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:
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.
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.
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.
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.
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.
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