photo: Russell B. Murphy
Imagine yourself, as a trusted advisor assisting a client in selling a company, speaking with a new prospective buyer. They have told you they want to send a letter of intent with an attractive offer to acquire your client. However, there’s just one thing: the buyer company uses blockchain (aka “distributed ledger”) recordkeeping, decentralized finance, and smart contracts in transactions as much as possible, and they would like to conduct this acquisition using these capabilities. Are you prepared to respond knowledgeably to this request?
Cryptocurrencies, decentralized finance applications, and smart contracts are all part of the category of “Web 3.0” technology innovations that we think will rapidly change how people do business. The cryptocurrency phenomenon is still relatively new, but already the combined value of the top 10 cryptocurrencies is, as of this writing, currently valued at $2 trillion.i One exchange has predicted that in 2025 the value of all cryptocurrencies will be $3 trillion.ii
You might be noticing more frequent media reports that national, state and local government entities, international banking firms, and global investment funds are all building cryptocurrency capabilities. Decentralization is a central tenet of Web 3.0 and is promoted by proponents to eliminate the need for banks and traditional payment systems; however, the reality is more likely that the institutions will adapt to these technologies and thus help facilitate the adoption of a much broader global audience.
To participate in Web 3.0 M&A transactions, professionals need to understand how these capabilities alter our traditional way of managing a transaction. Advantages of smart contracts and cryptocurrency-based corporate transactions will be nearly immediate execution of transactions upon satisfaction of specified conditions written into smart contract code, all recorded to an immutable ledger, with full transparency to the participants.
Preparation of M&A documents involving Web 3.0 technologies will require careful attention to the use of new nomenclature in drafting terms and conditions and the mechanics of closing transactions. Perhaps you will soon be expected to understand how executable code can be merged with a text-based document.iii We expect these methods to become commonplace over time and make permanent changes in our respective professional practices.
Let’s look at some of the ways Web 3.0 will start to show up in the M&A process.
Payment and form of consideration.
If it hasn’t happened already, I predict that in 2022, an M&A transaction will use cryptocurrency as the specified consideration to be paid. It is hard to argue that the Bitcoin network is not capable of substantial transactions with minimal delay and low transaction costs. For example, a recent Bitcoin transfer of $850,000,000 took place with a few keyboard clicks and a transaction cost of 93 cents. The funds were immediately available to the recipient.
Planning to receive cryptocurrency in substantial transactions will require preparation for receiving the proceeds and making necessary disbursements after closing. It might not make sense to convert 100% of the proceeds into a fiat currency. Depending on the stakeholders’ interests, funds can be retained in the original transmitted form or quickly converted to other cryptocurrencies or into USD or EUR. As a result, major banking entities are introducing cryptocurrency custodial services in partnership with Web 3.0 technology companies.iv We expect these services to begin to be important in M&A transactions.
Documenting cryptocurrency as the transaction consideration will require additional language in the documents. Generally, parties are free to specify any form of consideration. However, if price volatility concerns either the buyer or seller, the agreement may require Exchange Rate or Dollar/ Currency Equivalent provisions. The language of existing provisions of this type can be repurposed to accommodate a cryptocurrency marketplace that trades 24/7. The parties may also agree to include a predefined trading range or period to allow for a volatility buffer and post-closing adjustments price adjustments.
Another disruptive change to transaction documentation will be substituting a cryptocurrency wallet address in the place of a bank account and wiring instructions. A wallet address will be required as the destination for the transfer of consideration at closing. The highest degree of care will be necessary to assure that the wallet address is accurately stated, most likely through an officer’s certificate. The certificate will be highly confidential and redacted from any disclosures of the Stock Purchase Agreement or Agreement of Merger for security reasons.
It will be incumbent on the lawyers and authorized corporate representatives to verify that the wallet address is accessible only by the appropriate parties. These will be multi-signature wallets, requiring at least two authorized parties to access. Proof that the wallet address and private keys are linked to the parties to the transaction is possible via several alternatives now. We anticipate that certificates of verification of the wallet address will become as routine as the issuance of an incumbency certificate is today.
Decentralized acquisition financing
Decentralized finance (“Defi”) currently generates great excitement in the cryptocurrency trading and speculation markets. Automating algorithmic transactions through smart contracts and near-instantaneous settlements are feeding an explosion of innovation. Most Defi lending protocols today are used to facilitate cryptocurrency trading. However, the bridge between financing real-world assets (“RWA”) with decentralized finance protocols is taking shape. Recently a bitcoin mining operation raised $60 million to finance their operations. A German company, Centrifuge GmbH, has teamed up with the AAVE protocol to provide pools of RWA that can be funded through staking AAVE tokens for yield. Some of the current pools include trade finance instruments and revenue share agreements.v The amount involved, about $1,000,000 as of December 29, 2021, is relatively modest, but they have only just launched.vi The critical takeaway is that the connections between RWA and Defi have been made and will only grow from here. As with every financial innovation, once the larger financial institutions get comfortable with the technology and the regulatory framework, it may be only a short time before M&A buyers and sellers begin to accept Defi-based financing in the ordinary course of business.
Blockchain-enabled entity formation
Sometimes in a transaction, an entity needs to be formed to hold assets or facilitate the acquirer’s liability containment strategy. The entity may have a limited existence, as in an assignment for the benefit of creditors, or a perpetual one. Where the entity is unlikely to have any changes in ownership, simple LLCs formed on blockchain applications may be used. The ability to quickly create a legal entity, and prove existence with nearly instantaneous effect, can be a handy tool in a closing.
Beginning in 2017, Wyoming began adopting pro-cryptocurrency and blockchain legislation.vii They have amended their LLC statute to allow crypto wallet addresses to serve in place of a named person as a member. Using crypto wallet addresses will simplify Web 3.0 companies’ formation because companies and their lawyers can use smart contracts to create entities customized to facilitate transactions. For example, at least one company has worked with the State of Wyoming to promote the formation of limited liability companies on the blockchain with a decentralized application. The company claims that a legally formed LLC can be created for less than $40 and in only six seconds.viii
How many creative ways these new entity formation options can be used remains to be seen. But, for lawyers advising clients, these new entities would create new challenges if the entities involved must be the subject of “status, power, and action” opinions, including whether traditional approaches for validating the status, power, and authority for actions for blockchain-based entities are suitable for the task.
These are just the beginning of the developments that we predict will transform the M&A process. Significant sports stars, city mayors, and movie theater chains are announcing their acceptance of cryptocurrency compensation. With institutional capabilities increasing daily, our professions will undoubtedly be seeing announcements from early adopters willing to apply newly developed techniques for transaction management.
The developments described here are just the beginning of changes we will see as M&A dealmakers adopt Web 3.0 technology. With the greater acceptance by corporate finance professionals and corporate transaction use cases, powerful transformations of business processes are possible.
In a follow-on post on this topic, I will discuss other disruptive Web 3.0 developments that are likely to begin making appearances in M&A transactions as the technology gains acceptance.
The views expressed herein are solely those of the author. They should not be construed as legal advice, and the suitability of any such matters discussed for a particular transaction should not be assumed without the advice of legal counsel. Any reference to a company or product is solely for illustrative and informational purposes and is not an endorsement or recommendation of such a company or product. None of the opinions expressed herein should be construed as investment advice. As is regularly stated in writings that are crypto-related, DYOR (Do Your Own Research)!
Russell Murphy is a partner in the Flatiron Law Group’s Emerging Companies and Venture Capital practice based in Silicon Valley. Russell brings over thirty years of experience working in private practice and as outside general counsel, advising innovative companies in the software and hardware, wireless/ IoT, and eCommerce spaces through their lifecycle—from formation and launch through critical milestones to exit. Russell supports clients across a broad range of transactions, and he has a focus on the intersection of law, business technology, and data, providing transaction counseling and strategic advice to multidisciplinary founder teams.
i Top 10 Cryptocurrencies In December 2021 – Forbes Advisor
ii Eye-Popping Projection for $3T Crypto Market Underpins Bakkt Deal – CoinDesk
iii An Introduction to Smart Contracts and Their Potential and Inherent Limitations (harvard.edu)
iv U.S. Bank announces new cryptocurrency custody services for institutional investment managers | Company blog | U.S. Bank (usbank.com)
v Tinlake | Centrifuge | Decentralized Asset Financing
vi How to onboard on to the RWA Market — a step-by-step guide | by Anna | Centrifuge | Dec, 2021 | Medium
vii Wyoming Blockchain Bills, Laws, and Regulations | Gemini
viii Otoco – Automated Company Assembly on Blockchain