Hedera January Update on Business Operations and SAFT Amendment Proposal
Jan 27, 2020
by Mance Harmon
CEO and Co-founder

"Safe Harbor" Statement: Statements in this blog post relating to Hedera's future plans, expectations, beliefs, intentions and prospects, including statements regarding its cash run rate, are "forward-looking statements" and are subject to material risks and uncertainties.

Part 1: Business Operations

As part of the recent business and coin economics review, the senior leadership team at Hedera has examined every part of Hedera’s strategy and operations. Hedera achieved a major milestone in 2019 when we opened the network for anyone to create accounts (i.e., Open Access). The nature of the work leading up to Open Access was in many ways different from what is required for the next phase of growth. The first phase of Hedera necessitated developing new technologies from scratch, bootstrapping development of a global scalable network, and recruiting the earliest council members. Some of these front-loaded costs can now be reduced as Hedera progresses along its published path of ever-increasing decentralization.

As a result, we are adjusting Hedera’s mix of resources, reducing costs in a number of areas while continuing to focus resources on supporting the growth and use of applications on the platform. We believe this is important to position Hedera for continued growth in a very competitive market, which is experiencing an extended ‘crypto winter’ for distributed ledger companies.

This narrowing of focus unfortunately includes the elimination of 10 positions globally, including a mix of contractors and full-time employees. These are very hard decisions, and we do not take them lightly. We are colleagues and friends at Hedera, and we appreciate everyone’s contributions. Hedera is offering enhanced severance benefits and out placement services to make this transition as smooth as possible for those affected. We hold every one of them in high regard, and have utmost respect for their talents and work ethic. We will always be thankful for the important work they have done to help build Hedera, and are confident others will benefit from their skills as they transition to new opportunities.

The difficult actions we are taking now will better enable Hedera to focus resources on the essential activities for Hedera’s next chapter of growth.

Hedera raised approximately $124 million from December 2017 to August 2018, which after accounting for taxes, transaction costs, and the 10% payment to Swirlds, resulted in net proceeds of approximately $83 million. We maintain a robust cash position of more than $31 million as of January 1, 2020 and today’s actions are part of reducing our projected run-rate, based on various internal financial assumptions, to less than $2.5 million per month. There continues to be strong interest, including from big enterprise, in purchasing hbars directly from Hedera. We anticipate that, at a time and in a manner to be determined by the Council based on network usage, regulatory requirements, and other considerations, Hedera will commence selling some of the hbars held in treasury. Any plan to sell hbars will be designed to avoid flooding the market and will comport with all applicable laws and regulations. Those sales will be included in the total number used to calculate the additional hbars to be distributed to SAFT holders who elect to participate in the new SAFT proposal. This is explained more fully in the next section of this post.

Part 2: Update and clarification of SAFT Proposal

We have received questions about the SAFT proposal shared in December, and here we provide additional detail.

This does not constitute the definitive offer, which will follow when we have completed the documentation. But to restate the proposal, beginning in February, existing SAFT holders may choose to participate in a program that further incentivizes network usage and growth. Specifically, participating SAFT holders, in exchange for stretching out the release schedule for their remaining coins, will receive additional allocations of coins on a quarterly basis, beginning in Q4 of 2020, and continuing until the cumulative value of those additional distributions equals the value of their original principal investment.

The release of these additional hbars will be based on the pace of network adoption. On a quarterly basis, Hedera will calculate the total number of coins it has sold, whether from coins received as network transaction fees or from Hedera’s treasury. A pool of coins equal to 10% of those sold will be released to the participating SAFT holders. These “additional allocations” will be made pro rata, based on, and with a cumulative cap equal to, each SAFT holder’s aggregate USD investment amount (as shown in the “Purchase Amount” field on the SAFT documentation which, for purchases made in BTC, was calculated as described at the time of purchase).

SAFT holders who do not want to participate will keep their existing SAFTs without change.

Any current SAFT holder that chooses to participate will receive the full number of coins expected in their original SAFT agreement, but will agree to extend the distribution schedule for what remains of their original SAFT allocation (i.e. what has not yet been distributed) by 25%. In exchange, Hedera will make additional distributions over time until the aggregate additional distributions of coins are equal in value to the full value of their original investment. Those additional distributions will be made at a rate commensurate with network growth and adoption. Note that the additional payments will likely be made over a period longer than the remaining distribution period on the SAFTs, since they are limited to 10% of hbars sold. We are not able to accurately estimate how long it will take for the additional distributions to participating SAFT holders to equal the value of their principal investment, as it depends both on participation in this program and network activity levels.

1. On a quarterly basis, Hedera will calculate the total number of coins sold, whether from coins received as network transaction fees or from Hedera’s treasury.

In early Q4, 2020, Hedera will calculate the total number of coins that it has sold from February 1st through September 30th 2020, and publish this number to the market in a formal report or blog. In each subsequent quarter, Hedera will publish the same information for the prior quarter.

2. A pool of coins equal to 10% of the number of coins sold will be released to the participating SAFT holders.

At the beginning of each quarter, Hedera will put into a publicly identified account a number of coins equal to 10% of the published number of coins it sold in the prior quarter. Hedera will distribute the coins from that SAFT distribution account in one or more tranches, all of which are distributed within the same quarter. For example, if 1,000,000 coins are sold in Q3, in early Q4, 100,000 coins will be placed in the SAFT distribution account, and all 100,000 coins will be distributed to the participating SAFT holders by the end of Q4 in one or more tranches. For each distribution, Hedera will notify the public before the distribution is made. Depending on the number of coins to be distributed in a quarter, it is likely that Hedera will spread out distributions over multiple days rather than concentrate all distributions on a particular day.

3. These “additional allocations” will be made pro rata, based on and capped at each SAFT holder’s aggregate USD investment amount.

The number of coins one receives depends on the number of dollars one invested as a percentage of the total number of dollars invested by those participating in this new program. By way of example, we can calculate the number of coins the fictional investor Alice would receive in a single quarter given the following assumptions:

• 1000 coins are sold in Q4, 2020

• 100 coins are allocated for distribution in the new program in Q1, 2021

• 500 people participate in the new program

• The sum of their principal investments is $100,000,000

• Alice invested $1,000,000, or 1% of the total invested by the 500 program participants

• Alice will receive 1 coin in Q1, 2021 (100 X 1% = 1)

Because coins are distributed pro-rata based on the number of dollars invested, and because SAFT 3 invested substantially more dollars than SAFT 1 and 2 combined, it is anticipated that most additional coins will be distributed to those that participated in SAFT 3.

4. Any current SAFT holder that chooses to participate will receive the full number of coins expected in their original SAFT agreement, but will agree to extend the distribution schedule for what remains of their original SAFT allocation by 25%.

Assume a fictional SAFT 3b investor named Bob, who invested $9,600 for 100,000 coins. The original allocation of 100,000 coins will be paid in 6 annual installments over 5 years, rather than 5 annual installments over 4 years. The first 20,000 coins were distributed at Open Access in September, 2019. Instead of receiving 4 additional annual releases of 20,000 coins, Bob will receive 5 additional annual releases of 16,000 coins for a total of 100,000 coins.

5. In exchange, Hedera will make additional distributions of coins over time, at a rate commensurate with network growth and adoption, until the cumulative value of those additional distributions equals the full value of the original investment.

Continuing with the example from #4 above, in addition to the original 100,000 coins, Bob will receive quarterly allocations until the aggregate value of the additional coin distributions is $9,600. For example, assume that Bob is distributed 100 coins in Q4. Hedera will use the Hedera platform Exchange Rate Tool to determine the coin conversion rate at the time of distribution. Again, by way of example, if the coin conversion rate on the day of distribution is $0.05, then Bob is credited as having received $5 of value. Similarly, if the conversion rate is $0.01, then $1 of value, or if $0.10, then $10 of value.

This is a summary and not the definitive offer; there aren’t any steps you need to take for now. Documents describing these options in greater detail will be provided to all SAFT holders. After receiving those documents, each SAFT holder will have at least twenty business days to review the offer and supporting documents and disclosures and to determine whether to participate in the new program or to maintain the existing SAFT. The effect of participating or choosing not to participate in this program may vary based on individual considerations, and SAFT holders should review the documents carefully and consult their counsel and financial advisors before deciding how to proceed. We will finalize the new coin release schedule and publish a revised plan once the election period for the new SAFT option has closed.

This update does not constitute an offer to sell, or a solicitation of an offer to buy, hbars or any securities. The terms of the SAFT distributions described above do not constitute a legally binding agreement and are subject to change, based on the definitive documentation to be distributed.

Part 3: 2017 Executive and Advisor Coin Grant Release Schedule and Restrictions

The work we completed in Q4 2019 around Hedera’s coin economics model is informing ongoing decisions around coin release schedules. This post addresses coin grants that were made to executives and advisors who started working on Hedera before December 2017. The right to coins under those grants vests over a period of years. As we described before Open Access, some of those recipients previously agreed to postpone receipt of the coins that vested under those grants until after January 1, 2020. The detail below outlines further voluntary limitations on the sale of those coins, beyond what was outlined at Open Access. The goal of doing so is two-fold: to take additional steps, where possible, to better match network growth and utilization, and to provide more visibility and certainty to the Hedera community about the sale of coins by Hedera’s earliest executives and advisors.

2017 Executives: Co-founders

Leemon Baird and Mance Harmon each have coin grants as follows.

Two billion hbars (4%) in total allocation each, vesting over a six-year period:

• 500 million coins each, previously described for ‘short term’ release, which vest over a period ending in 2021 (1 billion coins for Mance and Leemon combined). Under the terms of the grant and requirements of the tax laws, the coins that vested through December 31, 2019 (400 million combined, or 40% of the combined short-term allocation) must be released no later than March 15, 2020.

• 1.5 billion coins each, previously described for ‘long term’ release, which vest over a period from 2020-2023 (3 billion coins for Mance and Leemon combined)

• Mance and Leemon previously agreed to delay receipt of a portion of their “short term” allocation until August 2023 through November 2024 (4-5 years post-OA).

• As with all employees, for each release of coins, Hedera withholds a certain percent in order to meet the company’s tax withholding obligations.

Leemon and Mance do not have any present intent to sell their vested coins and are in discussions with Hedera on terms for formally locking them up, subject to certain carve outs. Any such lockup will be communicated to the public. While those discussions continue, and if they end without a formal lockup agreement, Leemon and Mance are committing that they will not sell any of the granted coins without informing the public at least 30 days in advance.

• The 400 million coins mentioned above (coins that vested through December 31, 2019) will be released on February 1, 2020. Those coins, less the amount that Hedera withholds for tax purposes, will be deposited into a common account with the other early executives who intend to hold their coins and are participating in the discussions with Hedera about a voluntary lockup.

• Approximately 25 million coins will be released in monthly distributions for the next 14 months. Each of those additional 14 distributions, less the coins withheld for taxes, also will be deposited into the common account.

• Details about the release of coins beyond the next 14 months will be shared after discussions about the voluntary lockup have concluded.

• Additionally, Mance and Leemon each participated in SAFT 1 and SAFT 3. The total number of coins they each are entitled to under their SAFTs is 461 million and 500 million, respectively, under SAFT 1, and 83,333 each under SAFT 3. Mance and Leemon each sold less than $500,000 worth of coins received from their SAFT distributions on the day of Open Access to a third party in an over-the-counter transaction at a price of $0.096, but have not sold any coins since that day.

• Accounting for both coins they may receive through coin grants and the coins they will receive under their SAFTs, the founders each have a right to just over 5% of the total coin supply.

• For both coins received under their coin grants and coins received under their SAFTs, Leemon and Mance will define a reasonable selling plan, which will be disclosed publicly at least 30 days before selling any of their coins. The selling plan will be designed to avoid flooding the market or selling based on non-public information, and to comport with available regulatory guidance (if any).

Other 2017 Executives

Other early 2017 executives who remain with the company received grants with a combined total of approximately 550 million coins, which vest over a number of years ending in 2021. Like Mance and Leemon, these executives do not have any present intent to sell these coins and are speaking with the company about voluntarily locking up the coins that have vested through December 2019, subject to certain carve outs.

• A combined 220 million of these coins (40%) have vested through December 2019 and will be released on February 1, 2020. These coins, less the amount withheld by Hedera for taxes, will be deposited into a common account with those from Mance and Leemon pending final terms on the voluntary lockup. While those discussions continue, and if they end without a formal lockup agreement, these executives will not sell any of the granted coins without informing the public at least 30 days in advance.

• These executives will continue to vest into their coin grants from January 2020 forward. They will receive, combined, approximately 9 million monthly, less the amount withheld for taxes, for the next 14 months, consistent with the schedule for releases to other (non-founder) employees. These coins will not be restricted nor deposited into a common account.

• Details about the release of coins beyond the next 14 months will be shared after discussions about the voluntary lockup have concluded.

• In addition, these executives participated in SAFT 1 and SAFT 3, and will receive those coins consistent with distributions to other SAFT 1 and SAFT 3 holders.

Former Hedera president Tom Trowbridge, with whom the company parted ways in 2019, will receive 300 million vested coins, less the amount withheld for taxes, on February 1, 2020, after which there are no further distributions owed to Mr. Trowbridge under his coin grant. Unlike the other executives, Mr. Trowbridge has chosen not to participate in any lock-up plans proposed by the company.

Senior Advisors

Senior advisors that have been advising the team since the beginning, have coin grants for a combined total of 200 million coins. Approximately half of these coins have vested, and will be released on January 31, 2020, with the remainder to be released on a regular basis (currently expected to be monthly) moving forward. Unlike for employees, Hedera does not have an obligation to pay withholding taxes on distributions to advisors, who receive the full amount of the coins released to them and are responsible for covering their own tax liability. Other than to potentially cover that tax obligation, these advisors do not have any present intent to sell these coins and have agreed to provide 30 days of notice if they start selling any coins (other than for taxes) before the one-year anniversary of Open Access, September 16th, 2020.

We note that this distribution to senior advisors on January 31 was not included in the prior January distribution report. Because these advisors have agreed not to sell the coins without at least 30 days’ notice, we do not expect this change to the distribution number to have any practical effect of the liquid supply of coins.

Coins Withheld For Taxes

As described above and previously, Hedera withholds coins to cover the company’s tax withholding obligations for employee distributions. The immediate tax obligations from the distributions to the founders and early executives will be paid using cash on hand. As with other coins withheld from employee distributions, the company may sell those coins slowly over time to a third party to replenish those funds.

We appreciate that there is a lot of information in this post; we wanted to provide timely and comprehensive information to our community. We appreciate all the support, and look forward to providing more updates in coming weeks related to network services, the ecosystem, and the governing council.