Blog

By Eric R. Smith and Yair Y. Even-Tal

A startup agrees to pay Emma, a media personality with many connections to wealthy people, for introductions that result in investments in the company. Emma introduces multiple investors to the company and receives periodic checks from the startup.

This might seem innocent enough — a win-win for her and for the startup. But are Emma and the startup actually at risk for engaging in illegal broker activity?

It is an issue that comes up regularly: Can you compensate a person who helps with a capital raise or sale of your business?

In fact, hiring “finders” can create problems for everyone involved in a deal. The risks include possible cancellation of the investment (and required return of capital), giving up any profits that have been made, and even criminal prosecution and fines.

Under U.S. securities laws, finders are not allowed to play an active role in negotiations of transactions that involve marketing, distribution and sale of securities, handling securities or cash, or binding either party to a transaction.

Given the narrow nature of finders’ permitted activities, their involvement in capital raising or mergers and acquisitions may trigger a set of comprehensive regulations, including passing a broker licensing test and complying with professional conduct standards.

To determine whether a finder should be registered as a broker, various factors need to be considered. They include:

• An analysis of whether the compensation is tied to the size or successful completion of the transaction.
• The finder’s participation in discussions between the business and the investor.
• The finder’s role in handling funds and securities in connection with the transaction they help bring together.

One place where the rules are a little less stringent is for those who connect and assist parties to smaller M&A transactions. This M&A exemption often applies in sales of private companies.

The M&A exemption rules require that the private company did not record more than $25 million in EBITDA or $250 million in gross revenue in the year prior to engaging the M&A broker.

There are other technical requirements that may also be applicable to comply with the M&A exception.

As federal and state regulators remain vigilant in monitoring finder and unregistered broker activities, the best practice for companies looking to get the help of finders, M&A brokers or other intermediaries is to the status of those people and ensuring that unregistered persons are not involved in capital raising or M&A activities that require a license and registration.

Eric R. Smith is a partner in the corporate and securities group at Venable LLP regularly representing issues, investors and intermediaries in capital raising and merger and acquisition transactions.

Yair Y. Even-Tal is an associate in the firm’s corporate and securities group, focusing his practice on corporate securities matters, including IPOs, SEC reporting and compliance, and corporate governance matters.