By Liz Dunshee
Cryptocurrency companies are facing opportunities in the US public markets like never before. In the midst of the current market demand, the president’s Working Group on Digital Asset Markets has directed a multiagency approach to creating a workable regulatory framework for the industry. As part of that, the Securities and Exchange Commission (SEC) has not only launched a fast-track initiative to improve its rules and guidance, but also is considering an “innovation exemption” that would allow new business models and services to comply with principles-based conditions to quickly get to market.
For crypto companies considering public capital raising, it is important to understand the variety of paths available and make a strategic decision based on the best fit. Here’s a rundown of the main flavors of strategies for accessing public markets and launching digital asset treasury companies (DATCos) – with practical considerations gleaned from Cooley’s work on these deals.
Initial public offering (IPO)
Recent shifts in regulatory and market dynamics have made traditional IPOs a newly viable path for the cryptocurrency sector, with several notable deals announced.
IPOs offer a mainstream path to the public market – with less baggage than other types of deals. While these deals typically involve rigorous regulatory review and significant transactional costs, they also can offer greater credibility and unlock substantial capital, especially if the business or its leadership team has a proven track record. Traditional IPOs tend to take four to six months or longer, depending on company readiness and market strength. Although a streamlined regulatory framework is still in the early stages, companies that have a longer runway before wanting to enter the market may benefit from the administration’s directive to adopt laws and rules that would expedite crypto-related registrations.
Special purpose acquisition company (SPAC) business combination
SPAC deals have surged alongside the rise of cryptocurrency financings, and they are especially attractive for crypto companies with strong narratives. A SPAC combination involves a reverse merger with a public company that was formed for the purpose of a business combination.
The SPAC typically comes with experienced financial players and a sophisticated investor base. While this can enhance deal certainty compared to some other structures, SPAC deals still tend to be riskier to execute than traditional IPOs, and it is important to consider the SPAC’s expiration date, redemption dynamics and whether post-closing sales by SPAC investors will drive down the share price and restrict liquidity. Deal terms, including lock-ups and board rights, also are subject to negotiation. The sponsor typically retains the ability to nominate one or two directors.
The specific time frame for a SPAC combination depends on the circumstances but often is akin to a traditional IPO. SPAC deals tend to require less extensive roadshow efforts and lower underwriter fees – but transaction costs are still relatively high in light of the hybrid M&A/IPO nature of the deal. It can be time-consuming to clear the SEC’s review process for a combined proxy/“business combination” registration statement and obtain approval from the SPAC shareholders. To increase the likelihood of a successful deal, cryptocurrency companies may need to give extra attention to explaining the business model and the impact of potential fluctuations in cryptocurrency values.
Companies pursuing a de-SPAC must comply with stock exchange listing standards at and after closing and be prepared to face extra complications on capital raising and insider sales post-closing. The good news is that so long as the SPAC is already listed on an exchange, the combined company will not be subject to “seasoning” requirements post-closing, which is a big advantage. Nasdaq also has proposed a rule change that would extend this accommodation to unlisted SPACs that trade over the counter.
Typically, SPAC combinations are accompanied by a secondary capital raise in the form of a private investment in public equity (PIPE), structured as an investment in the public SPAC, but effectively an investment in the target operating company. These investments may be backstopped in part by the SPAC sponsors. This can mitigate market volatility risks and may yield higher proceeds than would be available from a traditional IPO. However, companies considering a de-SPAC path should analyze the portion of the capital that may ultimately be allocated to the SPAC sponsors and SPAC investors who exercise redemption rights.
Double dummy acquisition
The “double dummy” structure is more complex but can offer a cleaner slate for the surviving public company. If carefully structured, the transaction also can qualify as a tax-free event for shareholders of both the public and private company. A concurrent capital raise, such as a PIPE, can provide certainty for cash on hand at closing.
The “double dummy” approach involves the merger parties forming a holding company, which is considered a successor of the public company under SEC rules. The holding company forms two wholly owned acquisition subsidiaries, which merge into the public and private companies, making them wholly owned subsidiaries of the holding company. The holding company, which now owns 100% of the stock of the private and public company, issues registered stock to the private and public company shareholders.
The time frame for these deals typically runs four to five months from signing to closing – but deal complexities and negotiation sticking points present a greater risk of delay than in other paths to market. Similar to the RTO and SPAC structures, the “double dummy” approach requires clearing the SEC’s review process for a combined proxy/“business combination” registration statement and obtaining approval from the shareholders of the existing public company. Legal and accounting costs are higher as compared to RTOs and SPACs.
A benefit to the holding company structure, in addition to the possibility of tax-free treatment, is that it is less vulnerable to market whims and provides a “fresh start” to the newly public crypto company in terms of liabilities, governance structures and shareholder rights – while still allowing legal continuity of both surviving entities for the purpose of contracts and licenses. Although the registration statement will require audited financials for both parties, as well as combined pro formas, and the surviving company will face restrictions on streamlined registration procedures for at least 12 months, the surviving company also will benefit from phase-in periods for governance requirements.
Reverse merger (reverse takeover/RTO)
In a reverse merger, a private crypto company acquires a majority interest in and then merges with an exchange-listed public shell or underperforming company – often a “fallen angel” life sciences company. Historically, this path was much faster and less expensive than an IPO, but regulatory changes have narrowed the gap, especially if the target is deemed a “shell company,” which is often the case. The timeline and costs involved with a shell-company RTO are now only incrementally less than, and in some cases may even exceed, those of a traditional IPO or a de-SPAC deal, depending on how long it takes to find a suitable public company target and the particulars of the deal.
An RTO requires careful diligence of the public company to understand its SEC reporting history, liabilities, shareholder and third-party contractual rights, and the quality of the shareholder base and secondary market opportunities after the deal closes. “Clean” public companies available for an RTO are in high demand, and merger agreement negotiations are not always straightforward, especially if the public company shareholders take issue with their dilution, or if there are other factors that could jeopardize getting shareholder approval from the private or public company.
RTOs give no phase-in to the private crypto company for audited financials and other public company compliance matters. Additionally, RTOs often involve a public company with nominal operations and operational assets, which may be considered a “shell company” under SEC and exchange rules. If that’s the case, the surviving public company will face complications, including:
- Inability to use short-form registration statements and conduct at-the-market offerings for a year post-closing, and to take advantage of certain other capital raising and broker coverage accommodations for three years post-closing.
- Ongoing restrictions on secondary transactions, especially for affiliates.
- “Seasoning” requirement for exchange listings, meaning that unless the deal also involves a firm-commitment underwritten public offering with at least $40 million in gross proceeds, the combined company will need to trade on the US over-the-counter market or a regulated foreign exchange for a year post-closing, and meet certain pricing and current public information requirements, before it can uplist to the Nasdaq or New York Stock Exchange (NYSE).
These complexities are similar to – and in the case of the seasoning requirement, even more restrictive than – those facing former SPACs. Yet, despite its potential downsides, the RTO structure can be the right choice for some companies. It offers a middle-of-the-road approach on the spectrum of traditional IPO to faster (but potentially riskier) alternatives. Additionally, tax-free reorganization treatment may be available, and if the operating public company is eligible for streamlined registration procedures, the surviving public company inherits that eligibility.
An RTO also can be conducted concurrently with a private placement or a private investment in public equity (PIPE), which mitigates market risk, provides more control over the amount of cash on hand at closing and, depending on the circumstances and dilution involved, may persuade the public company shareholders that they will benefit from approving the deal.
Secondary acquisition of majority interest
In this approach, a crypto company negotiates buying 50% or more of the voting power from the shareholders of an underperforming microcap. When the acquired shares are held by a sole shareholder or a small group, negotiations can move quickly. Alternatively, a crypto company can buy a microcap’s shares on the open market, but this affords less price certainty, especially if the purchases are conducted over an extended time, which may trigger ownership filings that drive up the stock price.
The downside to the secondary acquisition structure is the potential baggage of the microcap and restrictions on pivoting the business. Similar to other structures that involve an existing public company, it is important to diligence the company’s anti-takeover provisions, SEC reporting history, liabilities and shareholder base. Additionally, the SEC may take a closer look at the deal – and impose additional restrictions – if the crypto company attempts to pivot the business too quickly.
However, under the right circumstances, a secondary acquisition can provide significant benefits. That’s because the crypto company steps into a control position of a public reporting, exchange-listed company, without the need to seek approval from nonselling shareholders or provide audited financials. The result is that the crypto company can get to market more quickly, with less regulatory scrutiny and likely at a lower cost. If the public company is eligible for streamlined registrations before the deal, it will remain eligible post-closing. The deal process also can include a funding component – either as part of or following acquisition of the control stake – which can be structured in a way that avoids needing shareholder approval under stock exchange listing standards.
Phased acquisition or treasury-only strategy
If a crypto company’s near-term goal is to have the quickest avenue to the public market, and immediate voting control is less important, consider a phased approach with a public company target. In this approach, the crypto company purchases a noncontrolling interest in a public company. This can be accomplished in a secondary transaction or by negotiating a PIPE directly with the public company. So long as this PIPE involves less than 20% of the public company’s ownership, the issuance would not typically require shareholder approval under stock exchange rules. That said, companies should be aware that Nasdaq has been taking a close look at deal structures and broadly interpreting the shareholder approval requirements, especially the change of control implications. It is critical to have experienced counsel to address these issues.
A phased acquisition can be even faster and less expensive than the secondary acquisition model, and there is a larger universe of public company targets. Diligence remains essential, as well as comfort with the public company’s board and management.
The downside to this approach is that post-closing returns are tied to the minority ownership interest. Moreover, the crypto company’s ability to influence corporate and treasury strategies largely depends on contractually negotiated rights – for example, through shareholder agreements providing governance rights and/or board seats, or operational agreements outlining your rights to manage corporate assets. While the phased approach does not preclude acquiring a majority stake in the future, it is a less efficient and less certain approach, as it likely would require board and shareholder approval.
Selecting a structure
Each of these models has trade-offs – timing, cost, governance and regulatory exposure. For companies focused on blockchain and digital asset strategies, the right path depends on their appetite for control, public scrutiny and capital needs. Cooley uses a multidisciplinary, solutions-focused approach to help investors and sponsors achieve their goals, and our team has partnered with a broad range of stakeholders launching DATCos and pursuing funding once public, including through convertible notes offerings, which can be a flexible tool for raising for companies trading at a premium to their underlying assets.
Our representative transactions include advising:
- Blockchain infrastructure and mining companies, as well as other companies in the cryptocurrency industry, on various public company exit and financing opportunities, including de-SPAC mergers, convertible notes offerings and M&A exits.
- Blockchain technology and analysis companies on venture financing rounds, from early to late stage.
- Initial purchasers in convertible notes offerings, with proceeds used to finance digital asset treasury strategies.
- Venture capital firms in seed investments, PIPEs and private placements of crypto-related exchange-traded funds, DATCos and blockchain infrastructure companies.
