What Is It Like for a Red Circle Law Firm Lawyer to Transition into a Crypto Fund Investor?

Sullivan：

The common transaction structures for investment and financing in blockchain projects include the following four types:

（1）Standalone Equity FinancingThis financing structure is similar to traditional equity financing. Early-stage projects may directly use SAFE [1] agreements, while mid-to-late stage projects may use a complete set of equity investment instruments such as SPA, SHA, and MAA. Although this involves Web3 project financing, the financing structure closely resembles that of traditional capital markets.

（2）Standalone Token FinancingThe primary forms are SAFT and TPA. Similar to SAFE, the reason for signing a SAFT lies in its convenience, enabling rapid cooperation with details to be negotiated later.

（3）Equity-Linked TokensThis financing structure is currently favored by North American projects. It basically includes a Stock Purchase Agreement, Investors’ Rights Agreement, Right of First Refusal and Co-Sale Agreement, and Voting Agreement, plus a token linkage agreement in the form of a Warrant to Purchase Tokens. From a compliance perspective, this structure can sometimes be more convenient because investors are essentially investing in equity, with the project granting investors the right to "purchase" tokens at a very low price at a later stage. In other words, if an investor’s equity interest is transferred, their future right to "purchase" tokens will also be transferred accordingly. For earlier-stage projects, a combination of SAFE and a token linkage agreement may also be used directly.

（4）Parallel Equity and Token FinancingIn the same financing round, the project conducts both equity financing and token financing. Distinct from the equity-linked token structure where the token "purchase" right is tied to equity, in a parallel equity and token financing structure, investors retain their token rights even if they sell their equity portion. A small number of projects also choose the SAFTE structure, a model that flexibly combines SAFE and SAFT, allowing the project to adjust whether to grant investors equity or token rights based on development progress.

In addition, we have recently encountered numerous project sponsors that previously completed a round of equity financing and now seek to add a round of token-rights financing, or that previously conducted token-rights financing and now wish to add a new round of equity financing. In such scenarios, conducting an additional standalone round of token-rights financing or an additional standalone round of equity financing would adversely affect the rights and interests of investors from the prior round. A more favorable approach is to adopt a hybrid equity-and-token financing structure for the current round, regardless of whether the prior round consisted solely of equity or token-rights financing. If the prior round was equity financing, the new round should provide investors from the prior round with a gratuitous allocation of tokens; if the prior round was token-rights financing, the new round should provide investors from the prior round with a gratuitous allocation of equity interests. This approach better balances the interests of the project sponsor and investors across different rounds.

Regarding why Web3 companies may choose token financing over equity financing, preferences vary among project sponsors and investors. Generally, Web3-native funds tend to favor token financing, whereas traditional U.S. dollar-denominated funds tend to favor equity financing. Web3 investors prefer tokens because they offer easier exit liquidity; there is no need to undergo the cumbersome process of listing on equity capital markets. Instead, the project sponsor can issue tokens on exchanges or through other means, enabling early-stage investors to conveniently sell their tokens and realize profits. Conversely, some traditional U.S. dollar-denominated funds prefer equity because it facilitates clearer explanations and disclosures for compliance and financial reporting purposes. After all, invested funds correspond to registered equity interests, which are easier for limited partners (LPs) to understand.

Sullivan：

Having handled dozens of investment and financing agreements for Web3 projects, I have observed that the details in financing agreements for high-quality projects, such as EigenLayer, differ from those sent by less reliable project sponsors. Although some project sponsors verbally express confidence in their projects, if the contractual details are structured in a manner that prepares for a "soft rug," the reliability of the project becomes questionable. Conversely, with reliable project sponsors, many contractual provisions reflect an effort to balance the interests of the project sponsor and investors. I once engaged with an overseas project sponsor that appeared promising during discussions but whose agreement contained problematic terms. The counterparty remained adamant and refused to make amendments. Approximately six months later, they proactively contacted us stating that they were willing to amend the agreement. That project sponsor has since executed a "rug pull." Given the complex environment of the Web3 market, greater attention should be paid to these contractual issues.

Beyond the customary structural provisions in Web3 investment and financing agreements, the following are points that Web3 funds or project sponsors should pay particular attention to in their agreements:

• Valuation

In addition to the project valuation stipulated in the agreement, careful attention should be paid to the conversion ratio when mapping equity interests to tokens, as certain terms may be unfavorable to investors. For example, a project sponsor may claim a 1:1 mapping, but upon reviewing the agreement, an investor holding 10% of the equity interests may find that this maps to only 5% of the token supply. Failure to notice such a reduced mapping ratio effectively inflates the project's valuation.

• Vesting Mechanisms and Vesting Periods

Token financing agreements require careful review of token vesting mechanisms, allocation ratios, vesting periods, and related terms. For venture capital firms, shorter vesting periods are advantageous for receiving tokens earlier. However, some project sponsors impose lengthy lock-up periods, potentially extending up to five years. Without negotiation, such terms are highly unfavorable to investors and warrant close attention.

• Allocation and Mitigation of Risks and Liabilities

Some project agreements include broad exculpatory clauses disclaiming liability for regulatory compliance issues in the token investors' jurisdictions, tax matters, risks of hacking and theft of crypto assets, technical issues, personnel matters, force majeure, and other concerns. Some clauses may even euphemistically state the risk that the project may cease operations at any time. Investors should ideally incorporate these risks into their investment decision-making process in advance. Conversely, I have encountered project sponsors that explicitly address potential future issues in their agreements and agree that, if the project cannot continue, necessary expenses (such as operating costs and salaries) will be deducted, with any remaining funds returned to investors.

• Disputes Regarding Token Issuance Method and Timing—Long-Stop Date

Some project sponsors have not finalized whether to issue tokens in the future or the timing of such issuance at the time of fundraising, and investors seeking to invest in tokens will repeatedly negotiate on this point. A practical coordination mechanism is to include a long-stop date clause, which stipulates a latest date for token issuance (for example, two years). If the project sponsor fails to issue tokens by that date, the investors shall have two options: they may execute a supplemental agreement to reaffirm the timing of token issuance, or they may obtain a refund of their prior investment amount after deduction of necessary costs. Such flexible contractual design benefits both project sponsors and investors.

• Most-Favored-Nation Treatment Clause

Many SAFTs do not contain this clause, and some project sponsors are unwilling to add it even when requested by investors. For investors, the absence of this clause may indicate that other investors in the same financing round have obtained more favorable investment terms. However, if an investor participates as a co-investor rather than a lead investor, it is normal for the investment terms received to be less favorable than those obtained by the lead investor.

• Dispute Resolution

The dispute resolution provisions typically specify litigation or arbitration in jurisdictions such as California (United States), Hong Kong, or Singapore. As Hong Kong’s Web3 regulatory framework continues to improve, a greater number of disputes may be resolved through arbitration in Hong Kong in the future. For Asia-based investors, it is advisable to select a dispute resolution forum that is geographically closer. In addition, where certain project sponsors conduct public fundraising and maliciously defraud investors by using the proceeds for high-end personal consumption, some investors have been able to recover portions of their investments through criminal investigations and proceedings.