June 26, 2022

Volume XII, Number 177

Advertisement
Advertisement

June 24, 2022

Subscribe to Latest Legal News and Analysis

June 23, 2022

Subscribe to Latest Legal News and Analysis
Advertisement

The Metaverse: Considerations for VCs Evaluating Investments in the Next Digital Frontier

The metaverse is shaping up to be the next frontier in digital commerce, with businesses across industries spending millions of dollars buying digital real estate and investing in platforms to be market leaders. This has made companies with metaverse operations hot targets for venture capitalists and other investors looking to get in on the ground floor. Although metaverse-involved companies offer exciting opportunities, investors need to pay special attention to legal issues present for these targets. This alert highlights a few key legal issues for investors to keep on their radar while conducting diligence and negotiating investment documents.

What is the Metaverse?

At its core, the metaverse is the next generation of the Internet. Built largely on decentralized, blockchain technology instead of centralized servers, it consists of immersive, three-dimensional experiences with vibrant digital marketplaces, persistent and traceable digital assets, and a strong social component. While some elements remain aspirational, consumers are already flocking to metaverse platforms and spending significant sums on digital assets, making it an exciting opportunity for virtually all businesses, even those relying on physical space or face-to-face interaction, to generate revenue. Meanwhile, many tech companies are working on next-generation consumer electronics such as smart glasses that they hope will take e-commerce to the next level and make today’s two-dimensional web browsing a thing of the past.

All of these developments lead to fertile ground for venture capitalists and other investors placing bets on which technologies will pay off in the future.

Diligence Issues in Metaverse-Involved Transactions

Investors evaluating targets with metaverse operations should carefully evaluate these operations. Here are three key diligence considerations:

  1. Custody of digital assets. Metaverse-involved businesses often possess and rely on digital assets such as cryptocurrency and non-fungible tokens (“NFTs”), which are uniquely vulnerable to loss and theft. Investors should ensure that potential targets have set up a secure blockchain wallet and adopted appropriate access and security controls.

  2. Platform Terms and Conditions There are multiple metaverse platforms, and they all have tradeoffs. Some, including Roblox and Fortnite, offer access to more consumers but generally give businesses less control over content within the programs. Others, such as Decentraland and the Sandbox, provide businesses with greater control but smaller audiences and higher barriers to entry. Investors should critically evaluate the terms and conditions of the platform selected to ensure that they align with the target’s business objectives.

  3. Registered IP. Investors should ensure that targets have filed appropriate trademark applications covering core metaverse goods or services and securing any available blockchain domains, which can be used to facilitate metaverse payments and to direct users to blockchain content, such as websites and decentralized applications. Given the accelerating adoption of blockchain domains along with limited dispute resolution recourse available, targets should secure intellectual property rights now.

Special Representations, Warranties, and Indemnities

Given the novelty of metaverse operations, investors may also seek to supplement their diligence with special representations and warranties relating to metaverse operations.

  1. Regulatory Compliance. Investors should consider whether specific representations and indemnities are needed relating to compliance of the target’s metaverse operations with applicable regulations. This is especially true for heavily regulated industries such as healthcare, alcoholic beverages, and financial services. For example, an investor considering an investment in a metaverse financial services startup might want special assurances that the target’s metaverse operations comply with applicable regulations relating to providing financial advice in all of the jurisdictions relevant to its target users.

  2. IP Infringement and Enforcement. Investors may want special representations certifying that a target’s metaverse operations do not infringe on a third party’s intellectual property and that the target is enforcing its intellectual property rights in the metaverse.  

  3. Data Privacy. Investors should ensure that the target’s metaverse operations, including the collection, use, and transfer of any user data, comply with data privacy rules in all of the jurisdictions relevant to its target users.

While typical purchase agreement representations might provide general coverage, focusing specifically on the compliance of metaverse operations may be helpful in ensuring that management is adequately focused on the target’s metaverse operations. This is especially critical as metaverse operations may span multiple jurisdictions, and the regulatory scheme is still evolving.

Ready to Enter?

The metaverse poses a tremendous opportunity for investors as the technology threatens to change the way that people interact with businesses and each other in the digital environment. But like every new frontier, there are legal and regulatory hurdles to consider and overcome; some are novel, some are familiar. 

© 2022 ArentFox Schiff LLPNational Law Review, Volume XII, Number 140
Advertisement
Advertisement
Advertisement
Advertisement
Advertisement
Advertisement

About this Author

David M. Barbash Financial Investment Attorney Arentfox Schiff LLP Law Firm Boston
Managing Partner

David's diverse practice includes representing public and private companies in mergers and acquisitions, public and private financings, and licensing and strategic alliances. David acts as counsel and advisor to corporate clients, including representing early-stage companies, in a wide range of industries including software, technology, manufacturing, medical devices, and consumer products and services. 

David co-chairs the firm’s Venture Capital & Emerging Businesses Industry Group.

David was previously with ...

617.973.6298
Amal U. Dave Financial Attorney Arent Fox Schiff
Partner

Amal advises companies and investors on strategic transactions such as mergers and acquisitions, joint ventures, and debt and equity financing transactions, across a variety of industries, including restaurants and hospitality, alcoholic beverages, airport concessions, and banking and financial services. Additionally, he advises public and private companies on commercial agreements and corporate governance matters.

Amal has a passion for early stage companies and their investors as well as companies in the food and beverage industry. Accordingly, he co-leads the Firm’s Venture...

202-857-6336
James Williams Crypto Attorney ArentFox Schiff Los Angeles
Partner

James practices at the intersection of corporate and intellectual property law, often structuring and negotiating leading-edge deals in the fashion, sports, and entertainment worlds. Having completed extended tours of duty as a global brand CEO and a private equity operator, he brings a heightened understanding of the strategic, financial, and operational issues that underpin his deals.

James chairs the firm’s Crypto practice and routinely counsels fashion brands, professional sports teams, athletes, and media companies on leading-edge deals...

213-443-7617
Advertisement
Advertisement
Advertisement