Nonprofit M&A: Practical Considerations for Nonprofits Exploring Mergers and Acquisitions
Practical Considerations for Nonprofit M&A
There has been an increase in nonprofit organizations considering merging with, acquiring, or being acquired by other organizations. These types of transactions in which an organization acquires the equity or assets of another are generically referred to in this article as “M&A,” or when a nonprofit is involved, “nonprofit M&A.”
Nonprofit M&A can help nonprofits achieve their goals and solve many of the challenges that they face throughout their existence. There are, however, some distinct differences between nonprofit M&A and for-profit M&A that make it important for nonprofit leaders to understand the nuances of nonprofit M&A before engaging in such transactions. This “Considerations for Nonprofit M&A” series will help staff, board members, financial institutions, professional advisors, and other key nonprofit players understand legal and practical matters concerning this type of transaction.
Before reading the third part of this series, please refer to “Part One: Why Consider Nonprofit M&A?” and “Part Two: Structuring the Nonprofit Acquisition.”
Part Three: Beyond the Legal - Practical Considerations for Nonprofits Exploring Mergers and Acquisitions
In addition to the legal considerations relating to nonprofit M&A discussed in parts one and two of this series, nonprofits exploring mergers, acquisitions, joint ventures, and similar transactions also will be driven by various non-legal factors unique to each transaction. This article does not attempt to address all non-legal considerations but rather addresses some of the common non-legal issues that nonprofits must navigate in determining if and how they will conduct a nonprofit M&A transaction.
While the reduction in overhead costs and the combined expertise of personnel are some of the greatest benefits nonprofits can derive from M&A transactions, figuring out how to combine resources and personnel and selecting who will — and will not — serve as directors and officers of the combined entity present logistical and political hurdles to organizations. Lowering overhead costs may entail reducing workforces to remove redundancies between merging organizations’ staffs, but the financial benefits of deleveraging human capital can backfire in the form of lower staff morale, loss of institutional knowledge, and, potential negative publicity. The elimination of staff, including executive positions as well as removing officers and directors who were formerly key stakeholders, can impact the negotiation of the deal to the extent that those negotiating the transaction may not continue to serve the combined company. Thoughtful consideration of the manner and timing of position elimination announcements can make or break a transaction.
While for-profit organizations must consider their shareholders’ interests in determining whether to enter into an M&A transaction, nonprofits must take into account how donors — and prospective donors — might react. In some instances, large donors may hold significant influence over a nonprofit, so it may be necessary to seek input and buy-in from those constituencies in order to ensure that the transaction will not result in an unexpected loss of funding. Additionally, if a nonprofit M&A transaction involves eliminating a particular program from an organization’s lineup, donors may lose interest in supporting the remaining organization. Furthermore, while a nonprofit generally must use donations in accordance with the donor’s intent, if it receives a donation for a program that is acquired by another organization, the original nonprofit may need to contact the donor – or even involve a state attorney general’s office – and request to use the funds for a different purpose. Restricted funds may not be used for purposes not expressly provided for in the gift instrument, even if such purposes are impossible in the face of changed circumstances like those that result from nonprofit M&A, without following the requirements of the applicable statutes (more about this can be found in Taft's previous bulletin here). Likewise, if an organization expands its mission as part of merging or associating with another nonprofit, it may risk alienating donors who do not approve of the expansion or change in organizational structure. When possible, contacting donors to seek input early in the process often helps avoid these issues. Of course, in the case of distressed organizations, this may not be possible, and likely will require careful consideration for communicating with donors and other stakeholders.
Nonprofits must operate within the bounds of their missions to retain tax exempt status and to properly accept and utilize donations. Sometimes, nonprofit M&A transactions can lead to “mission creep,” wherein nonprofits begin conducting activities that push beyond their missions. Revenue earned from activities outside of a nonprofit’s mission is categorized as taxable. Furthermore, nonprofits that are seen as conducting activities outside their purposes can develop reputational concerns. As a result, nonprofits that enter into nonprofit M&A transactions with entities with different missions should take care to craft thoughtful public messaging and update their mission statements to accurately reflect their revised programming and include those updates in the appropriate tax filings. Likewise, if a nonprofit acquires another entity as a subsidiary or acquires a specific program of another organization, it should ensure that its mission is broad enough to encompass the activities of the subsidiary or program so that it is not deemed to have expanded beyond its mission. As an example, religious organizations must be mindful of both their specific charitable purposes and any doctrinal limitations as they consider entering into nonprofit M&A transactions.
Any nonprofit M&A transaction may or may not involve cash consideration – but it certainly will involve transaction costs stemming from the negotiation of business terms, drafting and preparation of the relevant transaction documents, implementing the transaction, combining IT systems, and creating new marketing and programming reflecting the new relationship of the parties. Even if a transaction will ultimately benefit the nonprofits financially, it is important that such organizations understand how they will cover the expenses associated with exploring and implementing such transactions and the short-term impact the myriad of one-time expenses may have on cash flow. For these reasons, nonprofits exploring M&A transactions should consult with all of their advisors – including but not limited to legal, accounting, tax, and investment – about the impact a potential transaction might have on their organizations.
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