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Nonprofits in Crisis: Is Merging the Answer?

"A few years ago, I chaired the Board of a school that took over another school. The school we acquired had just built a fantastic new building, but the construction had left them drowning in debt. Their educational mission was much like ours, and we had always had a relationship of mutual admiration."

"When their leadership came to us and said, "We're going under", we jumped at the chance to acquire their buildings, even though we also acquired their debt. The other school closed and was formally dissolved as an entity. There was an uneasy year when the merged entity - our school with theirs folded into it - struggled to work as one.

Like blended families when there has been a new marriage, there were a lot of misunderstandings, mutterings, and even tears. Their way of doing things had been different from ours, and although we felt we were bending over backward to accommodate them, they were mourning the loss of their school.

We were surprised to discover that many of their teachers and students were convinced that their downfall was our fault. The fact that we had taken on their liabilities didn't seem important to them. They saw us as the predatory organization that had snatched their school's identity. Many of the facts about the other school's debts were not known to their parents, students, teachers and alums because they had never been made public. I began to understand what it felt like to be perceived as a wicked stepparent."

Merging is a popular topic in the independent sector these days. I've heard it suggested as the solution for all kinds of issues. The economic downturn has left many nonprofits struggling - shouldn't they just join up with each other? Some funders say they have been overwhelmed by too many small nonprofits looking for money. There is no question that the number of nonprofits is expanding rapidly. Wouldn’t their survival be easier if there weren't so many of them?

Ten Questions to Ask

After a number of experiences with nonprofit mergers, I've learned that mergers are not as straightforward as they often appear. There are some serious questions that should be considered before any nonprofit organization enters into the complex and tricky process of intermingling with another. Here are ten of the more important questions I would raise immediately:

1) Can the organization afford it? That may sound ridiculous when most likely the point of a merger is to save money, but mergers aren't cheap.

"Mergers are risky business," says David La Piana, a consultant whose firm specializes in mergers, in the Spring 2010 issue of The Stanford Social Innovation Review. Nonprofit mergers, he points out, don't make money or cut expenses. "In the short term, they actually require new money for one-time transactional and integration costs."

Merging is a VERY expensive solution, involving merger specialists, lawyers and accountants for each side and a long and careful process of due diligence.  Each side has to know what it's really getting into with the other before it can embark on the process of merging. Shortcuts are dangerous.  Governing boards have to thoroughly understand liabilities and problems of the other side as well as their own liabilities and issues, and they must ensure their own organization is represented realistically. All of this costs money.

2) Is the board in favor of a merger? A merger won't work without the support of the governing body. The board has to be leading the charge, because they are the ones who have the ultimate responsibility for the organization. A merger will involve a lot of work and planning on the part of the board -- much more than is ordinarily expected of them. Before it solves any problems, the merger will create a lot more!

Most likely the newly-created entity will take some - but perhaps not all - members of both boards onto the new board. Are the members of the board ready to step aside after taking on this big job? This can be a difficult moment for boards, especially after the intense engagement and involvement necessary to create a merger. "And now I don't get to be on the new board?" one board member said after his large board merged with the top-heavy board of another organization. There were just too many of them. "This was the most exciting and interesting moment in our board's history. Now this organization will do great things. It never occurred to me that there wouldn't be a place for me."

3) Is the staff being kept up to date and asked for their participation throughout the process? Staff may resist the idea of their nonprofit merging with another, first and foremost because nonprofits are built around a dream and an idealistic purpose. It isn't just about money.

People believe in the value of their organization and may have a passionate level of commitment to the vision and mission. Not surprisingly, employees are not eager to lose their jobs.

Although most of the statistics on nonprofit mergers show that relatively few jobs are lost in a merger (more typically the merged organization grows larger and expands programs), this is still a fearful and anxious moment for staff because economies of scale are almost always on the list of reasons for merging. Some of that anxiety is reasonable, because there definitely will be a reshuffling or restructuring once the organizations merge. Employees’ job responsibilities and titles may change, and salaries and benefits might be affected. "We just didn't know what was happening," one staff member said, "Rumors were flying everywhere. It turned out that the rumors were way off and we had worried about all the wrong things." Unlike the for-profit model, where secrecy is required to avoid insider trading, staff on every level should be part of the planning process and be kept abreast of what is happening.

4) What gains would be achieved by a merger? It seems like an obvious question, but it's actually a hard one to answer. Something like "greater administrative efficiency" is what you often hear, but each nonprofit should be very specific about what ‘efficiency’ means to them and their programs. It is much harder to define efficiency for nonprofits than for the business world, because outcomes are not as clear.

Financial gain is not the only incentive for nonprofit mergers as it is in the for-profit sector. Clearly spell out what the added value will be. Before considering a merger, a nonprofit should undertake a serious self-assessment. Asking themselves "Why do we need to exist?" would be a good start.

Before talks begin, each side should be able to describe their own organization, what they do best, and where they're struggling. I've known several organizations have discovered that just taking this step of self examination, clarifying what they want to accomplish, and defining the problem, has clearly shown that a merger would not be the solution to their issues because their issues would still be there.

5) Is there major change ahead that means restructuring will occur anyway?
Is the CEO or another key leader retiring or thinking of leaving?  One of the most complicated issues to deal with in a merger is who will end up being the Executive Director of the merged organization. If the merger works, one or maybe even both of the current Executive Directors may have to step aside. But if a nonprofit already knows it will be losing the Executive Director and looking for new leadership, this might be an ideal moment to think about restructuring the Executive Director role as part of a merger.

Has the organization just lost its lease? Has there been a shift in the population served? Has something happened - like a major loss of funding, or new government requirements, or a lawsuit - that could make it hard to stay in business even with effective programs? Merging with another organization could be on the on the list of possible resolutions.

6) Whose way of doing things will survive? Cultures are different, and most people resist change that is imposed on them. This is where the human cost of merging organizations is often as great as the financial cost. After the merger has been worked out by lawyers and consultants, the daily negotiations of life together begin, often rife with tension.

This is complicated stuff. Ten years after our schools merged, I was seated by chance next to a former teacher from the other school. "Your school got everything," she said with palpable bitterness. "We didn't just lose our buildings, we lost our way of doing things."

In fact, we had made a great effort (we thought) to keep a lot of their cultural legacy alive by maintaining many of their customs and keeping their alumni association alive. But there was no question that their school ceased to exist, and yes, our school got everything. Her grief was understandable, but surprising to me after so many years.

7) Will the constituencies feel abandoned or betrayed by a merger? Will it be necessary to break commitments to programs already started? Be honest. "Abandonment" and "betrayal" are dramatic and tough words, but for nonprofits the connection to constituencies is powerful.

"We thought everyone would see what a good thing this was," said a nonprofit manager who had been part of the planning team for a merger. "Afterward, we realized that we had been so involved in the overarching plan that we weren't focusing on the people who are served by our programs on a daily basis." After announcing their merger, her organization received dozens of impassioned letters and several petitions signed by hundreds of people, begging them not to give up their programs.

8) Is it really a "merger"? What we called a "merger" when our school took over the other was actually an acquisition. There's a difference. Merger sounded less aggressive and more friendly, but one school disappeared and the other grew.

Clarity about this may be helpful for everyone, and not just for psychological reasons. Recently the Financial Accounting and Standards Bureau (the designated organization for establishing standards of financial accounting and reporting) released a statement defining a nonprofit merger as “two organizations dissolving to create a new entity”, and an acquisition as “one organization taking over another that had dissolved”. The IRS also requires, with a merger, that the new entity reapply for tax exemption.

When people talk about merging, they often picture two organizations blending, but in fact a real merger will always involve major restructuring and change for both organizations, and one or both of the nonprofits will dissolve, which literally means go out of business.

9) Are both organizations strong enough? The popular interest in mergers presumes that it is a good resolution for struggling nonprofits. But flailing organizations aren't necessarily the desirable ones for mergers - two leaky boats may simply make one very large leaking boat. Nonprofits operating in some form of financial distress may think merger is an option for them, but may not find another organization willing to merge.

The organizations likely to succeed in any sort of collaboration with another nonprofit are the ones who are struggling but solvent, or the ones who are doing well. They have something to offer another organization and won't bring with them the burden of debt and liabilities. It rarely makes sense for a nonprofit in good shape to take on the problems of another organization in financial trouble.

10) What about closing down, rather than a merger? As Ron Mattocks says, in Zone of Insolvency, "Nonprofit corporations have no particular right to exist forever."

Dissolution may be a very good and quite honorable solution when one organization has come to the end of its useful life. Often the best alternative for a nonprofit in dire financial straits to keep its mission going is to choose dissolution and contribute its assets to another organization with a similar mission.

It's not as unusual an occurrence as one might think: every tax exempt or 501(c)(3) organization must have a Charter which should include a statement determining where the assets of the organization go if it has to dissolve.

Why would an organization have any assets if it has to dissolve? Perhaps the organization owns property, like a building or art work or a small endowment, but no cash flow to keep the organization alive. In that case, dissolution can be a very practical - and sometimes downright noble - choice. The organization that cannot survive doesn't just die in ignominy - it searches for another nonprofit to carry on its mission, serve its constituency, and sometimes ensure the continuance of its programs. This can be an oddly satisfying outcome for the leadership of a nonprofit in trouble, often allowing them to protect jobs and look out for their programs.

I recently saw this happen in an organization that was in need of a major overhaul because their constituencies had changed and their technologically was severely outdated. It was clear that a new entity was needed. The board investigated other organizations with similar missions and donated its assets (which turned out to be surprisingly valuable) to two nonprofits they felt would continue their mission. The new organizations guaranteed the transferred staff jobs for at least a year, and both organizations received what one of them called a "miraculous" gift of assets.

Are there other, less extreme options?

Bear in mind that merging and dissolution may be more extreme solutions than are necessary. Collaborations of all kinds are being considered and undertaken by nonprofits, especially now that technology offers new and more efficient ways of working together and exchanging ideas. There are many other options of strategic alliances that nonprofits can explore, and as the number of new nonprofits increases each year, collaboration will become more and more attractive and necessary.

This article originally appeared on the Funding Exchange.