In the crypto world, "foundations" are one of the least understood and most expensive products purchased by founders.

Author: wassielawyer

Translated by: Deep Tide TechFlow

The Foundation of Web3 Projects: What They Are, What They Are Not, and Why Use Them

In the crypto world, "foundations" are one of the least understood and most expensive products purchased by founders. It often feels like most lawyers themselves do not fully understand it.

First, why do foundations exist in Web3? What problems are we actually solving by establishing a foundation?

The main reason for establishing a foundation is to address the issue of Token issuance. But to understand why this is a problem, we first need to briefly introduce the structure of most Web3 projects.

Currently, most Web3 projects typically establish so-called "LabsCo" or "DevCo" (development companies) in jurisdictions like Delaware or Singapore.

These jurisdictions are very suitable for operating companies that develop technology. They have Y-combinator-style SAFE (Simple Agreement for Future Equity), provide convenient banking services, have high efficiency in corporate services, and possess a well-established legal infrastructure.

Founders of Web3 projects usually become shareholders of this development company and raise funds through SAFE weighted warrants (we can discuss SAFTs separately).

However, one thing that absolutely cannot be done is to issue Tokens from Delaware or Singapore. Issuing Tokens from the U.S. is absolutely unfeasible, and Singapore's virtual asset laws are not very friendly to Token issuance.

Generally, you should not make mistakes on your own turf.

This is a problem for Web3 projects because their business model is basically

(a) raising funds to develop technology (or hold events),

(b) consuming funds over a few years, and ultimately

(c) launching a Token so that investors can profit and the team can earn money.

Your development company rarely generates significant revenue before the Token launch, let alone profits.

Therefore, you do need to launch a Token. So how can you do this without violating the law or making tax mistakes? This is where the "foundation" structure comes into play. It is designed to serve as an offshore Token issuance and governance structure, allegedly transferring liability 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 this is:

Issuing Tokens from the development company (LabsCo) is inappropriate because the founders are all within LabsCo. We need a structure unrelated to LabsCo to issue Tokens.

The best approach is to issue Tokens in a jurisdiction (a) that allows Token issuance, (b) that is unrelated to LabsCo, and (c) that is unrelated to the founders.

The reason for choosing Panama and BVI as Token issuance locations is that Panama has no virtual asset laws, while BVI's virtual asset laws are very favorable for Token issuance.

This addresses the issue mentioned in (a).

Now, addressing the issue in (b) is not actually difficult, although sometimes you see some lawyers making 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 easily make mistakes.

If LabsCo does not own the Token issuer, then who does? This is where the concept of the "foundation" comes into play. A foundation is considered a non-owned entity, making it an ideal choice to own the issuer.

Sounds good, but is it really that simple to just establish a non-owned foundation? If only it were that easy.

Here we introduce the concept of UBOs (Ultimate Beneficial Owners). UBOs refer to natural persons who ultimately own assets of a legal structure or who can exercise ultimate control in the absence of a clear owner.

The importance of UBOs lies in the fact that these individuals may (a) influence the tax treatment of the legal structure or be taxed due to the structure's activities, (b) bear personal liability for certain actions of the legal structure, (c) subject the structure to jurisdiction of a country, and (d) as part of KYC/AML (Know Your Customer/Anti-Money Laundering) activities, must disclose to certain national registration agencies and/or business partners (such as exchanges, banks, financial institutions, etc.).

In a typical corporate structure, UBOs are usually shareholders.

If the company is profitable, they can benefit not only from the appreciation of their equity but also indirectly control the company through shareholder rights, such as hiring and firing directors.

This is relatively straightforward.

But how does this work for a so-called "non-owned" foundation?

Next, we will explore two common foundation structures.

The Panama Private Interest Foundation (PIF) is a structure commonly used for estate planning, now repurposed as a low-cost Token issuance structure for Web3 projects. It is controlled by a foundation council consisting of three members, who are usually randomly selected nominees from Panama, sometimes including the founders. Control is exercised by beneficiaries or executors who hold the assets, and these individuals are often also the founders.

In the PIF structure, the ultimate beneficial owner (UBO) may be the beneficiary or executor, as they have the right to control these assets. In almost all Panama structures I have seen, the UBO is usually the founders themselves. Sometimes (interestingly), the founders even own all the assets of the decentralized autonomous organization (DAO).

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, its purpose is usually to "support the growth and development of the XYZ ecosystem." In the absence of members or shareholders, the power to appoint or remove directors is held by a "supervisor," who is responsible for ensuring that the directors' actions align with the foundation's goals.

The law effectively prevents the distribution of assets or income to directors or supervisors. Therefore, the UBO of a Cayman Foundation Company is usually the supervisor. Due to distribution restrictions, the supervisor is often a corporate service company that charges between $5,000 to $10,000 annually to fulfill this role.

Founders are generally not advised to serve as directors or supervisors of a Cayman Foundation. To ensure integrity, the Cayman Foundation is usually used in conjunction with a British Virgin Islands (BVI) company, as BVI's Token issuance laws are more favorable.

In any case, your primary goal is to ensure that the founders are not the ultimate beneficial owners (UBO). In contrast, Cayman foundations typically make it easier to achieve this goal because they have professional directors and supervisors willing to take on the associated risks of being managers and UBOs.

Panama structures usually operate through nominees, which does not completely resolve the UBO issue. Just because you list someone else's name as a member or executor does not mean you are not a UBO, especially if you ultimately control them through some service agreement.

In other words, Panama structures often rely on the opacity of information. They are effective because it is difficult to determine who is behind the structure, but once discovered, that person will be regarded as the UBO of the structure.

This does not mean that Cayman structures are perfect. To make them work effectively, you need a truly independent director and a real third-party supervisor. You cannot just find someone to fill this role and expect it to function properly.

So how do founders "control" the foundation? Does this mean the directors can act at will?

Not at all. Directors must act within the scope of the foundation's goals (and its charter, if any). They cannot distribute assets to themselves, thus addressing the risk of a rug pull.

Since the people most familiar with the project are usually the founders, directors can consult with the founders, who can provide advice and other relevant services. As long as this advice is reasonable, there is no reason for the directors not to adopt it.

This does not mean that Cayman structures are always superior to Panama structures, as "superiority" can be interpreted in different ways. Sometimes, due to virtual asset laws, even with a Cayman structure, Panama may still be used (this is another topic). But many times, founders choose Panama because of lower costs.

If done correctly, the costs are quite high. While it may not be as high as you imagine, if you run a simple Cayman-BVI structure and hire a professional director, you might need to budget at least $50,000 to $70,000. The setup costs for Panama are around $10,000 to $15,000, sometimes even lower.

Therefore, sometimes founders consider costs more important, and temporary opacity is acceptable.

Another major misunderstanding is about the timing of establishing 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 establish a foundation with seed round financing.

As a founder, your primary focus should be on actually building the project, not spending high amounts on legal structures. If you have achieved some success and plan to go to market within three months, that is when you should start considering establishing a foundation. I can elaborate further (and I do want to), but I realize this has already been one of my longest discussions, and a comprehensive coverage of this topic might require an entire article (or more than 100 posts).

If you have read this far, the key point is that through the foundation structure, the main issue to address is the ultimate beneficial owner (UBO) problem. You do not want the founders to be seen as UBOs.

But if you think the cost of not making them UBOs is too high, you might feel that as long as no one knows or cares, it is acceptable to proceed this way.

However, ensure that your lawyer has indeed explained how this structure works so that you can reasonably assess the risks. Additionally, this usually needs to be decided before the Token Generation Event (TGE), not at the time of the first fundraising (although we need to discuss Simple Agreements for Future Tokens (SAFTs) separately). I will conclude the discussion here.

I am sure I may receive many private messages, but if you want to discuss anything, feel free to contact @Vigil_eth to arrange a time to chat.

This is not legal or financial advice, for entertainment purposes only.

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