Nonprofits use mergers and acquisitions (“M&A”) for various strategic purposes. They can be a powerful means to scale impact, expand or diversify program services, acquire talent, increase fundraising capacity, and improve operational efficiency. Organizations dealing with critical challenges, such as funding cuts that jeopardize their sustainability, may find it especially important to evaluate the potential benefits of a merger or acquisition.
This article highlights the key characteristics of different M&A transaction options, outlines strategic questions to ask to help identify the best transactional structure for your nonprofit, and reviews essential due diligence steps to follow.
Structural Options
Mergers and acquisitions often appear similar because both are frequently announced as the combination of two organizations. However, the differences in these transaction structures carry significant legal implications, so understanding those distinctions is essential for deciding which is best for your nonprofit. A subsidiary restructuring is another frequently used option.
Merger
A merger is a legal combination of two or more entities into one. In a merger, the surviving corporation assumes all the non-surviving entity’s rights, assets, and liabilities. A nonprofit merger offers the advantage that any bequests or future gifts will go to the surviving organization. While this could be a significant benefit for organizations with a history of regularly receiving such planned gifts, many nonprofits do not have a history of receiving such gifts. Additionally, mergers come with the notable downside that all potential future claims and liabilities will persist within the merged entity.
Acquisition (or Asset Transfer)
Unlike a merger, in an asset transfer acquisition, there is no automatic legal succession to all rights and obligations. Instead, only the transferor’s specifically identified assets and liabilities are transferred. The actual legal nature of the transaction is often a dissolution under applicable state law, where the asset transfer occurs as part of a dissolution proceeding. Acquisitions or asset transfer transactions are popular choices for organizations looking to expand their programs and assets but want to avoid the risk of taking on another organization’s liabilities. However, a nonprofit must take reasonable steps to address known and unknown liabilities before dissolving.
Subsidiary Restructuring
Some organizations opt to bring another organization under its control through a subsidiary restructuring while continuing to operate as separate tax-exempt nonprofits. This structure might be chosen to keep the liabilities of different programs separate or to maintain distinct brand identities, while also benefiting from the cost efficiencies of a combined legal structure that often includes a cost-sharing or shared services arrangement. A subsidiary restructuring can be achieved by making one entity the sole member of the other. The “parent” nonprofit, as the sole member of the subsidiary, would have specific statutory rights regarding the “subsidiary” nonprofit, such as the right to elect the subsidiary’s directors and approve certain key corporate actions or transactions (e.g., mergers, asset transfers, dissolutions, and amendments to the certificate of incorporation). Additional rights may be granted to the member through the subsidiary’s certificate of incorporation or bylaws. However, the subsidiary’s board of directors is the legal fiduciary body responsible for overseeing the activities of the subsidiary, and appropriate corporate formalities must be maintained to ensure separation of liability between the parent and subsidiary.
Strategic Questions
Deciding if a merger or acquisition is the right next step for your organization involves asking specific key questions.
- Will the transaction allow us to accomplish our mission better?
Consider whether the transaction will help the organization enhance its services and program offerings or expand the reach of its programs. - Will the transaction improve our operational and financial efficiency?
Combining two smaller organizations or bringing a smaller organization’s programs into the operational framework of a larger organization can reduce the administrative costs necessary to support the combined programs. - Do the organizations have sufficiently compatible organizational cultures and values?
This question is particularly relevant if certain staff members or board members will move from one organization to the other as part of the transaction, which is often — though not always — the case. - How much would the transaction cost in legal and other fees?
For smaller organizations, complex transactions may not be practical or cost-effective. In addition to internal approvals, which may include approval by the board of directors and any voting members, some states also require Attorney General or court approval. Additional regulatory approvals may also be needed, depending on the organizations involved (e.g., state and federal education agencies for schools). That said, combining two organizations’ programs under one legal entity (or other unified structure) could be a worthwhile upfront investment for long-term savings and mission optimization.
Key Due Diligence Considerations
Nonprofits considering a merger or acquisition should thoroughly review key risk areas before moving forward. Although the due diligence process will differ based on the nature of the transaction and your nonprofit’s role in it, the following are important issues a nonprofit should examine regarding its counterparty.
Financial Health
Look for fiscal stability, donor concentration risks, and hidden liabilities.
Tax and Regulatory Compliance
Make sure the other organization has historically fulfilled its tax and compliance obligations.
Governance and Operational Health
Confirm whether the other organization followed good governance (e.g., annual conflict of interest disclosures, maintaining minutes of Board meetings) and operational practices (e.g., proper management of HR matters, internal financial controls, and data security).
Contracts
Determine which agreements require affirmative consent to be transferred and which should and can be terminated, versus those that would be critical or beneficial to continue.
Legal Proceedings
Review for any active or potential lawsuits or legal proceedings and evaluate their possible impact after the transaction.
Staffing/HR Considerations
Assess potential retention risks, including any necessary adjustments to ensure equal treatment among similarly situated staff members after the transaction.
Assets & Liabilities
Make sure you understand the assets and liabilities of the other party, including whether it holds clear title to its key assets (such as real property and intellectual property).
Reputation
Verify that the other organization has a trustworthy reputation among its stakeholders and the public.
Whether your organization aims to enter a strategic growth phase or establish a home for your key programs before winding down, nonprofit mergers and acquisitions can be an effective tool to help you reach your goals. By understanding how different M&A options impact your ability to achieve your objectives, your nonprofit can confidently step into the next phase.
