Optimizing Your Token Allocation & Compensation
People see token compensation plans as a tough job and we won’t say that their judgement is clouded. Given the volatility of crypto markets, tricky legal implications, and no absolute rulebook to follow, the situation is as murky as it sounds to employers. Whereas fragmented data, unending spreadsheets, and improper software play to further muddy the waters.
So, why should you go through the hassle of allocating and preparing a compensation plan? What possible hurdles are there to overcome? And most importantly, what’s the ‘right way’ to do it all? Let’s dive in.
Key Takeaway Token
- Token compensation plans are a great way to incentivize employees, keep them aligned with the company’s interests, and allow them to invest and generate more revenue.
- Lack of legal and operational clarity, plus utilisation of inaccurate valuation methods and faulty crypto tax softwares make allocation a tough deal.
- A three-step procedure covering key areas including allocation, grant specifications, and drafting, must be followed to prepare a standardised compensation plan.
Why go with Token Compensation?
Historically, an employee compensation plan comprises salary, bonuses, commissions, and other incentives. Adding tokens to the list is just a recently developed idea that has its unique perks:
- While in a conventional setup, aligning employee-organisation incentives is a wild goose chase, allocation allows aligning the interests of employers, employees, end users, as well as the entire community together
- Grants employees the liberty to participate in the protocol or network as users
- Let employees utilise techniques like staking or borrowing to leverage other primitives and generate additional returns
- Saves from excise costs while providing instant liquidity
What Problems to Expect While Preparing a Token Compensation Plan?
While many crypto organisations learn to send tokens, they lack proper understanding of the underlying operational, legal, and crypto taxation challenges. The problem might seem meagre in the beginning, but an absence of a standardised plan can be a big fish to fry if the project skyrockets.
Some of the common mistakes we’ve observed in compensation plans include:
- Lack of a clearly defined path for allocation in individual compensation plans
- Lack of identifying the best-suited grant structure (e.g., RTA, Phantom, etc.)
- Lack of proper knowledge of valuation methods and crypto accounting knowledge
- Lack of legal and operational understanding regarding crypto tax implications and grant agreements in different jurisdictions
To avoid these imminent problems, a step-by-step guide to a flawless compensation plan must be followed. So, what’s the wait for? Let’s delve deep into the world of crypto accounting and token allocation!
Token Allocation & Compensation Plan: A Comprehensive Guide?
Step 1: Token Allocation
Before deciding on your compensation plan, you need to decide how many tokens you are going to grant as a reward to both existing and future employees. While you might have a number in mind, some of the factors you shouldn’t avoid in decision-making are:
Price: Value in the fiat currency of the you are up for allocating to the grant pool as well as every individual employee
Headcount: Number of participants eligible for the plan and the anticipated headcount growth
Outcome: Project the possible impact of allocation on the supply and demand cycle
Allocate: Think of a percentage of from every project or the entire company you are ready to allocate
Now, the next leading question is, from where do I get the supply for allocation? Well, organisations can supply from three possible sources:
Allocate from Token Reserves
The most common approach by companies is to allocate a predetermined percentage of tokens from the pool for compensation. The percentage varies from case to case. Roughly speaking, up to 30% of the are kept in reserves for allocation.
Allocate from Existing Tokens
If a company hasn’t planned ahead, it can allocate existing . This situation is subject to the condition that the company has an abundant token supply and the allocation is not going to impact negatively.
Issue Fresh Tokens
In case of unavailability of for allocation, you may resort to creating new ones. However, this approach must be planned carefully as it will result in dilution which may impact stakeholders’ interests and token value.
Step 2: Decide on Token Grant Specifications
Once you’ve decided how much you are going to give to your employees, start thinking about ‘on what basis?’ and other details. Some key considerations you should keep in mind are:
1.Eligibility Criteria
You don’t want to share the assets of your company with everyone. Therefore, you need to figure out an eligibility criterion to restrict the opportunity to valuable employees only.
The criteria may include:
a) The period an employee has served you
b) Employee’s status and the value they’ve added to your firm
c)For contractors, reward them on the basis of their loyalty and involvement in your company
2. Standardised Grant Structure
Token grant agreements come in various forms and not every agreement meets the law of every jurisdiction. Given the same reason, some organisations pick a single grant agreement and use it for token allocation in all case scenarios. While others choose a set of grant agreements under the light of local law.
3. Vesting Schedule
To keep the employee base intact, you need to formulate a vesting schedule to grant tokens. For this, you can use the conventional 4-year vesting with a 1-year cliff method. This usually entails that the company will vest 25% of the tokens in the first year and the remaining tokens will be vested in the remaining period on a monthly basis.
4. Estimating Offers
Your compensation plan is not viable if you can’t tell your employees the value they’ll be granted in the form of tokens. Plus, accurate estimation is critical for tax purposes as well. But, given the volatile nature of tokens, we can tell you the task isn’t that simple.
Some of the common token valuation methods followed by companies are as follows:
Market-Value Based: Determination of value based on exchange or market rates.
Comparable Company Analysis: Estimating value based on drawing comparisons between similar projects.
Discounted Cash Flow Method: Valuation of token based on the future cash flows it will generate.
5. Token Distribution
To avoid any confusion, you need to inform the recipient what strategy you follow to move from your custody account to their wallet. Decide whether you want to settle tokens right away or put trading restrictions before settlement. Crypto tax software can help in making these decisions more streamlined.
Whatever you choose, make sure to communicate your choices accordingly.
6. Termination Clause
Your employees should have clear knowledge about what happens with the unvested tokens in case they are no longer a part of the company. Generally, if an employee quits the organisation voluntarily, the unvested are forfeited. Whereas, if the organization terminates the employee, the vesting process varies with the cause of termination. In case of layoffs, the vesting process may accelerate while in case of termination due to misconduct, the company may resort to forfeiting unvested tokens.
7. Clawback Provision
Would you like to share the assets of your company with an employee involved in fraudulent activities? Or with someone violating your company’s policy? We assume you won’t.
To deal with such situations, your grant agreement must have a clawback provision. This will allow you to reclaim your vested in case a contractor or employee is involved in misconduct.
8. Warranties and Counselling
Your employee expects some sort of guarantee from you ensuring that you will fulfil the commitments outlined in the compensation plan. Similarly, you want assurance that the employee will remain compliant and meet the eligibility terms. To back the expectations of you two, warranties and representations providing legal protection and clarity are a must. Moreover, you should seek legal counselling regarding key risks including governing law, custody, and ownership.
9. Reporting Requirements
Since crypto is still a new idea, the laws governing crypto transactions aren’t absolute or universal. While some jurisdictions require individuals to report the receipt of right at the time when they were granted, others require reporting along with annual tax returns. Ensuring you are using an appropriate crypto tax software for reporting requirements is pivotal!
In the case of an organisation, jurisdictions may obligate reporting at the time of vesting or during the year in which tokens are granted.
Step 3: Finalise and Draft the Grant Agreement
Once you’ve finalised all provisions of your token grant agreement, review them and start the documentation process. Make sure that the documents you prepare to support token grants are legally compliant.
Any breach of the laws can lead to reputational, legal, and financial losses. Plus, it impacts the legitimacy and integrality of grant agreements which, in turn, raises suspicion among employees. So, draft the agreement carefully and share it with employees to avoid any confusion. Consult with a crypto tax accountant and cryptocurrency accountant to make better informed decisions on your agreement.
Takeaway
We prepared this blog with our heart and soul to provide you with thorough guidance in the making of allocation and compensation plans.
But since it’s a recently adopted idea, perplexity at any stage is rightly justified. If that’s your case, feel free to reach out to the crypto CPAs at OnChain Accounting who are seasoned to provide you with financial guidance on areas like bitcoin accounting, crypto taxes, crypto tax reporting, and cryptocurrency accounting.
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