Investors Wary of Board Seats at Crypto Startups Due to Legal Risks

Crypto investment firms Pantera Capital and Standard Crypto are two other examples of firms that generally do not seek out board seats on token-issuing startups due to the legal risks, according to people with direct knowledge of the matter. Pantera did, however, take a board seat at decentralized finance startup Ondo Finance in 2021, one of the people said. At that time Ondo had not issued tokens, although it has recently done so.

There are other exceptions. Andreessen Horowitz General Partner Arianna Simpson holds a board seat at Axie Infinity, a token-issuing gaming startup the venture firm first backed in October 2021. But Axie stands apart because it’s seen as the highest-profile blockchain game to date.

VC firms have poured more than $1.1 billion into some of the top token-issuing blockchain startups since the start of 2020, viewing the token sales as an important way to lure users and help get projects off the ground. In doing so, they’ve also wagered that they can land significant gains as the tokens they receive in exchange for their investment increase in value.

But many of these startups have seen plummeting token prices as well as a growing onslaught of scandals that could attract regulatory enforcement actions and private investor lawsuits. This year, for instance, hackers have stolen hundreds of millions of dollars’ worth of tokens from the decentralized platforms that power blockchain videogame Axie Infinity and financial project Wormhole.

Securities and Exchange Commission Chair Gary Gensler meanwhile has been outspoken in his belief that many crypto tokens are securities and thus should be regulated by the SEC. All of these issues could increase liability for board members of startups.

“To the extent there's regulatory scrutiny, or the SEC is looking to target someone, or for that matter, plaintiffs’ lawyers are looking to target someone, they will always routinely name board members,” Perrie Weiner, chair of law firm Baker McKenzie’s North America securities litigation group, told The Information.

What can make venture capitalists particularly reluctant to join boards is that directors and officers insurance can be hard to get, at least at a reasonable cost, founders and lawyers said. This insurance covers members of a board for the costs of legal settlements or regulatory penalties. Without it, board members are on the hook for those expenses.

It’s not just crypto startups that are having trouble obtaining such insurance. MicroStrategy, an enterprise software firm that has poured billions of dollars into bitcoin in the past couple of years, said earlier this year it had not renewed its directors and officers insurance because it had become difficult to get on “acceptable terms.” The company said Executive Chair Michael Saylor would personally indemnify the board members.

Venture investors have been less skittish about taking seats on boards of centralized crypto companies that issue traditional equity, like non-fungible token marketplace OpenSea and crypto exchange Coinbase. That’s because those companies might be seen as a “more reliable part of the industry” in the eyes of regulators since they don’t issue their own tokens, said Marc Fagel, a securities lawyer and former regional director of the SEC’s San Francisco office.

But even sitting on those boards could be high risk, he added. That’s because the SEC is scrutinizing the entire crypto industry for potential violations related to unregistered securities. Exchanges haven’t been immune, given that the agency is now reportedly probing Coinbase and its peers for listing tokens issued by other crypto firms.

Decentralized Governance

VC investors can find ways to influence startups without taking board seats. One venture capitalist told The Information they sometimes will help startups form advisory councils, which offer informal advice to founders, to avoid the legal liabilities of serving as an official board director.

But while those councils may not have the same legal standing as boards, the SEC may still try to argue that members should be held accountable as company “gatekeepers,” securities lawyers said.

That line of reasoning has already shown up in private crypto litigation. A user lawsuit filed against Uniswap Labs named Andreessen Horowitz, Paradigm and Union Square Investors as defendants even though none of the VC firms has a board seat. The suit alleged that the VC firms played an active role in promoting unregistered securities by helping develop Uniswap and providing liquidity on the decentralized crypto exchange.

“These allegations are meritless and the complaint is riddled with factual inaccuracies. We plan to vigorously defend against this suit,” said a Uniswap Labs spokesperson in an email to The Information.

Meanwhile, some startups take an unconventional decentralized approach to corporate governance by allowing anyone who owns tokens to vote on company issues through the blockchain. That gives investors another way of influencing the startups’ direction.

Boris Revsin, a managing partner who oversees crypto investments at Tribe Capital, said his firm sometimes weighs in on product- or company-related issues through blockchain-based governance votes. Revsin said those arrangements create risk for investors because “inexperienced founders…don’t have a legal requirement to report certain things to a board.”

But Revsin said some investors have accepted that risk as part of the gamble of betting on emerging blockchain technology. “On the positive side, it does leave the door open for decentralization.”