Crypto and blockchain M&A
December 2022 | TALKINGPOINT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
December 2022 Issue
FW discusses crypto and blockchain M&A with Dario de Martino at Allen & Overy.
FW: Could you provide an overview of the market for buying and selling crypto companies over the past 12 months or so? How would you characterise M&A activity levels in this space?
de Martino: Despite drops in various cryptocurrencies ranging from 20 to 70 percent, an overall reduction in venture capital (VC) funding, the collapse of some algorithmic stablecoins and several bankruptcies, M&A activity in this space has remained relatively strong. According to recent data, there have been approximately 88 crypto-related M&A transactions in the first seven months of 2022, with a total estimated value of roughly $8bn. While the total deal activity may not reach the record levels of 2021 – where the industry saw about 220 crypto-related M&A transactions with a total estimated value of about $10bn – it is likely this year may surpass both 2020, with 96 crypto-related M&A transactions with a total estimated value of about $1.7bn, and 2019, with 89 crypto-related M&A transactions with a total estimated value of about $900m. Consistent with previous years, exchanges have continued to be the most prolific acquirers. However, non-crypto companies have begun circling this market looking for new opportunities or revenue models – from big corporations seeking to reward loyal customers, obtain access to new close-knit, cult-like communities or create a link between real-world assets and the ‘metaverse’, to content creators using smart contracts and non-fungible tokens (NFTs) to construct new royalty structures or revenue-sharing models to better monetise their original content.
FW: What types of crypto and blockchain companies seem to be attractive targets for acquirers? What opportunities are presenting themselves?
de Martino: Trading and infrastructure are the two sectors that continue to attract the most interest from buyers, accounting for most of the crypto-related M&A. However, a new trend has emerged with respect to interest in companies that are active in the NFT and crypto-gaming sectors. For example, in January 2022, OpenSea acquired crypto wallet startup Dharma Labs, and a few months later acquired NFT marketplace aggregator Gem. Similarly, Yugo Labs announced the acquisition of the intellectual property (IP) rights of the CryptoPunks and Meebits collections from Larva Labs, which gave Yugo Labs control over three of the most popular NFT collections on the market. In addition, in December 2021, Nike announced its acquisition of RTFKT, a company that creates virtual sneakers and other collectibles in the form of NFTs, and Adidas announced partnerships with NFT projects Bored Ape Yacht Club, GMoney and PUNKS Comic. We anticipate NFT-related M&A continuing during the rest of 2022 and into 2023.
FW: Are you seeing recurring examples of smaller businesses with advanced blockchain and crypto technologies being absorbed by much larger enterprises? What do such deals tell us about the direction of this market?
de Martino: There is certainly a significant amount of deal activity between big tech and VC-backed companies. In light of a looming recession, and the difficulty in raising a significant venture round and ensuing attractive valuations, several crypto venture capitalists have encouraged the founders of their portfolio companies to consider the M&A route. And founders are finding that entering into an M&A transaction, where often the consideration is a mix of cash and stock of the buyer, is better than being in imminent danger of running out of cash. In addition, it is worth noting that start-ups are entering into a variety of M&A transactions with other start-ups. According to recent data, there have been 124 acquisitions of VC-backed companies based in the US by other VC-backed companies in the first quarter of this year – the largest first-quarter total in a decade.
“Companies are still seeing dealmaking benefits and the strategic trends driving crypto M&A activity are not likely to weaken in the rest of 2022.”
FW: In your opinion, what are the key challenges facing acquirers in the crypto and blockchain space?
de Martino: Blockchain targets present a host of complex legal and regulatory challenges. In addition, crypto companies rely on intangible assets, such as software, data and know-how, and therefore IP due diligence on these assets is critical. Moreover, because crypto targets often operate in international markets, due diligence investigations should consider the target’s potential plurality of legal and regulatory regimes, as well as local norms and applicable practices. Finally, it is also worth noting that with any distressed seller for which valuations have tumbled dramatically, the spectre of fraudulent transfer claims arises if a sale takes place outside of a formal sale process – like a bankruptcy or foreclosure – and it may be difficult to determine whether an opportunistic acquirer has paid fair or reasonably equivalent value for a distressed target, or its assets and creditors are paid less than what they are owed. If an acquirer looks to negotiate and close a sale outside of a formal sale process, that buyer may want to obtain a ‘fairness opinion’ from a well-regarded valuation firm to reduce the risk of fraudulent transfer claims from a distressed seller’s creditors. Finally, it is important to understand exactly what is being purchased, especially when operating on an expedited basis: crypto firms may be deemed brokerages or custodians for clients, or both. Parties must determine ‘who has what rights’ to assets managed by the distressed seller.
FW: To what extent has the drop in cryptocurrency values impacted dealmaking? How should this volatility be factored into M&A transactions?
de Martino: Despite the recent market volatility, we are still seeing noteworthy transactions in this space. Companies are still seeing dealmaking benefits and the strategic trends driving crypto M&A activity are not likely to weaken in the rest of 2022. If the lower valuations reflected by the stock market decline continue, buyers are likely to become more acquisitive to take advantage of multiples that are lower than they have been in recent years. For sellers, turbulent capital markets will encourage companies to continue to re-evaluate their strategic plans and consider whether to sell or spin off non-core or underperforming assets. Nevertheless, the recent market volatility has created certain additional challenges for dealmakers. Key among these, sharp fluctuations in crypto values have made it difficult for dealmakers to determine valuations and deal consideration when a buyer is going to pay in crypto, or when a buyer with crypto on its balance sheet is going to pay in its stock.
FW: In what ways have regulatory developments, such as President Biden’s executive order on cryptocurrency and the recently announced regulatory frameworks in the European Union (EU), affected the outlook for M&A?
de Martino: Regulatory developments will certainly help in dealmaking decisions. It is important to clarify, however, that neither the executive order (EO) nor the more recent ‘Comprehensive Framework for Responsible Development of Digital Assets’ has the force of law. And while the EO signals this US administration’s interest in whole-government coordinated policies addressing digital assets, it does not preclude enforcement actions taken by various federal agencies based on traditional financial regulations. Indeed, the Securities and Exchange Commission (SEC) seems to have taken an enforcement-first approach in an area where market participants would have hoped for a regulatory-first approach. It is clear that US crypto companies actually want to comply with the law, but instead have been driven offshore by regulators’ approach, and are otherwise operating in a regulatory limbo. While developing an appropriate legislative and regulatory framework for digital assets is no easy task, until we have clarity over basic concepts, such as whether digital assets should be categorised as securities, like stocks and bonds, or commodities or interchangeable assets, such as oil and grain, M&A activity and the crypto economy in general will not be able to realise their full potential.
FW: What essential advice would you offer to acquirers looking to execute successful transactions in the crypto and blockchain space? What key considerations do they need to make to mitigate risk and maximise returns?
de Martino: Acquirers must choose financial, legal, tax and accounting advisers who are well-versed in this space. For example, if the target holds digital assets, a buyer will want to have its advisers conduct due diligence to ascertain the following. First, what assets are held, including whether the target owns any NFTs. Second, who owns them, including whether there are any multisig accounts. Third, how they are stored, such as hot online or cold offline wallets, or using custodial services. And finally, the terms of the storage provider, such as withdrawal and transfer fees, whether they are staked, their tax treatment, security protocols for wallet keys, any insurance coverage, and so forth. If the target is a crypto firm, due diligence should ascertain that it has all the required regulatory approvals, at the federal, state and international level, and adequate policies and procedures. Lastly, drafting an M&A agreement relating to crypto requires knowledge of the underlying technology, regulatory, IP and tax issues and related risks, and the mechanics of closing transactions using crypto or stock of a buyer that has crypto on its balance sheet.
FW: How do you expect crypto and blockchain M&A to mature in the months and years ahead? What factors are likely to drive momentum in this space?
de Martino: If there is any lesson to learn from the global financial crisis of 2007-09, it is that companies that made significant acquisitions during that time outperformed those that did not. There is truly no rest for strategic crypto buyers as premiums are likely to come down and assets that companies had been reluctant to sell may become available or become available at a more attractive price. Several companies are likely examining their existing lines and getting ready to act fast. We therefore expect challenging crypto markets and increasing interest in the metaverse to lead companies to embrace new transaction strategies in the short term. In the long term, we expect crypto M&A to continue to mature. Ultimately, this is a nascent industry that has only scratched the surface of its potential. We expect that companies will continue to seek opportunities at the intersection of various emerging technologies, and that synergies among those technologies will be a strong driver of growth.
Dario de Martino is a partner in the New York office of Allen & Overy and serves as co-chair of its Blockchain and Fintech Group. He advises clients on transformative matters relating to cryptocurrency and blockchain-enabled technologies. His experience includes advising on complex matters relating to crypto M&A, strategic investments, digital assets offerings, blockchain licensing and service agreements, and structuring of new blockchain-enabled products. He can be contacted on +1 (212) 610 6329 or by email: dario.demartino@allenovery.com.
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