As Bitcoin gains increasing traction since its inception 11 years ago, we begin to question whether it will slowly replace traditional dollar funding in M&A deals. Whether Bitcoin will be used to fund large M&A deals will likely depend on its ability to stabilize in value.
One of the most common concerns of using Bitcoin as a source of deal funding is its propensity to fluctuate in value. Over the past five years, Bitcoin prices have fluctuated from CAD $500 to CAD $72,000, sometimes even dropping as much as 50% over the course of a single day. This price fluctuation could seriously jeopardize the ultimate value of large, high-profile M&A deals, which could be worth $500 million one day and $250 million the next.
Headways in the M&A Market
While still relatively uncommon, using Bitcoin as a form of consideration is not an entirely foreign concept. We previously reported that as early as 2013, two companies were purchased using Bitcoin as the only form of payment. Additionally, M&A activity involving cryptocurrency companies has picked up significantly in the past few years. In 2018, prior to the impact of the global pandemic, there were 189 M&A deals involving cryptocurrency companies within the 25 most active cryptocurrency jurisdictions, worth approximately US$1.9 billion, according to a PwC report.
The recent economic volatility has also seen an increase in the use of alternatives to one-time cash purchases in the context of M&A deals, including earnouts and working capital adjustments. These payment structures take into account the wary buyer that cannot accurately assess whether a target company's accounts are a reflection of the economy or an enduring business problem. By adjusting the purchase price to either account for or depend on future milestones, parties are more likely to come to an agreement.
The use of cryptocurrency in such transactions can offer both parties to an acquisition a level of flexibility in the purchase price. For example, a seller might decide to lower the asking price where payment is made in Bitcoin, in anticipation that its value might increase at a future date.
Additionally, despite the fact that Bitcoin is relatively new in the marketplace, we are already seeing an increase in regulations from both the Canada Revenue Agency and Ontario Securities Commission that can increase confidence in the use of Bitcoin. As of February 11, 2021, the OSC gave the green light for the first publicly traded bitcoin exchange-traded funds in North America.
Taxation of Cryptocurrency Transactions in Canada
Parties considering the use of Bitcoin as consideration in an M&A transaction should also keep in mind the potential tax implications. The CRA has stated that it will generally consider a transaction involving cryptocurrency to have been carried out without an exchange of legal currency, and treat it as a barter transaction for income tax purposes. Thus, a buyer using cryptocurrency to effect a transaction will have a taxable disposition of the cryptocurrency it uses to pay the purchase price, whereas a buyer paying with Canadian currency would not realize a gain or loss for Canadian tax purposes.
In addition, for Canadian tax reporting purposes, the purchase price in an M&A transaction must be expressed in Canadian dollars. Unlike foreign currency transactions, there is no statutory rule or administrative guideline for how, or at what point in time, cryptocurrency is to be valued in Canadian dollars. Due to its volatility, the value of cryptocurrency expressed in Canadian dollars may vary widely over the course of a day.
Additional issues could arise where a buyer and seller ascribe different values to the cryptocurrency so exchanged, which may lead to the CRA challenging either the calculation of the seller's gain or loss, or the buyer's cost of the purchased assets. In order to minimize audit risks, any purchase agreement where cryptocurrency is contemplated should ensure that the buyer and seller agree to a valuation methodology for the cryptocurrency and to file their tax returns in accordance with that agreement.
Overall, while the use of Bitcoin in M&A transactions could provide some flexibility in uncertain markets, the Catch-22 is that the after-tax value of cryptocurrency pocketed by a seller is very volatile and can severely fluctuate in the marketplace. Unless disposed of same-day, Bitcoin used to pay for an acquisition one day could drop down (or appreciate) significantly within the week. Until the value of Bitcoin stabilizes, high-value M&A deals will likely stick to traditional payments to avoid gambling in an unpredictable market.
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