How to choose a legal wrapper for your DAO

In this guide, we’ll discuss steps you can take to choose a legal wrapper for your DAO.

This is not legal advice, rather, it is written to help you get an overhead view of the regulatory options for DAOs so you can best protect yourself and your contributors.

Much of this guide is split between U.S. and non-U.S. entities. This is because of the unique regulatory environment in the U.S. It’s essential for DAOs to consider the nationality of their members when choosing a legal wrapper. If a DAO has a significant number of U.S. members and the organization is “wrapped” in an entity that the U.S. deems insufficient, unfriendly, or uncooperative, there could be government intervention.‍

Why does your DAO need a legal wrapper?

Your DAO needs a legal wrapper for these reasons:

• Interact with other parties: Your DAO can’t sign contracts or enter into agreements without corporate personhood, which your DAO will gain when it creates a legal wrapper.
• Protect the liability of your contributors: If your DAO is not incorporated, it may be considered a general partnership. This means that all your contributors are liable in the case of a lawsuit or other legal issue.
• Hire employees: If your DAO is going to hire employees, or even just contractors, it will need a legal wrapper to legally hire employees rather than paying workers “under the table,” or “off the books,” which is technically considered tax evasion.
• Pay taxes: To be legally compliant, DAOs need to pay their taxes. Whenever money is changing hands, you’ll need to consider the tax implications.

Your DAO also needs a legal wrapper as a kind of insurance policy against the future of regulation in the crypto space. a16z wrote, “In the next wave of growth for the industry, the most successful networks and protocols will have too many users and too much income to be overlooked by regulators and would be attackers.” When it comes to future regulation, being in a legal gray area could be dangerous for contributors.

When should you get a legal wrapper?

It’s best to get a legal wrapper before you start your DAO if you want to perform any of the actions listed above. If you get a legal wrapper retroactively, it may be more difficult to get buy-in from all your contributors. By getting a legal wrapper first, contributors can properly evaluate the wrapper and decide if they want to work in your organization. Waiting until later could cause regulatory headache.

However, if you haven’t gotten a legal wrapper yet, don’t worry: it’s not too late to become legally compliant.

What options for organization types are there?

DAOs can organize in these ways:

United States:

• UNA: Unincorporated Nonprofit Association (U.S. based)

1. A nonprofit formed without any paperwork or management organization formalities.
2. No board or management group is necessary to interact with the law.
3. Can still generate profits, even with the “nonprofit” status.
4. Cannot distribute dividends. Pays members as long as it is considered “reasonable compensation.”
5. Will likely limit liability of members, but the structure is relatively untested.
6. Highly flexible operations are permitted, which means that you don’t need a clear management or operation structure when submitting your forms.
7. Entity-level taxation (meaning, the business is taxed, and individuals do not need to take extra steps to be compliant with taxes other than income tax).
8. Simple and easy to implement.

• LCA: Limited Cooperative Association (U.S. based)

1. Highly flexible operations are permitted.
2. May require members to reveal identities on a “membership list,” depending on the statutes of the state you’re registering in.

• LLC: Limited Liability Corporation (U.S. based)

1. Highly flexible operations are permitted.
2. May require members to reveal identities on a “membership list,” depending on the statutes of the state you’re registering in.
3. Entity-level taxation (meaning, the business is taxed, and individuals do not need to take extra steps to be compliant with taxes other than income tax).
4. Simple and easy to implement.

Outside the United States:

• Foreign Foundation/Association

1. Requires liaisons willing to exercise larger responsibility over the DAO, such as directors, trustees, or a board of managers.
2. DAO members are not considered “members” or “owners” of the organization.
3. According to a16z’, “the relationship between DAO and Foreign Foundation can never be trustless.”
4. If the DAO has “significant U.S. membership,” any potential tax benefits of being a Foreign Association would be negated.

• No legal wrapper

1. Everything is "off the books."
2. Easy to set up, but may not be sufficient to protect contributors from liability.
3. Might be considered a General Partnership, in which all contributors share equal liability and don't have protection of personal assets.

A16z put together a checklist and flowchart showing the advantages and disadvantages of each organization type. See the chart below:

What states/countries provide good options for DAO legal wrappers?

This non-exhaustive list includes a few possible legal wrappers:

• UNA (U.S.)
• Wyoming LLC (U.S.)
• Delaware LLC (U.S.)
• Marshall Islands Nonprofit (foreign foundation)
• Swiss Association (foreign foundation)

For DAO builders navigating legal wrappers, you may wish to consult a verified DAO Expert. Otoco is one of our DAO Experts that specializes in legal wrappers for DAOs. Get in contact with them here.

UNA

An Unincorporated Nonprofit Association in the U.S. might be the most flexible option DAOs have for incorporating today. With the precedent of liability protection, it still offers limited liability of members even with the “unincorporated” status.

This framework is best for DAOs that:

• Are based in the U.S. or have significant U.S. membership.
• Want a quick, minimal-paperwork option.
• Need to protect the anonymity of their members (no membership lists are necessary).
• Are a charitable DA

Wyoming LLC

Wyoming paved the way for DAO LLC registration when they introduced legislation specific to DAOs. This wrapper is unique because it allows members to specify a smart contract as a manager in the system, rather than only human managers. However, DAO builders should tread lightly, because the Wyoming DAO LLC is more restrictive than a typical LLC.

This framework is best for DAOs that:

• Are based in the U.S. or have significant U.S. membership.
• Are willing to file in Wyoming (they cannot be out of state, although you do not have to live in Wyoming to file there).
• Can designate an in-state agent, such as a company that registers for them, or a lawyer in Wyoming.
• Have “DAO” or “LAO” in their official name.
• Want to include their smart contract into the official legal filings, because in Wyoming LLCs, the organization can be managed by both humans and smart contracts.
• Will remain active: if a DAO doesn’t approve a proposal for over a year, it will be dissolved.
• Are truly community-run, because Wyoming DAO LLCs cannot be “manager-managed,” which means a small group of people manage the organization. Wyoming DAO LLCs must be member-managed or algorithmically-managed, or some combination.

Delaware LLC

Delaware is a common state in the U.S. for companies to register their traditional organization because of its flexibility, low fees, and beneficial tax treatment.

This framework is best for DAOs that:

• Are based in the U.S. or have significant U.S. membership
• Are willing to file in Delaware (they cannot be out of state, although you do not have to live in Delaware to file there).
• Are seeking privacy for their members, because Delaware LLCs do not require disclosure of member information.

Read more

Marshall Islands Nonprofit

The Marshall Islands are where a large portion of the world’s ships are registered. Because shipping is multinational and difficult to categorize, they use the special jurisdiction of the Marshall Islands. In this framework, DAOs don’t need to register as a separate LLC. Instead, DAOs are recognized as a legal framework in themselves, without needing a new entity.

This framework is best for DAOs that:

• Are based anywhere in the world or don’t have significant U.S. membership
• Don’t want to register a separate LLC
• Want access to U.S. services (postal service, for example) without being subject to changes in U.S. regulation

Swiss Association

The Swiss Association framework is a way for DAOs to register as a nonprofit organization in Switzerland. Zug is known for being blockchain-friendly, and can be a good home base for DAOs. While the actual creation of the organization doesn’t require much paperwork, it requires the DAO to write the bylaws of the organization and list board members beforehand. This option doesn’t allow for DAOs to be considered fully decentralized, and many early-stage DAOs might not be ready to write such bylaws.

This framework is best for DAOs that:

• Are based anywhere in the world or don’t have significant U.S. membership
• Can draft bylaws prior to beginning the process
• Have a board to appoint
• Don’t need to be legally recognized as decentralized

Further Resources:

A16z’s Legal Framework for DAOs Part 1

Best for:

• DAOs that will register in the U.S.
• DAOs that use smart contracts to operate

A16z’s Legal Framework for DAOs Part 2

Best for:

• DAOs that will register in the U.S.
• DAOs that may or may not use smart contracts to operate
• DAOs that are still figuring out the best structure to pursue

When it comes to legal situations in DAOs, it’s best to do extensive research and hire a lawyer. Aragon is not your lawyer, and we cannot advise you on which legal entity to select.

For additional legal advice, you may want to consider hiring one of our qualified DAO experts. Find a service provider to help you wrap your DAO here