Change in U.S. securities law is good news for business owners
By John C. Johnson, M&AMI
Posted: 25th April 2023 15:08The federal Consolidated Appropriations Act that was passed in December 2022 includes Section 501: Registration Exemption for Merger and Acquisition Brokers. This important provision gives business owners, and their M&A Brokers improved options for carrying out a business acquisition or sale using professional help. It defines the term “M&A Broker” and clarifies the explicit circumstances and activities within which expert M&A Brokers can perform services for a business owner in seeking the best outcome from a sale or acquisition.
For many years, U.S. courts widely accepted the Sale of Business Doctrine, which held that a sale of a going concern business did not constitute a transfer of securities. That changed with the U.S. Supreme Court’s decision in Landreth Timber Co. v Landreth 471 U.S. 681 (1985), which held that the stock at issue was a “security” and the Sale of Business Doctrine did not apply.
After Landreth, reliance on the Doctrineas a presumed safe haven for unregistered advisors and their clients became riskier. However, the change was largely unnoticed in the business sales practice or was disregarded as impractical or not applicable, and activities remained mostly unchanged for more than a decade.
Over time, firms formed to specialise in providing registration to M&A Brokers. Some brokers registered, while others either did not know to register, did not choose to, or took engagements that did not necessitate registration. Confusion was prevalent for various reasons, among them securities laws – training and registration requirements were ill-conceived for effecting business acquisitions and were poorly suited to such sales. Applying them to business transfers was seen by many as being a wasteful and counterproductive exercise that put form over substance. Frequently, engagements were accepted as a sale of assets (not requiring registration); then, shortly before closing, the principals chose to morph the structure into one that might have required broker registration.
In 2014, the SEC’s Division of Trading and Markets issued a “no-action letter” permitting “M&A Brokers” to be involved in business acquisition transactions of privately held companies. The no-action letter does not have force of law, but it meantthat Securities and Exchange Commission (SEC) staff would not seek enforcement action against the described activities.
Through education by the profession, in cooperation with regulators and business advocacy groups, the Registration Exemption for Merger and Acquisitions Brokers law percolated in Congress before being passed a decade later.
What is an M&A Broker?
People who assist owners in business sale transactions go by many names. A standard term is now defined by the Registration Exemption for Merger and Acquisition Brokers. In part:
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, if the broker reasonably believes [a number of specified conditions are true].
Key benefits for business sellers and buyers
The revised law widens owners’ choices for selecting and benefitting from the services of expert M&A Brokers. Previously, the services described in the exemption may have required clients to cover substantial costs and administrative hurdles faced by registered advisors. In many cases, the added layers of cost, time, and bureaucracy put the use of registered brokers beyond the reach of selling owners. Sellers were left with limited options for retaining valuable services to prepare, market, negotiate, and structure a business sale to obtain top net value.
What changed? Before the M&A Broker exemption law, common components of business sale structures arguably required advisors to be registered or, in turn, face potential risks to the transaction, a client, and the advisor. Those components included:
- Owner-carried notes,
- Retained equity/rollover, or
- Selling stock (part or all).
While it’s not a blanket release from compliance with the securities law, Section 501 describes specific activities and circumstances that help a seller recognise whether an M&A Broker is exempt from registration. It provides critical clarity and relief for owners seeking to select the best advisor in light of their sale objectives, needed services, and budget.
To be exempt from registration, an M&A Broker must reasonably believe certain things, such as:
- The acquired business is eligible under the act;
- The buyer will, in effect, control the business and directly or indirectly be active in the management of the company or the business conducted with its assets; and
- If securities are offered, receiving parties will (before being bound) be provided with recent financial statements.
For a shell company to qualify, it must meet limiting parameters and may have only nominal assets other than cash or equivalents.
To qualify for the exemption, acquired firms must be eligible privately held firms with less than $250 million in revenues or $25 million in EBITDA, and they must not have securities that are required to be registered under Section 12 of the Securities and Exchange Act or be required to report under its sub-section (d).
The M&A Broker exemption is not available to a broker engaged in excluded activities, generally and partially described as the following:
- Directly or indirectly receives, holds, transmits or has custody of funds or securities to be transferred;
- Provides capital raising or financing related to the ownership transfer or assists in getting financing from a third party without disclosing compensation in writing and complying with all other laws in connection with such assistance;
- Fails to obtain clear written disclosures and consent from both parties if representing the buyer and seller in a transaction;
- Assists in forming a group of buyers for a transaction that the M&A Broker facilitates, or engages in a transfer to passive buyers; or
- Binds any party to a transfer of ownership.
An M&A Broker is disqualified and not exempt if the broker (a) has been barred by the SEC, a state commission, or a self-regulatory organisation or (b) is suspended from association with a broker or dealer.
Most states have a form of securities law, and the laws of about 20 states are now well aligned with the new exemption. Until updated, other states’ laws may still follow the pre-exemption requirements, meaning registration may still be necessary.
Success in a 20-year effort
The evolution leading to this change in federal law has been frustrating, interesting, and ultimately rewarding. It was started over two decades ago in various ways by leading M&A professional associations, groups of securities attorneys, and visionary M&A professionals. Hats off to them all.
Note: This article describes the business implications of a change in U.S. securities law regarding mergers and acquisitions but is not offered as a legal opinion or as legal advice. This article is for general introduction only and is not to be taken as legal or securities advice. For information or legal advice that is specific to your situation, please review the details of Section 501; Exemption Registration of M&A Brokers and consult an attorney experienced in securities regulation.
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John C. Johnson helps business owners exceed their objectives when buying or selling businesses. He is a certified M&A Broker with 35 years in the field and is respected and trusted as an award-winning mergers and acquisitions professional. John commits to ensuring his clients’ success and to supporting the quality of outcomes from the hard choices they face. He is a founding partner of leading U.S. M&A Broker and Advisor firm IBG Business (www.IBGbusiness.com).
IBG’s professionals have provided merger and acquisition services to the U.S. middle market since 1986. Their award-winning M&A Broker and Advisor teams have an exceptional track record of 1,100 successful transactions.