Whether it is the result of declining public and private support, increased accountability or the need to expand the footprint of your mission in an era of funding changes; the age of nonprofit mergers seems to be upon us.

In the wake of significant changes with funding sources as a result of large deficits at the state and local government level, the funding mix for many nonprofits has been subject to severe reductions now, with more possible for the future.

Nonprofits are looking for ways to reduce costs, without reducing quality or jeopardizing the infrastructure. Transactions between two nonprofit organizations can be more complicated and move more slowly than transactions between two commercial organizations since, most of the time, cash does not exchange hands. Usually if an organization has excess cash to purchase the assets of another organization, the organization does not feel the need to merge. Rather it feels it is in a position of strength and can remain with the status quo. On the contrary, if the organization were open to a transaction, it could achieve some economies of scale with costs and potentially expand the footprint of its mission.

Nonprofit mergers can take on several different looks. There is the full takeover of another organization, which results in one organization ceasing to exist. The successor organization assumes all debts and potential unknown liabilities. Types of potential unknown liabilities that could be a potential risk to the successor organization include litigation, third-party reimbursement overpayment and asset remediation costs, such as environmental problems at a site.

An alternative to the full takeover is the affiliation. This has been the preferred avenue for many of our healthcare-related clients. The affiliation is achieved through a change in the composition of the board of the organization being taken over so there is a majority of board members from the successor organization and control is achieved. This can be accomplished in two ways. First, you can add enough board members from the successor organization to achieve control or in combination remove some existing board
members to achieve control for the successor. An easier alternative would be to change the structure of the organization being taken over to a membership board and designating the successor organization as the sole member. This has been a more preferred vehicle of affiliation since it does not require any more involvement from existing volunteer board members. An additional benefit of this form of merger is that the liabilities remain at home and are not inherited by the successor organization. This transaction format is like a long–term engagement period that allows the successor organization time to uncover what is ailing the other organization without assuming all of the risk.

Either form of merger or affiliation will require proper due diligence on the part of both organizations. Some considerations for due diligence are as follows:

• Make sure both organizations have a common ground included in their missions.
• Understand the financial models and the burn rate of cash, both pre-merger and postmerger.
• Understand the comparison of compensation, benefits and union affiliations, if any, on the overall cost structure.
• Determine if you will gain leverage with both existing and future funding sources to negotiate reimbursement rates.
• Determine impact of any transaction on the debt covenants of both entities.
• E valuate the timeliness of the final reports each month and annually.
• Determine if there are any conflicts between existing board members that may derail the transaction.

Many mergers and affiliations have achieved success for the surviving organization. Many however have cost more than was originally anticipated. Much of that had to do with the length of the transition period before any revenue enhancement was achieved or expense efficiency materialized. Most of the time this was caused by the governing bodies not acting fast enough with tough decisions and being more concerned with perceptions outside the organization.

If you have any questions or would like to meet with one of our consultants regarding a nonprofit merger or an affiliation, please feel free to contact us. We can  guide you through the complex financial and tax decisions to aid  in structuring the transaction to accomplish your goals.

About Blackman & Sloop CPAs, P.A.:

Blackman & Sloop is a full-service CPA firm headquartered in Chapel Hill, North Carolina and is actively involved in auditing, taxation, management consulting, financial planning, and related services. The firm directs a large part of its services toward providing management with advice on budgeting, forecasts, projections, financing decisions, financial analysis, and tax developments. The firm also performs review and compilation services and prepares not-for-profit, corporate, individual, estate, retirement plan, and trust tax returns as well as technology consulting services regarding installation and training on QuickBooks. Blackman & Sloop provides services in Raleigh, Durham, Chapel Hill, RTP, Hillsborough, Pittsboro, Charlotte, and the rest of North Carolina. To find out more please visit http://www.blackmansloop.com

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*This article originally appeared in BDO USA, LLP’sNonprofit Standard (December 2011)“. Written by Adam Cole, BDO CPA. Copyright © 2012 BDO USA, LLP. All rights reserved. http://www.bdo.com