As today’s not-for-profit organizations face the challenges of decreasing funds, fewer volunteers and increasing demand for services, one popular solution has been to combine forces in partnership with other groups and occasionally merge.
The right partnership can allow the smaller organization to preserve its programming and services with fewer overhead costs and gain the fiscally sound security of the larger group. However, there are many considerations, too.
Define a Shared Purpose
An organization must be able to clearly express its mission and goals. That means board members and staff should have a shared view of the organization’s purpose. This “elevator statement” will be used to market your organization to potential partners or merger candidates similarly to how a salesman markets goods or services to his or her clients.
Looking for a potential partner or merger candidate could mean looking at competing service providers in your organization’s market, vendors, or organizations in other geographic areas that might wish to expand their service areas. Basically, when an organization first considers a merger or partnership, it’s like a courtship. Mutual interest must be established. Finding a common mission and culture will be important to continuing your organization’s work.
As your organization considers potential partner or merger candidates, consider organizations that will fit with your group’s strategic plan, strengthen or broaden services, add expertise or allow the organization to expand operations. Geographical expansion may also be a consideration for potential partner/merger candidates.
Find Common Ground
As organizations consider combining forces, leaders will need to determine what elements of each group’s mission, culture and operation are in common, and those issues where the two groups disagree. Many organizations contract with an outside consultant with experience in nonprofit mergers to facilitate these discussions. Even if the discussions remain informal, a skilled facilitator can keep the discussions orderly and diplomatically steer leaders in a constructive purpose.
Perform Due Diligence
If two or more organizations begin to negotiate a merger, it is important for each group to perform due diligence. This involves a legal and financial review of each potential merger partner. Each organization examines legal issues such as incorporation, contracts, claims or litigation, human resources, benefits, real estate and other areas of risk. Financially, due diligence can involve a full financial audit or agreed-upon procedures to determine the potential partner’s true financial position and risks. The financial audit is usually based on the organization’s past audited financial reports.
As your accountant reviews the audited financial statements, he or she should be looking for positive cash flows, especially from operations, as well as information such as liabilities, debt balances and payables. The Notes section of a financial statement is an area that often tells the financial story of the organization, and can help you determine similarities and differences from your organization. Notes can help show the organization’s accounting policies and how they are similar or different to your nonprofit. Notes can also highlight contingent liabilities or pending litigation or other risks the potential partner may be facing. Another potential area of concern is risk concentration – does all of the organization’s revenue come from one funding source?
As organizations conduct due diligence, they must also consider the financial impact the merger will have on both organizations, including unrelated business income tax, sales tax, payroll tax or property tax liabilities, impact on fundraising efforts and impact to funding of services or products each organization provides.
Due diligence is very important because courts have held board members who recommended a merger personally and individually responsible in cases where board members failed to closely examine the merger partners in advance. That doesn’t mean a board cannot vote to merge with a less-than-perfect partner, it only means that the board must thoroughly investigate and understand the implications of those imperfections.
Hash Out the Details
If the organizations have successfully completed the “courtship,” it’s time to work out the details, and they can get sticky. A facilitator can assist, but involving leadership, staff and volunteers from both organizations in the negotiating process is also important. It may be tempting to put past chairs of both organizations as leaders in merger or partnership discussions, but appointing future chairs to lead these discussions may lead to a more cohesive and productive outcome. Subcommittees, which can be given specific parts of the combined plan, can seek consensus from the various entities and allow the organizations to cover more ground in less time. Negotiation will be an important part of the process, so organization leaders should choose a few key issues considered most important, and less important issues that will be easily negotiable.
It’s also not important to rush the process. After seeing some of the successful mergers that have occurred nationwide over the past several years, an 18-24 month negotiation and implementation process is a reasonable timeframe.
Make It Formal
As the details of the merger or partnership begin to solidify, a formal merger or partnership agreement should be written. The formal agreement outlines the rights and obligations for each entity, as well as the history and understanding the merger/partnership is based on. This agreement also defines what happens before the merger or partnership can close and can incorporate memos, term sheets, bylaws and representations and warranties of each organization. A formal agreement is usually closely negotiated and may go through many drafts before all sides are satisfied.
Get Approvals
One of the final steps in the merger/partnership process is the approval process. The formal approval process can have two steps. First, the governing board of the merging organization must approve the pending merge. At the final approval stage, the board may consider the impending merger at two or more meetings at which due diligence, written agreements, membership or other details are presented before feeling comfortable making the decision. In organizations that have members with voting privileges, a general membership meeting must also be held at which membership approval must be gained for the merger/partnership. State nonprofit corporation laws dictate the mechanics of this process. Keeping open communication with members throughout the exploration, due diligence and negotiation process can help facilitate a greater understanding of the merger/partnership process prior to the final vote.
Partnerships, Reorganization, Dissolution and Notification
When an organization considers a joint venture, partnership or merger, such agreements must be managed very carefully to avoid risks in meeting compliance and tax exemption rules. These agreements can quickly become complex and can also become a trap for unwary organization volunteers or executives. As a result, we recommend that you involve both an attorney and accounting professional who are familiar with tax-exempt organizations and their compliance rules.
If organizations are considering a merger, there are three different ways they can combine and be structured for tax purposes. If both groups terminate and create a new entity, they will need to apply for a new entity identification number, tax exemption and nonprofit status. One organization can also merge into another yet remains in existence under the “shell” of a new parent group. However the most popular option is when two organizations merge and one ceases to exist.
If one or more organizations will be dissolved as a result of the merger, there is a specific process the organization must follow to legally dissolve. A certificate must be filed with the Secretary of State’s office. The Department of Taxation, the Department of Job and Family Services and the Bureau of Workers Compensation, as well as the county treasurer’s office (should the organization own property) must also be notified of the dissolved entity. The state provides a document certifying dissolution, which is then provided to the Internal Revenue Service. The IRS then removes the organization from its list of organizations for charitable gifts, and revokes the organization’s tax exemption.
Most organizations place a clause in their incorporation documents that designate where any money that remains in the organization will go upon dissolution. However, the default in many states, including Ohio, is that the property, building and any assets go to the state if a beneficiary is not named.
Today’s economic realities have forced many nonprofit organizations to look for new ways to operate more efficiently and cost-effectively, including cooperative partnerships and mergers. Although working out the details of such ventures can be challenging, they can lead to healthier, more productive organizations that better meet the needs of those they serve.
This article was originally published in Illuminations: Facts & Figures from people with a brighter way, a Rea & Associates enewsletter, December 17, 2008.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.