Chain Reaction: Navigating the New Frontier of Blockchain M&A | Dario de Martino

[Music] welcome to chain reaction navigating the New Frontier of blockchain m&a my name is Dario D Martino I'm a partner at alen overy and I also serve as the head of our fintech and blockchain Practice Group if you don't know about alen overy we're a law firm we're Global we have offices in about 30 countries as far as the United States goes we have offices in New York Washington DC Boston San Francisco Silicon Valley and La uh we have about 600 Partners 2600 lawyers and two 2800 other uh business professionals um we help Tech and crypto companies across a broad spectrum of activities um and really at all stages of product development so uh we represent companies from you know two person startups all the way to the largest uh tech company in the world this is an example of some of the recent transactions that we have handled you can see we do deals from some of the largest tech companies in the world we also do smaller transactions from anything really from 50 million to to $50 billion uh in terms of today's agenda uh I'm going to give you a little bit of an overview of the market of the crypto market in terms of the transactional uh Market uh we're going to talk a little bit about how to address structural challenges in m&a uh we're going to talk a a little bit about how to navigate regulatory uncertainty um we're going to talk a little bit about due diligence and how to unpack due diligence findings and then I'll give you a quick update on cus so there's a lot to unpack so let's get started uh in terms of an overview of the market blockchain m&a witnessed a Slowdown in 2023 uh but there's also reason to believe that overall deal making in 2024 will increase uh we saw significant microeconomics headwinds in 2023 including Rising interest rates inflation geopolitical conflicts fear of a recession increase regulatory scrutiny and is slow in demand for digitalization however as I mentioned in 2024 we expect interest rate reductions and recessionary feares subsiding uh despite all these headwinds um in 2023 we saw a few notable transactions uh notably Ripple acquire Swiss medical for 20 50 million uh coinbase bought a couple of companies uh W River digital Asset Management making its first buy since the 275 million acquisition of the r exchange Fair acts in 2022 we also saw tokenization efforts surge with dtc's acquisition of securency for 50 million we saw a merg of equals between hot8 and US Bitcoin Corp uh signaling consolidation in the mining sector uh and we also saw two interesting deals in the crypto media space I actually handled one of them uh I represented for side ventures in connection with the acquisition of a majority stake in the block um and we also saw the acquisition of coindesk by bullish Global so all to say that the Spy hadwins deals are still being made um so in terms of what we expect um for the rest of 2024 uh I personally expect deals below 100 million um where a lot of startups are going to start buying each other uh in terms of the anatos threshold for this year that been set at9 million so if you want to do an acquisition above that threshold you have to deal with anotr issues uh we also expect strong companies that have reached cash flow neutral or that can raise fresh Capital uh to be well positioned to make new acquisitions many startups however are running out of cash and that will lay the ground work for a slow but steady start startup to Startup m&a wave and if you think about you know what are the drivers uh Behind These Acquisitions well you know I see a lot of interest in Talent there's still a lot of scarcity of talent um human capital in this space uh so a lot of Acquisitions are being made to acquire key talent and knowledge a lot of Acquisitions will also be made to bring on new products and technology for cross- selling um also to obtain new customers to home to reverse cross sell to access new geographies there's nothing better than uh an m&a transaction to enter a new market in a new country uh or to obtain necessary licenses some of the Acquisitions that coinbase just closed were made to acquire regulatory licenses that it didn't have before um some of the challenges that I saw in my practice last year uh relate to valuation discrepancies right a lot of Founders expect to get the same valuation that they got in 2021 and then when they get a term Shi from a buyer in 2023 or in 2024 they get really disappointed uh and this disparity in pricing expectations and the Readiness of sellers to agree to valuation proposed by buyer was a significant barrier in 2023 and I expect to continue in 2024 but sometimes you can bridge that cap in valuation through the use of earn outs uh earnout can be complex and can be structured in a variety of different ways but it is the one successful way of bridging that Gap so I put on the slide an example of an earn now that I structured in a recent transaction uh it was an ear now with Revenue targets meaning that the buyer would make additional cash payments to the seller post closing if the seller company if the target company meets certain net revenue thresholds six months and a year out from closing and in some cases you can structure is ear out so that there's additional cash or there's additional stock paid uh when reaching certain miles Milestones so in this case there was additional stock paid to the seller based on the retention of certain key employees between the first and the third year after closing because one of the concerns of the buyer would be that some of the key employees would leave the company after closing so um this is the perfect time to get ready for an m& transaction again because interest rates are potentially subsiding and recession figures have also disappeared but some of the key things to keep in mind when getting ready for an transactions are on this slide so first revenue and customer tracking and Reporting are critical for helping potential buyers develop confidence in the Target I cannot stress this enough second developing a cohesive story that focuses on a Target strength helps acquirer get um better evaluate the deal third acquisitive Founders values strong and stable customer relationships enduring cultures and technological company ability with the target fourth the process should begin early to achieve the best outcome and avoiding approaching a low cash position you know it could take anywhere from three months to a year to close an m&a transaction depending on whether you need third party consents or regulatory approvals so it's never too late to get started and start prepping ahead fifth clean the cap table you know I see a lot of deals that are delayed or sometimes they don't close because the cap table is messy you know a lot of startup Founders sometimes you know don't have a lot of cash initially but have a lot of stock and sometimes they grant that stock to their first employees or their CTO and so forth and that's probably the one biggest mistake that you can make because that uh stock is really hard to evaluate in the beginning so it's probably best to delay the hiring or you know pay in cash rather than getting that stock and and not getting that value back from the stock it's also important to know that last year there was a a Delaware Court decision that basically allowed the buyer to terminate a transaction that had already been signed because there was a surprise in the cap table so after they signed the merger agreement they discovered that the sellers had granted Phantom Equity to some employees and and the buyer said well even though this is not uh economical um economically material uh in the overall context of the deal I still want to walk away from the deal because the capitalization representation is a fundamental rep and I need to know who owns what before I buy a company so pay attention to the cap table clean it up as much as possible lastly a lawsuit a data breach an employment misclassification that's actually very important I see a lot of Founders they hire Talent outside of the United States but it's really important to understand the differences between employees and independent contractors sometimes you go to you know countries where you can get cheaper human capital and you hire them independent contractors but then 3 four years later you find out that you actually had higher an employee under local jurisdiction laws and so you owe backup taxes sometimes you have um liabilities that are uh pretty significant so important to look into employment misclassification uh also it's important to get ahead of potential regulatory issues or other conflicts the worst that can happen to your deal is that you start negotiating uh a term sheet or a purchase agreement and then later on do diligence you dis you disclose an issue to the buyer and then they either want to you know retrade or renegotiate some of the fundamentals of a deal so communicating these issues early is a best practice now let's talk a little bit about some of these regulatory uncertainties you know I've been a lawyer for 20 years and is very frustrating when a client comes to me and I cannot give a straight answer and that's because us regulatory authorities have not provided in my view comprehensive a comprehensive regulatory framework when it comes to crypto so when you develop a new product that has a crypto component you have to worry about the applicability of several regulatory framework Frameworks and potentially um several um jurisdictional uh several authorities that could Asser jurisdiction over your product so for instance you developed a crypto product that could be deemed a security under us Securities laws or a commodity it could be also considered a money payment and therefore be subject to money transmission laws or anti-money laundering uh Provisions so just to give you an example in the United States as of today the SEC has said that they will apply the ho test which is a test that was developed by the Supreme Court in 1946 now ex imagine explaining Bitcoin to your grandparents right that's not a straightforward process but today we lawyers and Market participants are left with a decision from 1947 to decide whether the product that you're developing is or is not an investment contract and therefore a security and so the SEC said that um the core factors of the how we test are four so if all the answers to these four questions are yes then you are an investment contract and you have to comply with Securities laws which is a burden so if you have sold your product to purchasers that contributed money if they contributed money in a common price if purchasers reasonably expect a profit derived from your efforts you have an investment contract and therefore a security and this is not just a theoretical risk because the SEC has conducted a lot of enforcement actions against companies that went ahead and sold their products without complying with the registrations requirements of the Securities act so it's really important to get ahead of your product as you are developing it it's it's a good idea to talk to your Council and say is what I'm doing okay or should we pivot to make sure that we don't breach us Securities laws um so because of the ambiguity with respect to Securities laws a lot of my clients are actually Now setting up shopped overseas and so they come to me and say hey Dario can you do a benchmarking analysis to tell me which is the best jurisdiction to incorporate and so that's something that we do right we look at offshore jurisdictions like Cayman Islands and BVI or sometimes we go to Hong Kong and Singapore Japan or the EU with mikar um and and do this benchmarking analysis now another thing it's important to keep in mind is that under the US Securities act uh any offer or sale of Securities uh and I just explained why your product could be deemed as Security in the US regardless of the form of the offer or sale or whether it's located must be either registered with the SEC or conducted under an exemption or rely on a safe harbor regulation s is a safe harbor that a lot of crypto Market participants are using to basically structure a transaction completely offshore right so they typically come to me and say hey Dario can you help us structure these transactions so that we avoid the applicability of us Securities laws and that's something that can be achieved um but it's really important to hire competent Council because Council needs to make sure that the transaction is completely offshore and that there's no direct selling into the United States um and and it's also important to have covidence in your purchase agreements telling your purchasers okay you're buying my product outside of the United States as a non- US person and you also promise not to resell this product back into the United States for at least one year uh now it's important to also note that you know this is not a way to sort of circumvent uh us Securities Law so again it's important to council uh to get good Council on board and and do this in a way that you know doesn't um upset the the US Regulators um now in addition to being a security your product could also be considered a commodity right there's not enough time today to go over all the potential regulatory Frameworks that could apply to your product but if there's one take away from this presentation is that again your product could be deemed a security a commodity uh um a m a money uh payment uh or combination of all these things so it's important to conduct an run an analysis under all these lenses including AML um and uh kyc uh now I only have a couple of minutes left so I also want to just uh quickly uh mention that IP due diligence is super important sometimes you know Founders hire developers of Ip outside of the United States and don't have robust IP invention assignment agreements you basically need to make sure that your company will own the IP that is being developed by you know uh employees or independent contractors so super important another quick thing that I'll mention is open source software make sure that if you use open source software you look at the license because sometimes uh you can use open source software for free obviously but then if you want to commercialize your product that includes open source software then there may be some Provisions in the license that say you know you have to pay a percentage of the profits back to uh The Grand Tour of the open source software um so I only have 30 seconds left and um I'm going to be here for questions um but otherwise the most important takeaway is that you know with enough planning m&a could be key to success key to onboard Talent key to expand in uh non us jurisdictions ultimately scale and succeed so thanks very much