests all or a portion of shares upon a single event—typically an acquisition or change of control. Double-trigger acceleration, which venture investors generally prefer, requires two events: a change of control and the termination of the founder’s employment without cause within a specified window following the transaction. Double-trigger provisions protect investors from founders who might be incentivized to pursue an acquisition solely to accelerate their vesting.
83(b) Elections
Section 83(b) of the Internal Revenue Code permits individuals who receive restricted property (including unvested stock) to elect to recognize the income at the time of receipt rather than at the time of vesting. The practical effect is that the individual pays taxes on the fair market value of the shares at grant—typically a very low amount for early-stage companies—rather than on the potentially much higher value at the time each tranche vests.
To make a valid 83(b) election, you must file a written election with the IRS within 30 days of receiving the restricted stock. This deadline is absolute and cannot be extended. File three copies: one with the IRS, one with your employer, and one for your personal records. Use certified mail with return receipt requested.
For founders receiving shares at par value in an early-stage company, the 83(b) election is almost always advisable—the tax cost at filing is nominal, and the potential savings as the company appreciates can be substantial. However, the analysis changes if the shares are not purchased at a nominal price or if there is meaningful risk the company will fail before the shares vest. Consult with tax counsel before making or declining to make an 83(b) election.
Non-U.S. residents should be aware that they can still be subject to U.S. taxation on equity received from U.S. companies. The interaction of 83(b) elections with foreign tax obligations requires specialized advice.
Raising Outside Capital: The Exemption Landscape
Companies that need capital beyond what founders can contribute must raise it from outside investors. Unless your company has reached the scale and maturity to justify a registered public offering, you will rely on exemptions from SEC registration. Understanding the exemption landscape is essential for any crypto founder planning a fundraise.
Regulation D
Regulation D is the most commonly used exemption framework for private capital formation. It offers three pathways, each with distinct parameters.
A note on bad actors – if key individuals or entities associated with your company have prior securities law violations, the company may be disqualified from using certain exemptions (including Rules 506(b) and 506(c)). The disqualification provisions are broad, covering the issuer, its directors, officers, general partners, managing members, and holders of more than 20% of the outstanding voting equity. The violations that trigger disqualification are serious—criminal convictions, regulatory orders, SEC disciplinary actions. So, be carefuly who you do business with.
Rule 504
Rule 504 permits offerings of up to $10 million with no limit on the number of investors. General solicitation is prohibited unless the issuer meets specific state law requirements. Rule 504 is less commonly used by venture-backed startups but can be useful for smaller raises where the accredited investor restrictions of Rule 506 are impractical.
Rule 506(b)
Rule 506(b) permits an unlimited raise from an unlimited number of accredited investors and up to 35 non-accredited investors per 90-day period. The critical limitation is a ban on general solicitation: the issuer cannot advertise the offering or sell to investors with whom it has no pre-existing substantive relationship. Rule 506(b) is the workhorse exemption for early-stage fundraising, particularly for companies that rely on warm introductions and established investor networks.
Rule 506(c)
Introduced by the JOBS Act, Rule 506(c) permits general solicitation and advertising, provided that all investors are accredited and the issuer takes reasonable steps to verify their accredited status. Verification requires more than self-certification—issuers must review income documentation, net worth statements, or third-party verification letters. Despite the solicitation benefit, many issuers prefer 506(b) to avoid the verification burden, though 506(c) has become more attractive as verification services have become cheaper and more streamlined.
Regulation A+
Regulation A+ provides a scaled pathway for companies that want access to non-accredited investors without a full registration. It offers two tiers.
Tier 1 permits offerings of up to $20 million in a 12-month period. Tier 1 issuers must register their offering with each state in which they sell securities, which adds cost and complexity. Tier 2 permits offerings of up to $75 million and preempts state registration requirements, but imposes ongoing SEC reporting obligations and limits non-accredited investor participation. Both tiers require a qualified offering statement—a process less burdensome than a full S-1 registration but more involved than a Reg D filing.
Reg A+ has found a niche with crypto and digital asset companies that want broader retail participation in their offerings. Several token issuers have used Tier 2 offerings to distribute tokens to both accredited and non-accredited investors with SEC qualification.
Regulation Crowdfunding (Reg CF)
Reg CF, enacted as part of the JOBS Act, permits offerings of up to $5 million in a 12-month period through SEC-registered online funding portals. Individual investment limits apply: investors with annual income or net worth below $124,000 may invest the greater of $2,500 or 5% of the lesser of their income or net worth. Investors above that threshold may invest up to 10% of the lesser of their income or net worth, capped at $124,000 per year. Accredited investors are not subject to these limits. Reg CF securities are subject to a 12-month resale restriction.
Reg CF has become an increasingly popular tool for early-stage crypto companies that want to build community ownership alongside their product. The funding portal requirement adds a layer of oversight but also provides a structured distribution channel.
Regulation S
Regulation S exempts offerings conducted entirely outside the United States from SEC registration. To qualify, the offer must be an offshore transaction—meaning the offer is not made to a person in the United States, and the buyer is outside the United States at the time the buy order originates—and there can be no directed selling efforts within the United States. Reg S is commonly used by crypto projects with global user bases that want to distribute tokens to non-U.S. participants without triggering SEC registration requirements.
A Note on Simple Agreements for Future Equity (SAFEs)
SAFEs, popularized by Bay area accelerator, Y Combinator, are the standard instrument for early-stage equity fundraising. A SAFE “note” is not debt: it is an agreement that converts into equity upon a future financing event, typically at a discount or subject to a valuation cap. SAFEs have become the default instrument for pre-seed and seed rounds because (in theory) they are fast, cheap, and avoid the complexity of pricing a round before the company has meaningful traction.
Intrastate Exemptions
The SEC provides exemptions for purely intrastate offerings under Section 3(a)(11) and Rules 147 and 147A. These require that all purchasers reside within a single state and that the issuer is incorporated in and conducts significant business within that state. Given the inherently borderless nature of most crypto businesses, intrastate exemptions are rarely viable for digital asset companies.
Rule 701
Shares issued to employees under a compensatory stock plan may qualify for exemption under Rule 701. Companies can sell at least $1 million in securities under this exemption regardless of their size, with higher thresholds available based on total assets or outstanding securities. Rule 701 is not available to publicly reporting companies.
Token-Specific Fundraising
Just as traditional companies issue stocks and bonds to fund their operations, many crypto companies issue tokens. Token issuances present unique legal challenges because the securities classification of a token depends on its specific characteristics, the state of the underlying network, and the expectations of purchasers at the time of the distribution.
Initial Coin Offerings (ICOs)
ICOs were the dominant fundraising mechanism for crypto projects from roughly 2017 through 2019. An ICO functions like a public offering of tokens: the project publishes a white paper describing the proposed network or application, and purchasers acquire tokens using fiat currency or other cryptocurrency. The SEC’s 2017 Report on The DAO established that ICOs can constitute securities offerings, and the subsequent enforcement wave made unregistered ICOs effectively untenable for projects with meaningful U.S. exposure. While the regulatory environment has become more nuanced under the current administration, the lesson remains: token offerings that satisfy the Howey test are securities offerings, regardless of their label.
Initial Exchange Offerings (IEOs)
IEOs are administered by registered cryptocurrency exchanges, which conduct due diligence on the issuing project and facilitate the token sale through their platform. The exchange’s involvement adds a layer of vetting that ICOs lack, and the listing provides immediate secondary market liquidity. However, IEOs do not automatically resolve the securities analysis—if the underlying token is a security, the exchange may need to be registered as a broker-dealer or alternative trading system.
Simple Agreements for Future Tokens (SAFTs)
SAFTs emerged around 2017 as a response to the regulatory uncertainty surrounding token issuances. A SAFT is an investment contract that gives the holder a right to receive utility tokens upon the occurrence of a future event—typically the launch of a functional network. The theory was that the SAFT itself is a security (and can be offered under a Reg D exemption to accredited investors), but the utility tokens delivered upon network launch are not securities because they have functional utility rather than investment characteristics.
The SAFT framework has been debated extensively, and its viability depends on the specific facts of each token and network. Courts and regulators have not uniformly endorsed the SAFT model, but it remains a widely used structuring tool, particularly for projects that anticipate a transition from centralized development to decentralized operation.
At this point, I rarely ever see SAFTs, with the most common playbook being a combination of a SAFE and a “Token Warrant” which grants the holder the right to a certain portion of future token supply, based on their as-converted equity holdings.
Certain Other Investment Concepts
Rights of First Refusal
Investors invariably seek rights of first refusal (ROFRs) to protect against dilution. A ROFR requires any shareholder who wishes to sell their shares to first offer them to the rights-holder before entertaining outside offers. ROFRs are standard in venture financing and should be expected in every institutional round.
Lock-Up Provisions
Lock-up provisions restrict the ability of founders, employees, and early investors to sell their shares for a specified period, typically 180 days following a liquidity event. Lock-ups protect against a flood of insider selling that could depress the market price and undermine investor confidence.
Convertible Instruments
In addition to SAFEs, convertible notes are the most common instruments in early-stage fundraising. Convertible notes are debt instruments that convert into equity upon a future financing event, typically at a discount to the price paid by new investors. The note accrues interest and has a maturity date, though maturity is usually extended or waived if a qualifying financing has not occurred. SAFEs, as noted above, accomplish a similar conversion without the debt structure. In either case, the conversion mechanics (discount rate, valuation cap, and qualifying financing thresholds) are the key negotiation points.
A Plea For Proper Recordkeeping
Meticulous recordkeeping of all securities issuances is not optional. Your company must maintain a stock ledger, copies of all stock purchase agreements, evidence of all securities filings, and records of all option and token grants. Delaware permits uncertificated record keeping through electronic means, which can reduce costs and improve efficiency. The capital table should be treated as a living document, updated in real time as issuances, exercises, and transfers occur. Investors will scrutinize your cap table during due diligence, and errors or gaps erode confidence quickly.
Written by David Lopez Kurtz