M&A for DAOs, DeFi and web3

As the web3 ecosystem matures, mergers & acquisitions (M&A) are becoming increasingly common as projects seek to expand, consolidate resources, acquire technology, and attract talent to strengthen their market positions.

For instance, Arbitrum DAO, with over $3 billion in assets, approved an M&A pilot earlier this year. Recognizing M&A as a strategic tool to consolidate the fragmented layer 2 (L2) market, Arbitrum aims to grow non-organically through acquisitions, setting up an M&A unit with a budget between $100-250 million. Other projects, like on-chain asset manager Enzyme Finance, are also exploring M&A, while advisors like Areta provide commercial M&A advisory tailored to the decentralized space.

M&A stems from traditional finance and executing these transactions in a web3 environment presents unique challenges. Traditional M&A structures like share or asset deals don’t fully translate to decentralized projects, which operate with diverse governance models, token economies, and a mix of off-chain entities such as non-profit foundations and contributor collectives. To navigate this, M&A in web3 often revolves around token swaps.

Token Swaps: The way to acquire DeFi and DAO projects

In traditional M&A, companies acquire shares or assets to facilitate a merger or an acquisition. However, in DeFi projects that are driven by tokenomics and community governance, there are no often shares or tangible assets to purchase. Instead, the project tokens are often distributed across a broad range of stakeholders, including team members, investors, and users, with no legal mechanism like drag-along rights to force token sales during acquisitions.

Token swaps have emerged as a vital tool to align incentives and consolidate resources, somewhat comparable to a traditional share swap. Instead of buying equity in a legal entity, projects swap tokens. For example, a larger project might offer a portion of its treasury tokens to a smaller project in exchange for their tokens, talent, or other resources. As seen before, projects are increasingly earmarking part of their treasury specifically for expansion through such token swaps.

Defining the goals: Acquihiring, TVL, or IP acquisition

When merging with or acquiring another project, it is crucial to first define the goal. Are you looking to “acquihire” the team behind a project and get them to work on your project? Do you want to technically integrate the two projects, and shift the user based as well as total value locked (TVL) of the other project to your project? Do you want to benefit from the brand name or marketing reach of the other project? Are you interested in acquiring the codebase and intellectual property (IP) of the target project? Should the acquired project continue to run under its own brand or are you looking to consolidate?

Your strategy will guide the structure of the deal and the necessary due diligence for the M&A transaction. In some cases, a simple token swap might suffice, while others may require governance token holder approval or buying out existing SAFT investors.

Regardless of your goals, any collaboration will likely involve a token swap in one way or another for the following reasons:

• Incentive alignment: The main reason is that tokens typically align incentives. Often, tokens are used to incentives contributors and users – by giving tokens to the team members, investors, and user base of the acquired project, they will be much more likely to act in the interest of the purchasing project.
• Control: As smaller projects will often still be on their way to full decentralization, an acquirer can potentially gain control of a DeFi project by simply taking control of a substantial part of the governance tokens of the project.
• Protecting your liquidity: The alternative to purchasing a project would be to simply pay for whatever part you wish to acquire in cash / stables. However, as in traditional M&A, the acquiring project may not have sufficient cash reserves to pay the full purchase price and pay fully or partially with its own token.  

Navigating legal challenges

M&A in web3 and crypto introduces unique legal complexities. Here are key areas to focus on:

Due diligence: Any M&A transaction involves due diligence, essentially to understand what you are acquiring and at what (legal and commercial) risk. Due diligence includes a thorough review of tokenomics, governance structures, legal setups, IP rights (often open-sourced), and regulatory exposure. Due diligence in web3 M&A can differ significantly from traditional deals. We are soon publishing a list of due diligence factors to consider in web3 M&A deals, stay tuned!

Transfer of assets: Ensure that identified key assets – such as tokens, intellectual property, contracts, social media access, control over front-ends, and team resources – are transferred safely yet in a leanly structured transfer agreement. Given the international nature of many web3 projects, cross-jurisdictional considerations are crucial as well.

Regulatory requirements: Understand the regulatory implications of the transaction, including token qualifications (security tokens vs. utility tokens vs. payment tokens), KYC obligations, former token sales and so forth. Regulatory risks in DeFi and crypto are substantial and must be carefully managed.

Investor alignment: Early-stage equity or SAFT investors may have veto rights or approval requirements, which must be addressed.

Tax: Depending on the jurisdiction, tax implications – such as VAT, capital gains, or income tax – may arise from the token swap.

Lock-up, vesting an earn-outs: Ensure new token holders do not dump the tokens at once crashing market price. Lock up and vesting provisions, similar as seen in SAFTs, Token Warrants and similar investment agreements, are prevent this. Additionally, earn-out mechanisms ensure that key team members are incentivized long-term.

Conclusion: Embrace the Future of M&A in DAOs, DeFi and web3

M&A in the web3 space offers exciting opportunities but requires careful navigation of both technical and legal challenges. As more projects mature, token swaps and similar structures will continue to redefine how M&A is conducted in this space. However, it is crucial to recognize the legal pitfalls such as specific due diligence requirements, regulatory uncertainty, token classifications, and the complexities of managing decentralized governance. Missteps in these areas can jeopardize the success of a deal.

Contact us today to ensure your project stays ahead in the web3 space while respecting legal requirements. In today’s decentralized world, compliance is a strategic advantage.