Disclaimer: This is not legal or financial advice. I am not your attorney. Always consult with qualified legal and financial professionals in your jurisdiction. Just like any other financial system, the cryptocurrency arena is plagued with bad actors and scammers, so do your own research and stay safe.
This is the legal thought process that I went through in choosing the best legal entity for Vanlife DAO. Decentralized Autonomous Organizations (“DAO”) are groups of people “using blockchain technology to design and govern collective decision making over shared assets on the internet.”- Shann.eth. DAOs can be made up of a small group of friends getting together as a book club with a joint crypto wallet, or millions of people across the planet engaging in a decentralized finance protocol that creates new currencies. Typically, to become a member of a DAO, you acquire and hold the DAO’s fungible or non fungible token.
NFTs as DAO Membership
We will use the term NFT to refer to tokens in general (both fungible and non-fungible). At the most basic level, NFTs are smart contract code on blockchains that store information related to the NFT’s creation and ownership. Creators of NFTs can designate whether the NFT endows the owner with membership in a DAO or whether it is just a collector’s item. This article, for example, is published as a limited edition of 555 collector NFTs that does not grant membership in any DAO. The article is openly available to the public even if they do not purchase the NFT. Purchasing a collector NFT like this article is similar to purchasing a limited edition, autographed print of your favorite painting from your favorite painter or autographed vinyl from your favorite musician--anyone can google the painting or listen to the record on Spotify, but the owners of these limited editions have the satisfaction of having a more direct connection to the artist or author by owning the unique edition. The record of the NFT on the blockchain is akin to the autograph on the painting or vinyl because it is transparent and immutable proof that the NFT is legitimate and has gotten the direct blessing of the creator of the NFT.
DAO membership NFTs, on the other hand, expressly communicate to the purchaser--normally through the NFT’s website or marketing--that the NFT grants membership in a DAO. NFTs are the perfect representation of membership in a DAO because blockchains are designed to maintain immutable and transparent records so that membership through ownership of a NFT is readily verifiable. Furthermore, the blockchain also provides an open and efficient marketplace for NFTs, which allows the value that is created (or not created) by the DAO to be captured in the NFT through the desirability of being a member of the DAO. When DAO members no longer want to be part of the DAO, they can sell their membership NFT and grant the new purchaser membership in the DAO. NFTs are the perfect tool to grant direct ownership and governance of a community to the members.
When I first discovered DAO membership NFTs, my lawyer mind immediately wondered how the US legal system and the IRS would view these organizations. Considering that most DAOs interact and manage substantial financial and real assets, they need to establish a legal personality to facilitate optimum self-governance and financial structure for their communities.
Preliminary Securities Exchange Commission Considerations
When DAOs issue NFTs that may result in direct financial returns to the NFT owners (normally in the form of dividends or distributions), the Securities Exchange Commission (SEC) could categorize the NFT to be a security. If an investment is considered a security, each investor has to be an “accredited investor.” This is an issue because to be an accredited investor, you have to meet certain requirements (i.e. having a net worth of over $1,000,000 or earn over $200,000 per year). A NFT could potentially be considered a security if the members expect profits to be derived from the efforts of the work of others. (For a more detailed discussion on securities considerations see this Harvard law review article).
As with everything there are exceptions. The JOBS Act creates an exemption from securities registration for startups to issue internet-based securities to crowd-fund up to $1,070,000. To qualify for this exemption, the startup has to file various reports with the SEC and conduct the fundraiser online through an SEC-registered intermediary. Furthermore, the investor is also limited on the amount they can invest depending on their annual income. Cohere, for example, is currently conducting a fundraiser under these rules on Wefunder.
Hopefully, by the time that you are reading this, the SEC will have already modernized its rules to help alleviate DAOs’ identity crisis. Currently, it is still unclear whether the financial gains of DAO and NFT holders will be considered a security that needs to follow the SEC rules.
The Corporate Veil of Legal Entities
When you fail to plan, you plan to fail. A partnership may be formed when two or more persons carry on a business for profit, regardless of whether the persons intended to form a partnership. DAOs that do not form their organization into a specific legal entity, by default, are likely to be considered a partnership. Simply buying a NFT to support a project that intends to turn a profit, could make you a partner of every other NFT holder and make you personally liable to the liabilities and debts incurred by the project. If your friend incurs large amounts of credit card debt after going on a shopping spree, for example, you are typically not liable to pay that debt. However, if your friend incurs debt in furtherance of the goals of your DAO, you could be personally liable for that debt. A legal entity structure for your DAO can shield members from personal liability for the debts and liabilities of the DAO.
Legal entities are legal fictions that the law creates. Legal entities only exist in the ether (pun intended) and in our minds, they are not physical or tangible things. The main purpose of legal entities is to create a “corporate veil” to shield individual members from, for example, having their personal assets being exposed to creditors that have a claim against the legal entity. Generally, members of these legal entities collectively own and/or govern the legal entity as provided in the bylaws and incorporating documents. Legal entities can hire employees, have a bank account, and sue and be sued. Legal entities can also own land, intellectual property, and even other legal entities. Members do not directly own or govern the assets owned by the legal entity—they only own/govern the legal entity as provided in the entities documentation. The following chart provides a visualization of this relationship.
This corporate veil is vulnerable to being “pierced” and, again, expose members’ personal assets to the debts and liabilities incurred by the legal entity. Piercing the corporate veil is a topic beyond our scope, but some examples of the reasons why a corporate veil could be pierced include; the legal entity’s members perpetrating fraud, failing to adequately capitalized the legal entity, co-mingling the members’ and legal entity’s funds, and/or failing to follow the bylaws and/or legal formalities of the legal entity. It is vital that members create and implement proper bylaws and incorporation documents and obtain the guidance of attorneys and tax professionals to maintain a strong veil.
Legal entities create and maintain their governance and financial structure through creating, amending and implementing their governance documents. These documents are traditionally referred to as articles of incorporation, operating agreements and bylaws, but can include a wide range of documents. A simple way to generate these documents is on Kali DAO, which allows you to form a legal entity on blockchains with respective formation documents, membership structure and key signatures for LLCs, nonprofits and swiss associations. It is ideal to create these documents before launching your legal entity, but they can also be created afterwards.
Each legal entity has specific attributes that serve different purposes, so which entity is right for your DAO?
Traditional Corporations have not been widely adopted as a legal entity for DAOs because of the extensive formalities, inherent centralization and SEC supervision. Despite these challenges, Cohere Network Ltd is in the process of launching its DAO as a Delaware corporation with a CEO, CSO and COO. It will be interesting to witness the interactions between Cohere’s corporate structure and its DAO community. The benefits of this corporate structure include the ability to raise funds as a traditional startup. One of the challenges is the potential for centralization when an individual or group own the majority of the shares and can impose their will on the rest of the organization. Shareholders also expect returns on their investment, which is the traditional business model in web2. For a more detailed discussion on corporation governance see Austin Robey’s guide.
Partnerships have the advantage of being easy to form (sometimes unintentionally) and operate, but they lack the corporate veil and could leave members personally exposed to liability. There are exceptions, for example, in the case of “limited partnerships” that can be formed in some jurisdictions and function similar to an LLC.
Limited Liability Companies (“LLC”) provide the benefits of a corporate veil and the relative ease of formation of a partnership. The legal requirements vary in each jurisdiction. In Delaware, for example, your LLC is formed by simply filing a one-page document with the secretary of state containing the name of the LLC and the name of a registered agent.
Wyoming and Tennessee have made a further attempt to accommodate DAOs by enacting laws that specifically acknowledge the validity of blockchain smart contracts as governing documents. Theoretically, this allows DAOs based on NFT ownership as membership to simply point to the respective blockchain to legally verify the members of the LLC while maintaining the benefits of blockchain technology—privacy and immutability. While the Wyoming and Tennessee DAO legislation acknowledge blockchain technology, they create unnecessary requirements—publishing of the smart contract address, requiring yearly activity to prevent automatic dissolution, and suggesting a majority quorum. Delaware still provides for the greatest sovereignty and flexibility by allowing LLCs discretion to create their own governance structure.
In CityDAO, for example, I had the honor of being elected into the inaugural “city council.” CityDAO (which drew inspiration from Balaji Srinivasan’s theories and has been condoned by Vitalik himself) was incorporated as a Wyoming DAO LLC when our articles of organization were approved by Wyoming’s secretary of state on July 28, 2021. Thereafter, in December 2021, we voted to create a city council for a 30-day term for the sole purpose of establish our self-governing documents in the form of an operating agreement and a charter. These documents provide mechanisms for members of CityDAO as a community to vote on projects and deploy funds. These documents, as with most LLC governing documents, also provide the mechanism for the community to amend the documents themselves as CityDAO evolves and transforms.
Besides the traditional use of LLCs, they can also be used to create a SEC Investment Club that could be exempt from being considered a security if certain requirements are met. The club is limited to 99 members and the investments have to be openly available to any other person. Syndicate DAO provides a streamlined process of forming these clubs.
Cooperatives. The International Cooperative Alliance (“ICA”) defines cooperatives (“coops”) as “autonomous association of persons united voluntarily to meet their common economic, social and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise.” The ICA coop principles are: “1. Voluntary and open membership; 2. Democratic member control; 3. Member economic participation; 4. Autonomy and independence; 5. Education, training, and information; 6. Cooperation among coops; and 7. Concern for the community.” Do these principles sound familiar? Maybe it’s because these are the values that we have imputed to DAOs. This legal entity structure is ideal for DAOs that are looking to truly decentralize and allow each of its members a seat at the table. This is specifically a good structure where all the members are expected to contribute equally to the DAO coop.
Initially, I pushed back against coops out of ignorance—I equated coops to the negative stereotypes of a commune and having to share a toothbrush. The good news is that we do not have to share our toothbrush. Just like any other legal entity, a coop provides a corporate veil and can hire employees, have a bank account, own land/assets, and sue and be sued. Also, similar to an LLC, a coop has discretion in establishing its internal governance structure. The resources that are accumulated by the members of the coop are owned by the coop as a collective and can be managed and deployed as decided by the coop through its internal governance. Washington state and Colorado have enacted a limited coop act that allows coops additional discretion to issue distributions/dividends to investors (the SEC may disagree as noted above) that are not directly participating as traditional coop contributors. (For more comprehensive coop discussion see the seminal article on coops as DAOs by Jacqueline Radebaugh and Yev Muchnik). To study a transparent example of a coop DAO governing documents see SongADAO.
A potential challenge for DAOs as coops is that some jurisdictions require coops to have a board of directors, which could result in centralization. (See for example Washington’s and Colorado’s regulations). This could be a feature because some DAOs may need to be somewhat centralized for purposes of executing collective decisions like purchasing land or creating a bank account. Coop DAOs can establish an election process to fulfill this requirement and have elected directors that can carry out the operational tasks of the community.
Nonprofits. Being a successful entrepreneur by forming and working in several LLCs throughout my web2 career, I initially resisted the idea of being part of a nonprofit. After deep study of the ultimate goal of most DAOs, however, I came to the conclusion that nonprofits are the perfect legal entity structure for DAOs that are created for the purpose adding value to a certain community or cause. Some of the most successful DAOs have missions that generally benefit the public good: MoonDAO (my fav) is on a mission to decentralize space research and exploration: VitaDao is funding longevity research: UkraineDAO is providing financial support to the victims of war: DoinGud is empowering creators and doing good: and LexDAO focuses on establishing standards and education related to legal engineering in web3/blockchain space.
The IRS defines nonprofits as “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational or other specified purposes.” The IRS also provides favorable tax treatment for “social welfare organizations, civic leagues, social clubs, labor organizations and business leagues.”
The benefits of a nonprofit include tax benefits. However, in the United States, for example, these benefits come with extensive reporting and filing requirements. As with any legal entity, a nonprofit can hire employees, have a bank account, own land/assets and sue and be sued. A nonprofit also provides the handy, dandy corporate veil. However, members of a nonprofit generally do not have ownership of the nonprofit and cannot receive distributions or dividends from profits. This can be a feature not a bug because it will attract people that are truly interested in the community’s mission instead of looking to make a profit by flipping a NFT.
In some cases, DAOs that come together for a nonprofit purpose that fail to expressly establish their legal entity, could, by default, be considered an Unincorporated Nonprofit Associations (UNA) and enjoy the protections of the corporate veil. Organizations can also proactively declare themselves to be a UNA. I’m a proud member of LexDAO, which declared itself a UNA and established its own governing documents in the form of an “operating system.”
Attorneys David Kerr and Miles Jennings wrote the seminal summary of these entities in Legal Framework of UNAs. Currently, however, there is no clear consensus as to how strong the UNA corporate veil is. Texas, Colorado and Nevada courts have acknowledged and upheld the UNA corporate veil for charitable bingo associations and political campaign associations. Mohr v. Kelley, 8 P.3d 543, 544 (Colo. App. 2000); Vitale & Associates, LLC v. Lowden, 690 Fed. Appx. 555, 557 (9th Cir. 2017); and MT Falkin Investments, L.L.C. v. Chisholm Trail Elks Lodge No. 2659, 400 S.W.3d 658, 665 (Tex. App. 2013). In contrast, however, a Maryland court held an officer of a UNA that operated schools was personally liable for the contracts of the UNA because the officer authorized, assented to, or ratified the contract in question. Pinsky v. Pikesville Recreation Council, 214 Md. App. 550, 580, 78 A.3d 471, 488 (2013) (a similar decision was reached by a Pennsylvania court in Carpenters Health & Welfare Fund of Philadelphia & Vicinity v. Reyes, CV 17-05107, 2018 WL 3437212, at *4 (E.D. Pa. July 16, 2018)). Despite this uncertainty, UNA’s are still a good idea and are likely to be a good option for some DAOs. (Fun fact, the NFL was initially formed as a UNA).
Overseas Entities: Foundations. Some of the options for jurisdictions of overseas entities include countries like Malta, Macau, Panama, Republic of Marshall Islands and Cayman Islands. These entities have traditionally been sought out for privacy, tax benefits and flexibility. In most cases, however, these entities require directors and a “supervisor” from the host country, which can cause several points of unnecessary centralization. The yearly cost of establishing and running these foundations can be substantial. (ENS Foundation, for example, pays around $40,000 per year). A transparent example of a Cayman Island foundation is the ENS Foundation, which is setup as a nonprofit foundation with three (3) directors, a Cayman Island firm as a supervisor, and the NFT owners as the “council.” ENS NFT owners have the right to vote on the actions it takes and the directors and supervisor have the obligation to execute the decisions of the NFT holders. ENS formation documents even provide that if the entity is dissolved, any left-over assets will be donated to a nonprofit as decided by the council.
The Solution for Vanlife DAO…(drum roll please). Vanlife DAO is being formed as a nonprofit LLC based in the Republic of Marshall Islands (“RMI”). In December 2021, RMI became the first country to acknowledge and validate DAOs through an amendment to its Non-profit Act and Limited Liability Act. RMI has traditionally been the place for charter boats to establish their LLCs because RMI’s laws are modeled after Delaware. RMI is also the corporate home for over 40 companies publicly traded on United States stock markets. RMI has a seat at the United Nations, which establishes it as a respected jurisdiction.
The RMI nonprofit LLC entity specifically allows DAOs to establish and amend governance and track membership through smart contracts on a blockchain. The RMI amendment removes the requirement to have directors. Its definition of nonprofit includes educational entities, social entities and entities that are generally focused on good works (it excludes political entities). For DAOs that are true nonprofits, this entity combines the best attributes of all the entities.
MIDAO.org helps DAOs form RMI nonprofit LLCs at reasonable rates. It requires that three member of the DAO be identified and verified through a KYC process. MiDAO has been super helpful through the process and answered the thousands of questions that I had before deciding to hire them (even negotiated a 5% discount for your DAO, just mention this article).
As provided in the whitepaper and roadmap, Vanlife DAO is on the mission to empower and promote our Vanlife and digital nomad communities through acquiring and stewarding land to use as parking and gathering spaces. Vanlife DAO NFT owners will grant membership in the DAO. Membership give each member an equal vote and the right to propose projects and deploy funds. Membership will also give you the right to enjoy its assets (parking spaces and land) and projects (events and workshops) as provided by Vanlife DAO community. The community will have wide discretion on stewarding its assets for the benefit of its members and our global community. To become a member, you will simply purchase a Vanlife DAO NFT, which will be released late May 2022. The revenue from the sell of the NFTs will be used to establish Vanlife DAO treasury wallet and to reimburse the legal and formation costs. The Vanlife DAO treasury wallet will be managed by stewards that that will be elected from within the community by the NFT owners through a vote. We will also need to hire people to manage properties, put on events and facilitate communication among our members. Stay tuned for your chance to be part of the community by subscribing to Vanlife DAO official links.
Overcoming your DAO’s identity crisis
A clear symptom of a DAO’s identity crisis is not having an established legal entity and/or self-governance documentation—whitepaper, litepaper, charter, bylaws, etc. The best way to treat an identity crisis is to look inward as a community and explore your values and goals.
Personally, I was torn between forming Vanlife DAO as a cooperative or a RMI nonprofit LLC because both entities provided a solid structure to achieve the mission. I ultimately chose RMI nonprofit LLC because it does not require any directors and allows the greatest governance flexibility. “Do or do not. There is no try.”-Yoda. The best approach is to choose and form the legal entity that best fits your DAOs mission for now. If the legal entity you choose ends up not being a good fit, you may be able to change the legal entity structure or dissolve it and form a new one (which is a story for another day).
I hope this conversation gives you some ideas on how to overcome your DAOs’ identity crisis. Hit me up with any questions, comments, FUD or feedback. Until next time, go forth and DAO it!
P.S. I published on Mirror.xyz because it is a DAO itself and provides an intuitive platform to write and publish articles as NFTs. This article being released as an NFT funds Mirror to prevent targeted adds and also funds my Kombucha addiction and gas money. You can use Mirror’s platform to create and share your own NFTs--articles, videos, recordings, and even crowdfund. Looking forward to checking out your NFT!