E. How to Safeguard Tokenholders' Economics Claims?
In this chapter, we ask if by affording both DTH and The DAO's sponsors the protections under existing securities laws, we oblige The DAO itself to become an incorporated entity and its token holders shareholder-members?
Our thesis is that whilst this is doable, it is neither necessary nor desirable, and we propose a specific smart contract that aims to replicate the safeguards and rights shareholders enjoy under traditional corporate law to DTH in a non-incorporated DAO.
1. Is The DAO a Legal Persona?
First, we need to examine if The DAO is a body corporate. In this respect, Preston Byrne, in his blog post quoted above, probably correctly states that the DAO is not a "legal person", which he defines as having its "own agency" allowing it to e.g. own property or perform "legally meaningful actions".
One reason why there is no legal personality is that there is no "agreement, in the traditional sense, between its members" (i.e. the DTH). He continues:
It is possible that a contractual relationship may exist if the “DAO Code” is sufficiently certain to create one. I doubt that EVM bytecode is going to be readable by most of the DAO’s users; if it were (and possibly even if it were not) it is possible that a partnership (less likely) or unincorporated association (more likely) will be deemed to exist between its members.
He seems to conclude that, unless The DAO acquires a legal persona, it will be very difficult to properly assign ownership and hence receive dividends (the DAO%) in the projects The DAO funds.
This logic seems to imply that, in order to bestow on the DTH the type of ownership rights that give traditional investors a pro rata claim on the economic output of a venture, it is inevitable that they would all have to become shareholders in an separate legal entity to which they agreed to adhere. In other words: The DAO needs to incorporate.
2. Introducing Smart Synthetic Equity
Whilst we coincide that The DAO, as currently coded, falls short of being a "body corporate", we believe traditional shareholder rights, including their right to receive a pro-rated dividend and benefit in the economic upside from a sale of the projects The DAO funds, can be replicated without The DAO itself acquiring legal personality.
We propose to achieve this by deploying a Smart Synthetic Equity ("SSE") smart contract, for which we provided the concept code in our GitHub.
The SSE is a key smart contract we interpose between The DAO and its portfolio company investments to automatically enforce payments of dividends ("the DAO%") to the DTH and have them share in sale proceeds upon exit, without them in any way being shareholders in The DAO or The DAO itself becoming a legal separate entity.
In addition, it gives the DTH a way of drip-feeding working capital to the projects they agreed to fund, and a tool to adjudicate spending at the portfolio company level. Finally, it gives the DTH the ultimate power to pull the plug on projects.
At an operational level, the SSE is envisaged to work as follows:
- To the left, we listed the Project Owner. This can be either a legal entity, i.e. an incorporated real-world company, a virtual entity, being an unincorporated collaborative Ethereum project, or an individual, for instance a researcher of a project that contributes to Ethereum's core protocol.
- The Project Owner adds four ingredients to the basic SSE smart contract creation: how much equity the Founders of the project retain, the accounts payable of the project, the revenue forecasts and dividend terms.
- Once the contract is created, it goes into the "Funding Round" state where the DAO or any other investors can invest up to the total payables.
- Upon reaching the targeted budget the SSE Smart Contract comes alive and automates all payments and books sales revenue as receivables.
- Typically a project during its development state (Period 1 to n) would mostly be a cost center and dividends would not kick in until they turn profitable (Period n to N) as pre-agreed during the inception of the contract.
- Revenue comes from the Consumers bottom centre. These can be individuals or companies who pay for the Project's services. In the digital context, this could be transactions volumes. For more traditional businesses, this could be invoiced sales revenue from products or services it offers B2C or B2B. Key is that all revenue flows back into the SSE.
- This SSE is therefore the central node of the scheme and is also the wallet into which the DTH, and possibly other parties such as traditional VCs or individuals that co-invest with The DAO, dripfeed the working capital of the project.
- The SSE checks sales revenue against costs, distributes the surplus according to the agreed dividend split, which will reflect the pro rata funding by each of the participating investors, and ultimately apportions the sales proceeds when the project has an exit by way of trade sale or public offering, part of which will also fall to the Founders pro rata their residual stake in the Project.
Further iterations of the SSE could include options schemes that entitle Founder teams or managers to an increase of their equity, putting smart locks on shares to prevent transfer by key team members bound by Key Man provisions, liens on shares that have been collateralised can be recorded on blockchain, etc.
We have included 3 use cases in the Annex to this Proposal of how this control mechanism could work. Please note that at this point the contract design is still very much a concept, and budget towards the further open-source development of the SSE is a major component of our Proposal to The DAO.