Choosing the Investment Structure
This chapter explains the building blocks. The full benefits and risks of each instrument are covered once in Chapters 7-11; Chapter 12 provides the combined comparison.
Core principle: Choose the investment rights around the company’s business needs and financial capacity. Then evaluate the offering pathway and tokenization arrangements.
What is an investment structure?
An investment structure is the arrangement defining what investors receive, what the issuer must provide, and how the parties’ rights work.
It should answer:
- Who issues the investment?
- What does the investor own or hold?
- How might the investor receive a return?
- What obligations does the issuer assume?
- What happens if the business underperforms?
- How may the investment be transferred or sold? A tokenized format does not answer these questions by itself.
Example: Two companies each raise $10 million through tokens.
- Company A issues notes requiring interest and principal repayment.
- Company B issues shares representing ownership. Both use tokens. Their financing obligations and investor rights differ substantially.
The three basic categories
Category Investor’s relationship Typical source of return Main issuer consideration
| Debt | Creditor | Interest | and | repayment | under |
|---|---|---|---|---|---|
| the | agreement | ||||
| Ability | to | meet | payment |
obligations
| Equity | Owner | Distributions | and | changes | in |
|---|---|---|---|---|---|
| ownership | value | ||||
| Ownership | dilution | and | |||
| shareholder | rights |
Contractual payment rights Holder of defined payment rights Payments calculated under an agreed formula Scope, duration, and cost of the payment commitment Creditor means a party owed money.
Principal is the amount borrowed or otherwise repayable under a debt instrument. Distribution is a payment to an owner under the applicable terms and legal requirements.
Contractual payment rights can be incorporated into debt, equity, or another security. They are not necessarily a separate legal classification. Specialists must analyze the actual terms.
Debt: raising money through a repayment obligation
A note is an instrument documenting a debt obligation. Typical terms include: Principal amount; Interest rate or other payment formula; Payment dates; Maturity date; Collateral, if applicable; Default provisions; Any conversion or redemption rights.
Maturity is the date on which the specified repayment obligation becomes due. A default is a failure to meet an obligation identified in the agreement.
A covenant is a contractual promise, such as providing financial reports or limiting additional borrowing. Corporate debt makes the investor a creditor rather than a shareholder. Debt investments carry risks, including failure to receive promised payments. [R21]
Potential issuer benefit
A straightforward note may raise capital without issuing ownership interests.
| Corresponding | tradeoff |
|---|---|
| The company assumes payment obligations that | can pressure cash flow. |
| Discovery question: | What reliable sources of cash would support interest payments and repayment at |
maturity? A valuable asset is not necessarily a reliable source of cash for scheduled payments.
Equity: raising money by issuing ownership
Equity represents an ownership interest in an entity. Two common categories are:
- Common shares: Ownership interests typically participating in the business’s remaining economic value.
- Preferred shares: Ownership interests with specified preferences or special rights. Preferred shares may have dividend or liquidation preferences over common shares. However, preferred shareholders generally rank behind creditors in liquidation, and common shareholders may receive nothing. [R22]
Potential issuer benefit
Common equity generally avoids a fixed principal-repayment obligation.
| Corresponding | tradeoff |
|---|---|
| The issuer shares ownership and potentially | governance rights with investors. |
| Governance rights are rights affecting how | an entity is managed, such as voting or approval rights. |
| Preferred equity requires closer examination: redemption, | dividend, conversion, and other terms may create |
| significant | obligations. |
| Discovery question: | How much ownership and decision-making influence is the company willing to share? |
| Contractual payment rights: linking payments to | defined activity |
A royalty is a payment for using specified property or rights, often intellectual property. A royalty-linked instrument connects investor payments to defined royalty receipts or another agreed measure.
A revenue-linked instrument may reference a broader category of revenue. These descriptions are not interchangeable unless the documents define them that way.
Hypothetical example: Assume an instrument pays investors 10% of specified licensing receipts.
| Qualifying | licensing | receipts | Payment | at | 10% |
|---|---|---|---|---|---|
| $500,000 | $50,000 | ||||
| $1 | million | $100,000 | |||
| $2 | million | $200,000 |
This example assumes no deductions, minimum payments, caps, or other adjustments. The actual structure must specify: What receipts qualify; Whether payments use billed revenue or cash collected; Which deductions apply; Whether principal must also be repaid; How long payments continue; Whether minimums or caps exist; What reporting and verification rights investors receive.
Potential issuer benefit
Payments may vary with the defined activity.
Corresponding tradeoff
The payment obligation may reduce cash available for operations even when the company is unprofitable. Revenue is different from profit. A company can owe a percentage of receipts while its expenses exceed those receipts.
Identify the issuer before discussing benefits
The issuer is the legal entity offering the security. A parent company owns or controls another entity.
A subsidiary is an entity owned or controlled by another entity.
| Issuer | What | needs | investigation |
|---|---|---|---|
| Operating parent company Its | entire business, assets, liabilities, | and proposed security | |
| IP subsidiary Its ownership | or licensing rights, expenses, | obligations, and parent relationship |
Other special-purpose entity Its purpose, assets, contracts, management, and legal eligibility A special-purpose entity is an entity established for a defined activity or transaction.
Creating a separate entity does not automatically isolate every risk, protect assets from all creditors, or establish eligibility for Regulation A.
Example: Investors hold shares in an IP subsidiary. The parent company is not automatically obligated to support those shares or pay the subsidiary’s debts.
A guarantee is a separate commitment to answer for specified obligations of another party. Its scope must be documented.
Discovery question: Which entity would issue the security, and what support would the parent provide, if any?
The five structures involve overlapping choices
The five structures in this manual are not five completely separate categories. They combine three decisions:
| Decision | Examples |
|---|---|
| Instrument type | Secured note, preferred share, royalty-linked security |
| Issuing entity | Parent company or IP subsidiary |
| Digital format | Tokenized representation and related records |
For example, an IP subsidiary could issue tokenized preferred shares or tokenized secured notes. A parent company could also issue preferred shares or a royalty-linked instrument.
Training point: Always describe both the instrument and its issuer. “Tokenized IP investment” is too broad to explain the investor’s rights.
Financial capacity should shape the discussion
Use the company’s facts to identify what deserves further review.
Prospect’s situation Questions for specialists
Stable cash generation; prefers to retain ownership
Could debt be supported under realistic downside scenarios?
Recurring licensing receipts Could a defined payment participation fit the cash flow and legal requirements? Limited near-term cash flow Could equity fit better than substantial scheduled debt payments?
Wants financing focused on one IP business Would a subsidiary structure accurately contain the relevant rights and activity?
Wants funding across the entire company Would parent equity or another corporate financing fit the objective?
Wants investor preferences Which preferred-share rights are sustainable and acceptable? This is a discovery guide, not a suitability determination or a recommendation to use a particular security.
Downside scenario means a plausible adverse outcome used to test the proposal, such as lower receipts or delayed commercialization.
Regulation A eligibility is a separate review
A commercially attractive structure must still qualify for the proposed offering pathway. Regulation A permits specified equity and debt securities but excludes asset-backed securities as defined in Regulation AB. Certain issuers, including specified investment companies, are also ineligible. [R01] Consequently: A secured note is not automatically an excluded asset-backed security; A royalty-linked instrument is not automatically eligible; An IP subsidiary is not automatically an eligible issuer; Creating tokens does not resolve those questions.
The legal team evaluates the actual issuer, assets, activities, and instrument. SDR explanation: Once the commercial objectives are clear, the specialists assess which structures and offering pathways are legally available.
How the team evaluates a proposed structure
A productive specialist review follows this sequence: Establish the business objective: Amount, use of proceeds, and timing; Identify the issuer: Entity, ownership, assets, and obligations; Assess financial capacity: Existing results and realistic future cash flows; Define investor rights: Payments, ownership, priority, governance, and duration.
- Review legal availability: Issuer eligibility, security classification, consents, and restrictions.
- Assess accounting and tax effects: Classification, reporting, and transaction consequences.
- Design administration: Ownership records, tokenization, custody, and investor communications.
- Evaluate transfer and trading arrangements: Separately from issuance. A term sheet summarizes proposed commercial terms. Whether any provision is binding depends on the document.
An SDR may collect preferences for a term-sheet discussion. The authorized specialists negotiate and finalize the structure.
Practical discovery scenario
Prospect: We want to raise $10 million against our patents without diluting our public-company shareholders. SDR response: We should clarify whether your priority is avoiding parent-share issuance, preserving all ownership economics, or retaining voting control. Those goals can lead to different structures. The specialists will also need to review cash flow, patent ownership, existing claims, and the rights investors would receive.
Why this clarification matters
- Debt may avoid share issuance but create repayment obligations.
- Subsidiary equity may avoid parent-share issuance while reducing the parent’s subsidiary ownership.
- Preferred equity may preserve some control while adding economic preferences.
- Royalty participation may avoid common-share issuance while committing future receipts. “No dilution” is too broad unless the company specifies which ownership or economic measure it means.
Useful handoff: The prospect seeks $10 million for patent commercialization and prefers to avoid issuing parent common shares. Ownership, existing collateral claims, and licensing receipts remain unverified. Management is open to debt or a subsidiary transaction. Specialist review should assess repayment capacity, ownership economics, instrument terms, and offering eligibility.