Seeking Clarity on Corporate Transparency: A Practical Guide to CTA Compliance in M&A

This year’s introduction of Corporate Transparency Act reporting requirements have posed new questions for middle-market owners, including private equity investors, and could even impact structuring in M&A deals going forward.

Starting January 1, millions of businesses operating in the U.S. became subject to the Corporate Transparency Act (CTA), which requires domestic and foreign businesses to provide certain information to the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) agency by submitting an online Beneficial Owner Information Report (BOI Report).

While there are 23 statutory exemptions to the law, only a few are likely to apply to middle-market businesses—and even fewer may apply in an M&A context. But for the exemptions that will impact middle-market M&A, there are key considerations.

Reporting Companies and Available Exemptions for Middle-Market Companies

A “Reporting Company” that is required to submit a BOI Report includes any domestic U.S. business entity formed by filing its organization document with a state governmental authority or foreign entity registered to do business in the U.S. (except those eligible for an exemption). Each BOI Report must disclose information about the applicable Reporting Company, as well as personal identification information (PII) regarding the Reporting Company’s Beneficial Owners, and for those Reporting Companies formed on or after January 1, 2024, PII about the Company Applicant(s).

The most commonly available exemption available to middle-market businesses is for a “Large Operating Company” (LOC). The LOC exemption requires the relevant entity to (1) directly employ more than 20 full-time employees (FTEs), (2) have reported more than $5 million in annual gross receipts on its most recent tax return, and (3) have a physical operating presence in the U.S. Further, if an LOC has affiliated wholly-owned subsidiaries, the CTA’s “Subsidiary” exemption might spare those affiliates from CTA reporting obligations.

Carefully determining the availability (or absence) of a CTA exemption, identifying Beneficial Owners of Reporting Companies, adopting internal CTA compliance guidelines, and taking a thoughtful approach to transaction structure and documentation will be necessary steps to ensure compliance.

Deadlines for Initial BOI Reports and Updates

The deadlines for submitting an initial BOI Report for any non-exempt entity are set forth below:

The CTA also requires Reporting Companies to update most information submitted via a BOI Report within 30 days of any changes to the information.

Identifying Beneficial Owners

A Beneficial Owner under the CTA is any individual who, directly or indirectly, either (a) owns or controls not less than 25% of the fully diluted ownership interests of a Reporting Company or (b) exercises substantial control over a Reporting Company.

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CTA regulations and FinCEN guidance provide several illustrative examples of both ownership-based and control-based Beneficial Owners, including senior officers, certain board members, and individuals exercising substantial control pursuant to contract. The CTA does not cap the number of Beneficial Owners for any Reporting Company.

Internal CTA Compliance Implementation

Adopting an internal CTA Compliance Program should focus on the following four key areas:

• Identify all Reporting Companies and their Beneficial Owners, ensuring appropriate documentation of any applicable exemptions and/or copies of BOI Report submitted.
• Include information rights and covenants in any employment contracts for senior officers, any subscription agreements or other equity or governance documents for significant equity holders, and any other contractual arrangements giving an individual any substantial control over a Reporting Company.
• Ensure confidentiality and privacy of all PII in accordance with applicable privacy regulations.
• Add standard BOI Report updates to acquisition, onboarding, and severance checklists.

Larger corporate groups should consider appointing one or more CTA compliance person(s) to be responsible for maintaining these records on behalf of the group and establishing a routine process for CTA compliance.

Private equity funds should take particular care to clearly outline CTA compliance guidelines and expectations with portfolio company management.

Private equity funds should take particular care to clearly outline Corporate Transparency Act compliance guidelines and expectations with portfolio company management.

Transaction-Specific Considerations

Given the scope of the applicable reporting requirements, the CTA should be top of mind in every middle-market M&A transaction, regardless of its structure. Some specific considerations applicable to both equity and asset transactions are summarized below.

Equity Purchase Transactions

Because CTA compliance liability generally rests with the applicable Reporting Company, buyers of the equity of an existing company should seek specific representations and engage in due diligence regarding the target company’s historic compliance with the CTA, including the target’s CTA compliance policies and procedures. Buyers should consider requesting copies of any BOI Reports filed by the target and, if applicable, a description of the analysis supporting any determination by the target company that it is exempt from reporting under the CTA.

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Because willful failure to comply with the CTA may be punishable with penalties amounting to $500 per day for the period of noncompliance and up to two years’ imprisonment, buyers should carefully consider the structure and amount of indemnity required for adequately protecting against any historic liability. To the extent the target company’s compliance policies and procedures are lacking, buyers should prioritize implementing best practices consistent with the above considerations to ensure the target is in compliance with the CTA’s requirements going forward.

Update: On March 1, 2024, a federal district judge in the Northern District of Alabama held that the CTA is unconstitutional and enjoined enforcement of the CTA against the Plaintiffs. Since the District Court’s injunction applies only to the plaintiffs in the litigation, it is not expected to impact the compliance obligations of any other entities. The federal government will likely appeal the court ruling, but the appeal proceedings are not anticipated to delay implementation of the CTA.

Asset Purchase Transactions

While all transaction participants should keep the CTA in mind related to transaction structuring, those considerations are particularly important in asset purchases. Examples include the formation by buyers of any new holding company or buyer entities and the implementation by sellers of any pre-closing restructuring that may involve creation of new entities.

For example, an entity newly formed by a buyer (NewCo) to acquire substantially all of the assets of a CTA-exempt LOC will not be able to claim the LOC exemption for at least a transitional period after the transaction date. Even if NewCo continues to directly employ more than 20 FTEs and anticipates more than $5 million in gross receipts, NewCo will not be eligible for the LOC exemption and would be required to file BOI Reports until it has filed a tax return for the preceding year demonstrating over $5 million in gross receipts (absent another applicable exemption).

Katherine (Katie) Smalley is an attorney at Bass, Berry & Sims PLC. She represents public and private borrowers, private equity sponsors and financial institutions in negotiating and documenting financing transactions. She may be reached at katie.smalley@bassberry.com.

Christopher Climo is an attorney at Bass, Berry & Sims PLC. He represents clients in connection with mergers and acquisitions, investment fund formation, capital market transactions, and corporate governance matters. He may be reached at christopher.climo@bassberry.com.

Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.