International Society of Primerus Law Firms

Business Brokers and M&A Advisors Should Be Wary

By: K. Andrew Hall

Krass Monroe P.A.

Minneapolis, MN

Many of us who work in corporate finance represent companies who engage a business broker or M&A advisor when our client desires to sell the business. We also may represent business brokers and M&A advisors who help companies sell the business. For convenience, this article refers to both as simply business brokers.

The value a business broker can bring to the table cannot be overstated. The business broker understands the process of selling a business has knowledge of the marketplace and can bring a greater number of potential buyers to the table. From a regulatory standpoint, there is nothing wrong with engaging a business broker in the context of an asset sale for all cash.

However, many transactions raise the specter of federal and state securities laws, which regulate the offer and sale of a security. After Landreth Timber (1985), there is no exception for the sale of an entire business if securities are involved. A business sale is always a securities transaction if it involves the purchase, sale, issuance or exchange of stock, membership or partnership interests, options, warrants or other securities. This includes a sale of stock to an ESOP or any sale of a fractional interest in the business. Securities laws also are implicated if there is an earn-out of seller note involved, which is quite common in todays market.

The activities of business brokers are attracting more regulatory scrutiny, both at federal and state levels. In 2007, the SEC said in a denial of a no-action request that a company undertaking activities in which many business brokers typically engage should be registered as a broker/dealer (Hallmark Capital). The new Form D requires the disclosure of finders. Recently, the SEC has stepped up enforcement actions against unregistered broker/dealers. At the state level, several courts have invalidated business broker engagement agreements, causing the business brokers to lose the right to claim fees for their efforts. The State of Utah sent a letter in May 2009 to a host of business brokers stating that their activities likely require registration as a broker/dealer.

The consequences for both the business broker and the seller for violation of the securities laws can be severe. As noted above, an unregistered business broker can lose the right to fees in an adversary proceeding with their client, the seller. In addition, an unregistered business broker can be subject to administrative enforcement actions, which can result in fines, penalties and disgorgement of fees and can result in preventing the business broker from registering in the future. In some cases, an unregistered business broker can face criminal liabilities. Most importantly, both the business broker and the seller can face civil actions by the buyer of the business whose remedies include rescission of the transaction.

There is hope on the horizon. The SEC issued a no-action letter to Country Business, Inc., a business broker (November 8, 2006). The SEC indicated it would not recommend enforcement where the engagement is to sell the entire business and:

(1) if a decision is made to effect the transaction by a sale of securities, the business broker has a limited role in negotiations and will not have the power to bind either party in the transaction;

(2) the business is a going concern and not a “shell” organization;

(3) the seller satisfies the size standards for a “small business” pursuant to regulations issued by the SBA;

(4) only assets will be advertised or otherwise offered for sale by the business broker;

(5) if the transaction is effected by means of securities, it will be a conveyance of all of the business’s equity securities to a single purchaser or group of purchasers formed without the assistance of the business broker;

(6) the business broker will not advise the parties whether to issue securities, or otherwise to effect the transfer of the business by means of securities, or assess the value of any securities sold (other than by valuing the assets of the business as a going concern);

(7) the business brokers compensation will be determined prior to the decision on how to effect the sale of the business, will be a fixed fee, hourly fee, a commission, or a combination thereof, that is based upon the consideration received by the seller, regardless of the means used to effect the transaction and will not vary according to the form of conveyance (i.e., securities rather than assets), will be in cash and paid in connection with the payments to the seller; and

(8) the business broker will not assist purchasers with obtaining financing, other than providing uncompensated introductions to third-party lenders or help with completing the paperwork associated with loan applications.

The SEC is considering an M&A Broker Rule proposed by various trade groups that would create an exception from broker/dealer registration for business brokers. It is unclear when or if the SEC will issue a proposed rule.

Until the SEC acts, business brokers should adhere closely, if not exactly, to the Country Business guidelines. While Country Business is not binding on states or on courts, the Country Business request for no-action and its grant by the SEC outline a structure and process that likely would be persuasive in an argument that such activities are not effecting transactions in securities, the lodestone for broker/dealer activities. In the alternative, business brokers should consider taking the required FINRA tests and affiliating with a registered broker/dealer.

For our selling clients, we should carefully review any engagement of an M&A advisor or business broker by the client to reduce the risk of a rescission claim by an unsatisfied buyer.

KM: 4840-7069-5685, v. 1

For more information on Krass Monroe, visit the International Society of Primerus Law Firms or

The general information contained herein is intended for informational purposes only. It is not intended to be, and should not be construed as, legal advice or legal opinion on any specific facts or circumstances.

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