New federal law exempts ‘M&A brokers’ from SEC registration

Thomas R. Taylor 

Investment banks are generally engaged to sell companies with enterprise values of $20 million to $25 million or more. Business brokers or third-party intermediaries (M&A brokers), on the other hand, are often retained to help identify prospective buyers and market and sell companies with enterprise values less than that amount (small businesses).

M&A brokers are often engaged to sell small businesses because business owners often don’t have the expertise to properly structure, negotiate, draft and document a sale transaction. While most investment banks are registered as broker-dealers with the Securities and Exchange Commission (SEC), their fee structures generally don’t scale in a manner that will allow them to profitably engage in the sale of a small business. M&A brokers, on the other hand, routinely sell small businesses, but are rarely registered broker-dealers.

That dichotomy has historically left owners of small businesses in a quandary over how to sell their company. The problem is exacerbated if the owners wish to sell the stock in their company (as opposed to its assets) because federal security laws prohibit a person from acting as a “broker” of securities unless they are registered with the SEC or a registration exemption is available. In order to avoid problems created by not being a registered broker-dealer, M&A brokers usually recommend or insist on structuring sell-side M&A transactions as asset sales (as opposed to stock sales), even though asset sales are generally not as favorable to owners of a small business as is a stock sale.

Fortunately, a statute exempting M&A brokers from registering as a broker-dealer (the exemption) and clarifying what an M&A broker can and cannot do in connection with an M&A transaction structured as a stock sale was recently adopted by Congress.

Background

The Securities Exchange Act of 1934 (the 1934 act) defines a “broker” as any person engaged in the business of “effecting” transactions in securities for another person’s account. Therefore, M&A brokers selling a company through a stock sale will meet the definition of a “broker.” As noted, when an unlicensed M&A broker was engaged to sell a company, they would either structure the transaction as an asset sale in order to avoid having to register as a broker-dealer, or sometimes rely on a 2014 SEC NoAction Letter in order to avoid having to register. The exemption was adopted in order to add clarity to the requirements set forth in the 2014 NoAction Letter and provide more guidance to M&A brokers.

This article addresses broker-dealer registration from the perspective of a Utah-based small business and its owners. This article only provides a brief overview of the primary provisions of the exemption and does not set forth a comprehensive discussion or analysis. Small-business owners should consult their own counsel when considering a sale using an M&A broker.

The M&A Broker Exemption

The exemption is a federal exemption from broker-dealer registration that became effective on March 29, 2023, and has been codified as Section 15(b)(13) of the 1934 act. The exemption allows M&A brokers to engage in securities transactions in connection with the sale of an “eligible privately held company” (discussed below) without having to register as a broker-dealer. The exemption essentially codifies the 2014 NoAction Letter, with certain exceptions. It is important to note that the exemption only applies to M&A transactions and cannot be relied upon in connection with a capital raise.

Summary of the Exemption. The 1934 act defines a “broker” as “any person engaged in the business of effecting transactions in securities for another person’s account.” Accordingly, most M&A brokers meet the definition of a “broker.” State securities laws set forth similar definitions for “brokers” and require registration with the applicable state securities regulator unless a statutory exemption has been adopted. The exemption does not preempt state law, and therefore, care must be taken by M&A brokers to ensure that both the broker-dealer provisions of the 1934 act and all applicable state broker-dealer registration requirements are met.

• Eligible Privately Held Company and Control. The exemption applies to M&A brokers regardless of whether they act on behalf of the seller or the buyer, through the purchase or sale or a business combination involving securities or assets of an eligible privately held company. The broker must reasonably believe that upon consummation of the transaction, the buyer (a) will “control” (discussed below) the eligible privately held company and (b) directly or indirectly be actively involved in its management.
• Eligible Privately Held Company. An “eligible privately held company” is defined as a company that (a) does not have any class of securities registered under the 1934 act and does not file periodic reports with the SEC and (b) had EBITDA less than $25 million and/or gross revenues less than $250 million in the immediately preceding fiscal year (both subject to an inflation adjustment on March 29, 2028, and then every five years thereafter).
• Control. “Control” is defined as having the power, directly or indirectly, to direct the management or policies of a company. “Control” will be presumed to exist if the buyer has the right to vote, sell, or direct the sale of 25 percent or more of a class of voting securities.

Prohibited Activities. If an M&A broker does any of the following, it will not be exempt from registration as a broker-dealer and will not be able to rely on the exemption:

• Holds, transmits or has custody of funds or securities to be exchanged in the transaction.
• Engages in a transaction involving a “shell company” (other than a “shell company” organized to undertake the transaction in question).
• Provides financing for the transaction through an affiliate.
• Fails to provide written disclosure to, and obtain written consent from, both parties in the event the M&A broker represents both parties.
• Assists in forming the buyer group.

Disqualification. An M&A broker will be disqualified from relying on the exemption if it or any of its officers, directors, members, managers, partners or employees have been barred or suspended from associating with a broker-dealer (a so-called “Bad Actor” restriction).

Utah Policy Position

On Feb. 28, 2014, the Utah Division of Securities adopted a policy position titled “Policy Position Regarding M&A Brokers and Business Brokering.” The Utah Policy Position remains in force and continues to provide for the regulation of M&A brokers in Utah. Until the Division of Securities issues further guidance on this issue, the Utah Policy Position will continue to govern M&A brokers doing business in Utah. If the Utah Policy Position is adhered to, M&A brokers will not be required to register as a broker-dealer or agent under the Utah Securities Act.

Thomas R. Taylor is a Salt Lake City-based corporate and M&A lawyer and a shareholder in the international law firm of Dentons Durham Jones Pinegar PC.