The ‘positive disaster’ of startups putting cryptocurrency on term sheets

cryptocurrency term sheet

The investor term sheet is a staple of the startup world. It’s an essential document for entrepreneurs and investors during the fundraising process, outlining the non-binding terms of an investment ahead of a legally binding agreement.

No two are the same, but most contain key information such as a company’s assets, valuation and voting rights.

They act as a template outlining the terms and – crucially – the amount being invested.

However, a volatile element is being introduced to this mix that has the potential to massively alter the dynamics of a startup’s funding round: cryptocurrency.

Unsurprisingly, opting for cryptoassets on term sheets appears to be more popular with companies operating in the cryptocurrency space.

One such example is The9, a Chinese internet company listed on the US Nasdaq that last year expanded into cryptocurrency mining. A US Securities and Exchange Commission document states that “The9 has the right to decide whether the investors shall make payments in the form of US dollars or cryptocurrencies”.

Another company that has explored this option is Element, a secure collaboration messaging platform. One of its investors is Status, a decentralised mobile and desktop client for Ethereum that lets users send encrypted messages and cryptocurrency.

When Status invested in Element, part of its backing came in the form of Status Tokens. Matthew Hodgson, founder and CEO of Element, told the UKTN Podcast that this led to a “positive disaster”.

Hodgson explained: “They thought they were investing $5m of which, $500,000 or something was Status Tokens at the beginning. About two weeks later, it looks as if they’ve invested about $25m because the value of the tokens had gone up.”

Situations like this raise some big questions about the utility of cryptocurrency and crypoassets in the startup investment world.

The volatility of cryptocurrencies is no secret, with same-day double-digit swings not uncommon.

But amid the rise of Web3 and growing mainstream adoption of digital currencies, could cryptocurrency become a more common feature on a company term sheet?

“There is considerable scepticism as to whether unbacked cryptoassets could ever gain broad traction as a means of payment,” Sophia Le Vesconte, senior associate in Linklaters’ fintech team, told UKTN.

“Cryptoassets have been used much more widely for the purposes of speculative investment, which drives their volatility and undermines their utility as a form of currency.”

Volatility is the clear hurdle for using cryptocurrency to provide capital to startups. Blockchain entrepreneur Paul Rogash told UKTN that the “risk runs both ways if the valuation rises quickly or falls quickly”.

Rogash added: “If an investor has agreed to contribute a set USD value worth of crypto, a decline in that crypto price prior to the investment would mean they need to contribute far more crypto than they had planned.”

Rogash explained that the danger faced by the startups receiving the investment is raising enough funds to grow, only to see “a decline in price” that “could mean they run short of capital”.

One solution for companies wanting to invest using cryptocurrencies is to use stablecoins – cryptocurrencies pegged to the value of a fiat currency.

“Stablecoins are the only solution to ensure the price remains the same,” Rogash said. “When crypto is listed on a public market, other than a stablecoin, there is no way to be sure that it will be the same in a day let alone a week or a month.”

Cryptocurrency on a term sheet: a risky bet?

Status’ investment into Element is an example of companies with homegrown digital assets wanting to demonstrate their belief in a proprietary cryptoasset.

But what about an investor that wants to use a more established cryptoasset rather than one of their own?

Barry Downes, co-founder and managing partner of Sure Valley Ventures, told UKTN that he has seen examples of private investors using major cryptocurrencies, such as Bitcoin and Ethereum, to invest in companies.

But Downes says that Sure Valley Ventures, which recently launched a new £85m fund to back British metaverse and Web3 startups, only invests fiat currency in exchange for equity.

However, he sees the lines as becoming more blurred when it comes to companies operating in the cryptocurrency and NFT space.

“We have a company in our existing portfolio, Admix, which is very active in the metaverse advertising space and it could potentially hold metaverse land, tokens and NFTs on its balance sheet, bolstering its asset base,” Downes said.

However, Downes cautioned that there “can be issues with this in the UK” due to company law.

Despite this, Downes pointed out that it could be advantageous to include cryptocurrency on a term sheet as it is essentially “taking a bet that the network and the token is going to go up substantially”.

In this scenario, it would increase the value of the company’s balance sheet and would have to be considered by an entity making a future investment in that company.

Elon Musk’s Tesla has benefited from a similar situation, with the electric car maker seeing its $1.5bn Bitcoin investment rising to nearly $2bn on its balance sheet, as of February 2022.

Yet in the cash-hungry world of startup growth, most will prioritise liquidity above the chance for future gains on an asset.

“In all cases, it’s worth considering the liquidity of the token, as this will be important if the company wants to convert some of the tokens into a stablecoin to pay staff or ultimately fiat to pay for goods and services in the non-crypto world,” said Downes.