There is a high barrier to entry towards investing in a local restaurant that you believe in. This could be near impossible unless you’re part of an inner circle or institution focused on funding these types of ventures. It would be especially impractical to offer micro-equity in a small business for retail investors…until now? Token issuance and DAOs have drastically changed the way that companies can raise money and operate. If Balaji is right and DAOs continue to disrupt traditional VC, small real-world businesses like restaurants could be one of the new avenues. Note that while I’m focusing on restaurants for this post to make things concrete, this could really apply to any type of business.
DAOs have been primarily deployed in the worlds of DeFi (decentralized finance) and internet services companies to date. I have yet to see instances of “real world” businesses using such a model, perhaps because it is a logistically easier transition to make for digital-first enterprises. Is it even possible to exhibit the same level of “trustless” governance and fund dispersal when so much happens off-chain? Making the physical bridge would be an accelerant for crypto, given the exposure to new types of business owners and patrons.
What could this look like?
There are many possible structures for what I’m proposing so the following are just meant to get the wheels turning. I am not a smart contract engineer and realize there is plenty of nuance in the tokenomics and incentive models. Here’s a toy example:
A restaurant owner decides to give up a portion of equity in the business (and future profits) as a way to raise money for a large renovation he wishes to undertake. He believes the renovation will make the restaurant more attractive to street traffic which will bring in more revenue and profit.
The owner decides to offer up 10% of the business as a starting point. He mints 1M $RES tokens out of a maximum possible supply of 10M, which represents the equity of the business. The business is now a sort of ‘hybrid-DAO’, with ownership split between the crypto and physical worlds. Maybe we don’t want a ‘hybrid-DAO’ state and instead the full supply is minted with the owner retaining 9M. There are multiple ways of doing this.
The restaurant POS system uses some backend magic to redirect 10% of revenue (upon each transaction) to a USDC stable coin wallet, while the remaining 90% continues to go to his original USD bank account. It would be important to ensure the restaurant is taking in all transactions through this 90/10 mechanism — otherwise the owner would be underreporting revenue (skimming). Perhaps there could be some sort of validation done on every POS transaction to verify the USD bank account balance increases proportionally, reported through an oracle network.
The owner is now a partial owner and primary manager of the business. He buys ingredients, manages his workforce, and pays for expenses. The funding source for expenses is split between the USD bank account and USDC wallet (proportionally by equity stake). One key point is that the token holders are not calling all the shots in terms of the execution of the business. The analogy is the relationship between a board of directors and the company’s CEO. Finding the right balance on the spectrum of decentralization would be critical to managing the business effectively.
The business uses some mechanism to distribute $RES tokens to investors. This could be an ICO, an initial liquidity pool that they set up, or perhaps to each customer gradually through a mining operation on each transaction. The menu could advertise investment to patrons — “Do you want to own part of this business? [Insert QR code here]” An enthusiastic visitor could throw down a whopping $10 if they felt so inclined.
$RES token holders could stake their tokens (ie lock them up for a certain amount of time) to earn a proportional yield from the restaurant USDC wallet1. This represents an entitlement to future cashflows of the business. The returns would vary as a function of cashflow (less expenses), along with the proportion to other stakers. This would result in some interesting game theoretic properties, increasing the incentive to stake when others have pulled out. Configuring the optimal rate of profit disbursal would be important since draining funds quickly would hinder paying expenses and reinvestment into the business. On the flip side, choosing a rate too low would make the token less attractive to own and reduce its value.
Additionally, $RES tokens could provide some direct utility at the restaurant. Perhaps meals can be purchased using $RES at a 10% discount to the current RES/USD exchange rate, with the side effect of tokens get burned when spent. Token holders might approve of this because it would concentrate their equity and therefore yield earning potential.
After some time, the manager decides its time to renovate. He has already made $100k from the original 1M token sales. The price of $RES, however, now sits at $0.20 which values the total business at $2M! The cashflow of his business gives the token an ‘intrinsic value’ (based on the USDC yield), and speculation about future earning potential from the sleek renovation has given it ‘extrinsic value’. Mr. Manager decides to mint another 500k tokens and gradually sell them off at an average price of $0.15 to raise $75k in capital. In total he has raised $175k by parting with 15% of his business.
The manager pays for his renovation which works like a charm. The increase in patronage flows down to him in profits and grows the $RES token value since the USDC wallet is now taking in more funds. The process repeats and now lots of improvement ideas are starting to come in from $RES token owners, many of whom visit the restaurant frequently. The business begins to use DAO governance voting to decide which city to expand to next.
Heres an ugly diagram pulling some of this together:
Why would this be beneficial?
The scenario laid out above is oversimplified and filled with plenty of gaps. Implementation details withstanding, I believe the following are the high level benefits:
1) Selling equity though a token could make it easier for a restaurant to raise capital. The potential investor pool has gone from friends/family/institutions to anyone with an internet connection. Ideally this would bring in restaurant patrons and community members who have a vested interest and key insights towards the success of the business.
2) Retail investors would get entry into previously inaccessible investment opportunity. Individuals could buy into establishments which they believe are poised to succeed for whatever unique reason. In the section entitled “The Economic Nervous System”, Robert Breedlove posits that capitalism outcompeted centrally planned economies by capturing the ‘distributed knowledge’ of supply and demand via the dissemination of price signals. Can a private equity firm pick winners and losers better than the restaurant patrons and communities themselves? It seems that the latter could outcompete based on the pure increase in processing power (more nodes!)
3) The two points above could be accomplished without the need for a third party. Cutting out the middle man would reduce costs and expedite market discovery.
Challenges and nuance
Ok, time for some self-critique.
Part of the brilliance of DAOs is that payouts and governance can occur in a “trustless” fashion. Wouldn’t this completely break down for a hybrid model which interfaces with the physical world?
In principle, all parties would be economically aligned on the business succeeding, but this aspect needs a lot more thought. How could token holders be sure that the real world business is being operated above board? Oracle networks have been used to merge on-chain and off-chain data in the past and it seems like they could partially be deployed here. Also, what are the implications on decision making when <50% of the business is deployed in a DAO vs. >50%? Maybe these could be the equivalent of different classes of stock (preferred vs. common shares). The relationship between the original business owner/manager and the token holders seems like it would be a delicate balance. Designing the system correctly would be important to ensure that one party can’t game the system.
Wouldn’t this sort of revenue/governance model take the authenticity and charm out of the best restaurants, eventually turning each Michelin starred establishment into a Hooters?
Businesses need to make money. Without a doubt, distributing equity and voting rights is a forfeiture of control along with whatever original vision the restaurant started with. But that super charming restaurant you visited and told all your friends about is filling some specialized market need based on your enthusiasm. Losing differentiation would be a bad thing for business. Also, an organization may find that keeping creative control in the hands of a small number of people is both economically optimal as well as resulting in the most charming experience. Distributed ownership is not the same thing as mob rule.
How would restaurants be able to operate effectively when there are thousands of token holders who have proportional voting rights in the DAO?
As I mentioned in the toy example, I think there could be a wide spectrum in how much equity is given up. This could go anywhere from owners selling some tokens to pay for a one-off project, to a fully decentralized and automated business, though that may be challenging. As in the Board of directors/CEO analogy, it would seem useful to leave control over day-to-day execution in the hands of a manager and leave large decisions for the DAO to vote on (renovation, expansion etc). Perhaps there is a low expense threshold or whitelisted set of purchase types that the manager is safe to execute on directly. The rules could be clearly stated in the DAO and updated through votes. Maybe some organizations would decide to manage the supply-chain and menu and automatically hedge important ingredients with futures contracts!
Would the incentives from the token staking model actually work? Couldn’t a big event cause a restaurant to go instantaneously belly up?
A Forbes article from a few years ago quoted that 17% of restaurants fail within their first year. This could of course be due to many reasons, financial mismanagement and otherwise. I’m sure there could be new and spectacular ways for restaurants to fail by dabbling in uncharted waters here. I’m not going to say the token model I proposed is shit-tested by any means. A LOT more thinking needs to go into this.
How could a restaurant do this?
Two of the top candidates for a system like this would be an Ethereum ERC-20 token (most mature ecosystem) or Stacks/Bitcoin, which is gaining traction recently with projects such as CityCoins. There are many creation guides for ERC-20 tokens, and also SaaS style websites which allow you generate one automatically. There are also services that serve as a one-stop shop for DAO creation. DAOs can even register as LLCs in Wyoming as of a law passed earlier this year, though with some restrictions.
The individual tools seem to be generally available, though the full path is uncharted. It is exciting to think that individual small business owners could have access to such financial instruments, without the need for expensive third parties or legal work. If a particular token model ends up working efficiently, it could serve as a template for similar businesses who want to do the same (with tweakable parameters). It would seem reasonable for new businesses to emerge whose sole purpose is to bootstrap restaurants with a token, liquidity, and marketing materials to help in getting off the ground.
Thanks for reading, and let me know if you have any other ideas in the comments :)
This staking model is partially inspired by MiamiCoin/CityCoins which provides a way for anyone to invest in a city. The CityCoin model is slightly different though, some have described it as an improvement over equity and municipal bonds.