A Win for Small Business Brokers: New Federal Exemption to Expand “M&A Broker” Definition

by Justin Shelton, Attorney

For small business brokers, a recently codified federal exemption could open new doors of opportunity. That is, as of March 29, 2023, certain M&A service providers – primarily unregistered intermediaries seeking to facilitate smaller M&A and other corporate transactions – will now be exempt from SEC registration. Additionally, the new changes relax the definition of a broker, which was considered by many to be overly restrictive. In short, this means that, in certain situations, small business brokers now have increased flexibility to facilitate transactions in areas that would previously have been prohibited.

The exemption, which has significant limitations, was codified by President Biden on December 29, 2022.

Federal and state securities laws generally require that people engaged in the business of effecting securities transactions for the accounts of others be registered as brokers. Prior to the exemption, the broker definition, as applied to smaller private offerings, and hampered the provision of overwhelmingly benign services, without providing substantial consumer protection benefits.


The New Federal Exemption

Under the new exemption, the term “M&A broker” means a broker, and any person associated with a broker, engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company, regardless of whether the broker acts on behalf of a seller or buyer, through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the eligible privately held company.

Any broker relying on the exemption must reasonably believe that, upon consummation of the transaction, any person acquiring securities or assets of the “eligible privately held company” (as further discussed herein), acting alone or in concert will:

  • Control the eligible privately held company or the business conducted with the assets of the eligible privately held company; and
  • Directly or indirectly, be active in the management of the eligible privately held company or the business conducted with the assets of the eligible privately held company, including without limitation, for example, by electing executive officers, approving the annual budget, serving as an executive or other executive manager.

In addition, if the person selling the eligible privately held company will receive securities from the buyer, prior to becoming legally bound to consummate the transaction, the seller must receive or have reasonable access to financial statements and related information of the issuer of the securities used as part or all of the purchase consideration.

One of the most important definitional cornerstones when determining exemption applicability is that “eligible privately held company” means only a privately held company which:

  • Does not have any class of securities registered, or required to be registered, with the SEC under Exchange Act Section 12 or with respect to which the company files, or is required to file, periodic information, documents, and reports under Exchange Act Section 15(d); and
  • In the fiscal year ending immediately before the fiscal year in which the services of the M&A broker are initially engaged with respect to the securities transaction, the company meets either or both of the following conditions (determined in accordance with the historical financial accounting records of the company): EBIDTA is less than $25 million or the gross revenues of the company are less than $250 million.

The required “control” means the power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise. A presumption of control exists if, upon completion of a transaction, the buyer or group of buyers:

  • Has the right to vote 25% or more of a class of voting securities or the power to sell or direct the sale of 25% or more of a class of voting securities; or
  • In the case of a partnership or limited liability company, has the right to receive upon dissolution, or has contributed, 25% or more of the capital.

Another area of consistent concern relates to fundraising efforts. The new federal exemption is limited solely to the M&A activities enumerated therein and does not permit unregistered brokers to identify new sources of capital or otherwise facilitate securities offerings. Importantly, this does nothing to clarify payment of fees by licensed or exempt brokers to unregistered “finders.”

Regarding registration, the new federal exemption merely says eligible M&A brokers need not register with the SEC. This does not exemption such brokers from the purview of the SEC. They will remain subject to SEC jurisdiction, including antifraud provisions of the federal securities laws and potential enforcement actions.

Questions related to sufficient control will likely continue to arise, particularly in the context of private fund acquisitions or dispositions of portfolio companies. The new federal exemption prohibits transferring interests to “passive” buyers, stating that purchasers must “actively operate” the company. This should be carefully considered in the context of private equity, venture capital, and other funds acquiring and selling operating companies.

On a final, practical, note, parties contracting with exempt M&A brokers relying on the new exemption should retain competent legal representation to ensure representations and warranties related to compliance with the applicable provisions, including the absence of any disqualifying factors, are appropriately incorporated into any engagement agreements. Likewise, exempt M&A brokers should consult counsel to determine whether the prospective terms of any particular transaction they anticipate intermediating fits within the parameters of the new exemption. While useful, the new exemption contains a multitude of nuances requiring the advice of sophisticated counsel.

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