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Strength in Numbers: Merging with Another Not-for-Profit Takes Diligent Preparation

Shrinking federal funding, stiff competition for grants and a soft economy all challenge a not-for-profit's existence, which has given rise to mergers and other strategic alliances. At times like these, common sense might point to pooling organizational resources and eliminating duplicate services in a community or for a certain market. If your not-for-profit is contemplating teaming up with a like-minded organization, you'll need to address a variety of issues and take careful steps.

Explore the possibilities

The process often begins with one not-for-profit approaching another with the idea of working together more closely. Each organization typically puts together a small committee to explore future collaboration. As the exploration phase progresses, key people are sometimes brought in from each entity to discuss the specific outcomes of a collaboration. You'll want to talk about functions that are distinct to each not-for-profit and that should, therefore, be retained. You'll also want to discuss functions that are similar and can be combined and leveraged. How might the new organization's mission be different from its predecessor's—if at all?

It's important to gather the opinions of major funders during this phase. Knowing their thoughts about your potential alliance will help you ensure that the merged entity's focus aligns with their goals so you can avoid losing future revenue.

Make it legal

Because a merger will change your not-for-profit's structure dramatically, you and the other party must consider several legal matters such as:

• The terms and conditions of the merger
• Approval by both boards of directors and their restructuring into one entity
• State approval
• The effective date of the transaction

Be duly diligent

Once a merger looks viable, don't wait too long to start the due diligence process. You want to avoid wasting time if there are any insurmountable barriers to the merger.

Like auditing, due diligence procedures verify information and investigate undisclosed matters. They also involve reviewing an organization's cultural, organizational and operational sides. Here are some areas you'll want to address.

Corporate documents. Examine the not-for-profit's articles and bylaws to determine its corporate structure and various bodies—for example, the board of directors and standing committees. Gain insight on issues of importance to the organization by scanning board minutes.

Finances. Analyze audited financial statements and management letters to get a handle on the organization's basic financial status, liabilities and procedures. Make sure that any outstanding loan agreements permit a transaction like the one you're planning.

Taxes. Verify the organization's tax-exempt status. Also confirm that all necessary tax returns have been filed and that reported information coincides with financial statements.

Litigation. Secure a legal opinion for any existing or potential claim or lawsuit, and determine insurance coverage. Look for any possible violations of laws and regulations in areas such as discrimination, health and safety, environmental compliance and immigration practices.

Insurance. Identify the scope and limits of all insurance coverage, and determine whether claims have been filed and/or are pending. Such an examination can reveal weaknesses in existing insurance programs as well as internal risk management issues.

Human resources. Study the organization's employment policies, salaries and benefits and working climate, including turnover. Ensure compliance with all related legal requirements.

Property. Determine whether the organization maintains full legal rights to use all real, personal and intangible property integral to the transaction. Review property agreements such as leases, mortgages and other liens. You want to be certain these documents don't place any restrictions on the proposed transaction.

Grants and contracts. Confirm compliance with all conditions and terms and that the proposed affiliation won't terminate, or otherwise adversely affect, any grants or contracts.

Fundraising. Verify that the new entity can still comply with any restricted fund agreements and that all fundraising procedures are legally permissible. Look for any crossover in fundraising sources that could significantly lower net contributions.

Licenses, certifications and accreditations. Ensure that every required license, certification and accreditation is valid and transferable.

Retirement plans. Make sure all required IRS filings have been made and that there are no unfunded liabilities. Consult with plan advisors on the legalities of merging or terminating a plan.

Plan for your combined future

If the due diligence process goes smoothly, your focus will turn to integration planning. The committee you initially formed—or a descendant—must establish a plan to transition from two separate entities to one successor organization. For example, you'll need to transfer all gifts or grants to the surviving not-for-profit. This might mean contacting grantors of restricted funds to secure their consent or to assure them that the restrictions can still be met.

Current programs will also need to be analyzed more closely than during the exploration phase, and the possibility of new programs should also be examined.

The committee can expect to spend considerable time debating the composition and selection of the merged organization's board of directors. Board operations should be determined (including term of office, quorum and voting) and committees named.

Other things you'll need to consider include the staffing plan, office location, budget—including employee benefits—and corporate structure.

Finally, the committee should establish a name for the new entity and complete the legal documentation.

Make your future brighter

All in all, being on the verge of a merger isn't a bad place to be. If you proceed prudently, you'll be making a change that will help you achieve greater productivity, efficiency and sustainability in the future.

Questions?
Contact Jim Hagestad at 312-980-3245.

Ways to join forces

Here are the three most popular ways that not-for-profits choose to affiliate with each other:

• Merger.This entails a legal change in the not-for-profit’s corporate status and produces the highest level of integration. For example, Girl Scouts of the USA is merging many local councils into regional ones.
• Back-office consolidation. In this type of restructuring, the not-for-profits share core administrative functions, such as office space and/or staff, but maintain separate corporations with separate executive and board leadership.
• Joint venture. This is a collaboration of programs between two or more not-for-profits and often includes a joint-venture agreement. For example, organizations might "partner" for a program and dissolve the partnership once the program is completed.

Keep in mind that this is only a brief summary of a complex accounting matter. You'll want to work with your tax expert on this FIN 48 process.
 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.