How to prevent equity disputes in Web3 entrepreneurship?
Author: Iris
In a recent online sharing session related to the Yescoin dispute, Lawyer Manqun saw a comment that read, ‘How come starting a business together doesn’t count as being a shareholder?’
This is actually a common problem in Web3, and everyone may think: as a member of the core team of the project, I have contributed my own technology, experience, and even funds to the project, why isn’t it counted as shares?
But in fact, even if you carry the title of project partner and contribute greatly to the project, it does not necessarily mean that you are a shareholder.
Why do you say that?
Equity Participation in Traditional Entrepreneurship Models
Before discussing this issue, we might as well look back and see how the concept of ‘equity participation’ is defined in the traditional entrepreneurial context within the legal framework.
Usually, the “equity participation” we understand refers to entrepreneurs or investors using funds, equipment, technology, intellectual property, etc. as inputs, and obtaining a clear shareholder identity through establishing a company or signing a shareholder agreement. This method of equity participation has mature and clear legal definitions and protection mechanisms in company laws of various countries.
In traditional mode, the rights of each shareholder, such as dividend rights, voting rights, information rights, and share transfer rights, need to be clearly defined in advance. The articles of association or shareholder agreements will clearly record each shareholder’s contribution method, equity ratio, and corresponding rights and obligations. In other words, whether you invest in cash, technology, patents, or premises, it must ultimately be converted into a clear equity ratio and formally recorded in industrial and commercial registration documents or shareholder registers.
Because of this clarity, in traditional enterprises, the rights and obligations of each shareholder can be clearly legally protected during financing, dividend distribution, or equity transfer. Even if there are future shareholder disputes, all equity relationships can be clearly defined, and there will be no ambiguous situations such as ‘am I a shareholder or not’.
But precisely because of this clear reference, the issue of investment in Web3 appears even more perplexing.
Equity Participation in Web3 Entrepreneurial Model
Unlike traditional entrepreneurial models, the entrepreneurial approach of Web3 is more flexible and more decentralized. Many teams are not in a hurry to establish a company, and some have never even considered the need to establish a company first. Instead, they adopt a seemingly more relaxed approach, such as forming a core team of a few people based on oral agreements, or directly establishing a DAO.
However, in these modes, can the time, technology, and even funds you invest be clearly recognized as equity, just like traditional enterprises?
Core Team Model
In the early stages of Web3 entrepreneurship, a particularly common pattern is that several core members rely on mutual trust, passion, and simple verbal commitments to collaborate. At the same time, everyone’s contribution to entrepreneurship may not necessarily be funds, but could be technology, operations, or industry resources. However, everyone naturally assumes that they have become partners in the project. When the project successfully raises funds and issues tokens, they will receive tokens and shares in a certain proportion.
However, from the perspective of the law, this “seemingly simple” model may conceal significant uncertainty and potential legal issues.
Strictly speaking, this kind of verbal default based on commitment or contribution does not automatically equate to the legal concept of “shareholder identity” — generally requiring a clear written agreement or share registration process.
However, this does not mean that you cannot assert your rights.
For example, in mainland China, according to the Supreme People’s Court’s “Provisions on Several Issues Concerning the Application of Law in the Trial of Company Law Cases (III)”, if you can provide sufficient evidence to prove that you have contributed resources (such as technology development, capital investment, etc.) and actually participated in the operation and management of the project or company, the court may identify you as a “hidden shareholder”.
Similarly, in some cases in Delaware and California, the courts also recognize the ‘De facto Partnership,’ that is, if several founders start a business together, contribute resources, and share risks, even without formal documents and registration, they may be considered as de facto partners, thus sharing profits and bearing joint responsibilities.
However, these judicial practices do not mean that you can rest assured to participate in this entrepreneurial model. Because, once the project succeeds, such as successful financing, and the tokens appreciate significantly after issuance, the initial verbal agreements are often insignificant in the face of huge benefits: how to prove that you are a shareholder, ordinary workers also contribute to the company and project; even if it is recognized that you are a shareholder, how to determine your contribution ratio; even worse, if the project fails, some people may claim that their rights have been damaged, also likely to claim that they have made contributions but have not received appropriate compensation, leading to disputes, or even legal action.
DAO mode
In addition to founding a core small team, another popular form of entrepreneurship in the Web3 field is DAO (Decentralized Autonomous Organization).
Unlike traditional corporate startups, DAOs do not have a formal corporate entity, nor do they have so-called company articles or business registrations. Members participating in a DAO mostly join by contributing content or purchasing tokens, and receive corresponding governance tokens, exercising decision-making power through voting, including directions for fund use, investment project selection, and more.
From a strict legal perspective, the original intention of DAO is decentralized governance. Therefore, the tokens introduced by DAO are usually defined as tools for participating in project governance voting and as incentive feedback for contributing to DAO, and are not directly equivalent to traditional corporate equity. Therefore, in this case, the laws of the vast majority of countries or regions will not easily regard DAO members holding governance tokens as traditional ‘company shareholders’.
However, the key issue is that there is a type of investment-oriented DAO, whose members collectively decide through voting to invest funds in a specific project or asset, and then distribute profits according to each member’s coin holding ratio or contribution level after making profits. This operating model is actually very similar to the traditional investment partnership or company shareholder investment model. At this point, the pattern of DAO members obtaining profits through token governance has already possessed the characteristics of traditional dividends or profit distribution.
In this scenario, even if the tokens of the DAO are not initially clearly labeled with economic benefits, some jurisdictions (such as the United States) may still consider the governance tokens of the DAO as de facto securities or equity, and may consider the participants of the DAO as ‘de facto partners’ or ‘anonymous shareholders.’ The enforcement action by the Commodity Futures Trading Commission (CFTC) against Ooki DAO is a typical case. In this case, the regulatory agency believes that DAO members actually exercise the functions of corporate managers or partners through voting, and must bear legal responsibility for the illegal activities of the DAO.
Therefore, under the DAO mode, whether a member belongs to “equity participation” cannot simply be judged by whether the company is registered or whether there is a formal shareholder agreement, but requires a comprehensive evaluation of whether there is a clear investment decision and profit distribution behavior.
Traditional company model
Even though some Web3 projects now choose to register companies and adopt traditional equity structures to standardize operations, the boundary between equity and token rights can still become blurred, especially when it comes to token financing, potentially leading to legal disputes.
Web3 projects often involve not only traditional equity financing but also token financing. Token holders, although not necessarily company shareholders, may in many cases participate in governance, enjoy economic benefits, and even influence project decisions. This intersection of “token rights” and “equity rights” often brings about the following two major legal issues:
First, will participants in the coin rights financing be recognized as shareholders?
In Web3 project financing, some investors may participate in financing and obtain a certain percentage of project tokens without holding company equity. Whether these investors can be considered shareholders depends on the legal attributes of the tokens. If the tokens are only used for governance and ecosystem incentives, investors are usually not considered shareholders. However, if the tokens have dividend rights, profit rights, or if investors are involved in key project decisions, they may be classified as ‘de facto shareholders’ or ‘partners’ in some jurisdictions.
Secondly, is the governance power of token holders sufficient to constitute shareholder status?
In some Web3 projects, the project party will grant token holders certain governance rights, such as allowing community members to vote on project proposals and fund flows. When token holders, especially large investors (whales), exert substantial influence on the core business decisions of the company, some jurisdictions (such as the United States) may consider these token holders as performing functions similar to shareholders, thus, based on the principle of “substance over form”, they may be recognized as de facto shareholders or general partners.
How to prevent equity disputes?
No matter which entrepreneurial model it is, the most common cause of disputes is often not the issue of ‘the project cannot be started’, but the problem of ownership that was once vague after the project becomes large. So, how to prevent equity disputes in Web3 entrepreneurship?
Therefore, lawyer Mankun suggests starting from the following key points.
First, under the core team mode, it is necessary to clarify the contribution relationship and sign a written agreement as early as possible.
In the core team mode, it is easy for entrepreneurial members to default themselves as ‘partners’, but without clear legal documents, this default relationship often does not have legal effect. In order to avoid possible interest disputes in the future, team members should sign a written ‘Contributor Agreement’ or ‘Equity Structure Agreement’ early in the project, clarifying the types of contributions, the way future rights and interests will be realized, exit mechanisms, decision-making rights, etc.
Ultimately, while trust is beautiful, clear agreements are the cornerstone of protecting everyone’s legal rights. Once there is a written agreement, even future project financing and token issuance can clearly define the rights and obligations of all parties, preventing legal disputes caused by expectations gaps.
Secondly, under the DAO mode, it is necessary to clarify the legal attributes of tokens and distinguish between governance tokens and actual equity.
The equity disputes in the DAO mode mainly stem from the unclear legal attributes of governance tokens and the influence of token holders in DAO decision-making. In order to prevent potential legal disputes in the future, DAO project parties can take the following preventive measures in advance:
- In token design, clearly distinguish between governance tokens and equity tokens.
- By setting a limit on voting rights, implementing a time-weighted voting mechanism, and allowing delegated voting, the protocol prevents whales from manipulating and maintains its decentralized nature.
- Establish participant agreements to clarify roles and legal responsibility boundaries.
Third, under the traditional company model, ensure a clear boundary between equity and token rights to avoid mismatched interests.
In order to avoid disputes caused by the mixture of equity and coin rights, Web3 entrepreneurial teams need to clarify the boundaries of equity and coin rights early on. On the one hand, the company’s articles of association and shareholder agreements should clearly define the rights of shareholders, while the rights of token holders should be managed through a separate governance framework; on the other hand, it should be clear that tokens do not constitute traditional shares of the company, and token holders do not automatically become de facto or anonymous shareholders of the company.
Fourth, keep records and archives, introduce professional legal advisors to prevent risks.
All contributions, equity distribution, and protocol documents should be properly documented and archived to prevent a lack of evidence in the event of future disputes. This not only helps with internal governance within the team, but also provides strong support in financing or legal proceedings.
In addition, in Man Kun’s practice experience, it is often found that many Web3 entrepreneurial teams tend to focus on technology and the market, while neglecting legal issues, such as equity structure. Therefore, it is highly recommended to introduce legal advisors in the project development process, especially in the early stage, and conduct regular reviews to ensure the stable and compliant operation of the project.
