The government's set a steep learning curve for crypto compliance
The market and regulatory forces that fueled a substantial uptick in merger and acquisition activity in the blockchain industry in the U.S. in 2018 are expected to continue through 2019.
Cryptocurrency prices remain significantly below their high-water marks, while regulators in the U.S. sustain, or even increase, their scrutiny of ICOs and other market actors. Those are only two of the factors likely to impact both the pace of M&A activity and that well-counseled cryptocurrency entrepreneurs, investors and potential acquirers should consider.
Last year’s plunge in cryptocurrency prices should continue to have a powerful effect on the calculus for growing blockchain enterprises this year. Unless prices make a dramatic recovery, many growing, well-capitalized companies are likely to conclude that it makes more sense to improve their technology or achieve growth quickly through acquisition. At the same time, startup businesses may begin to feel capital constraints as ICO proceeds are less valuable, company tokens make less valuable incentive compensation and venture capital remains difficult to attract.
The Securities and Exchange Commission, the Financial Crimes Enforcement Network and state securities and financial regulators are finding their way to many of the companies that have crossed legal lines in recent years.
In the context of M&A, this contingent liability may motivate businesses to sell and could lead to opportunities for well-informed and well-regarded buyers. Companies, or their owners, may seek to sell assets to provide proceeds for a recession or otherwise address regulatory scrutiny and to ensure that their technology lives on. Buyers have opportunities to acquire tech and talent that show operational promise that could be realized if it can be divorced from compliance mistakes.
Proper tax planning is always essential to successful M&A, and the Global Intangible Low-Taxed Income regime, which became effective January 2018, intensifies this need. While GILTI is aimed at preventing U.S. taxpayers from avoiding U.S. income taxes by locating intellectual property overseas, it impacts U.S. taxpayers of any size regardless of business motive. For this reason, token issuers and other platforms located outside of the U.S. in order to facilitate compliance with U.S. securities laws may require additional tax planning for their U.S. owners.
Because blockchain technology is relatively new, the space has yet to see a significant volume of lawsuits claiming patent violations, but it is only a matter of time. Potential acquirers should understand their freedom to operate technology they seek to acquire. Separately, companies using proprietary technology in tandem with open-source — a fairly common combination in the crypto world — should ensure that they have properly protected their confidential information.
Regulators are still fleshing out filing requirements created by the Foreign Investment Risk Review Modernization Act adopted in the third quarter of 2018, but those requirements will be applied to foreign investors in U.S. blockchain businesses. Non-U.S. players seeking entry into the American market through acquisitions should already have been attuned to the Committee on Foreign Investment in the U.S., but the modernization act mandates filings where CFIUS disclosure was previously optional. Filings are currently in a pilot program stage, and the efficiency of the process in only now being tested.
As is the case in other contexts, blockchain acquirers and sellers face issues similar to other industries, but with unique elements due to the nature of the technology and its uncomfortable relationship with regulation in the U.S.