Nonprofit Merger Essentials

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It is not uncommon for a nonprofit’s leaders to consider at some point whether to combine operations with another organization. Perhaps the nonprofit is experiencing financial troubles or a serious leadership vacuum.  A vibrant nonprofit may become interested in absorbing a smaller organization. Or maybe two organizations realize that they can be more effective through joining forces, such as to better position themselves for grant opportunities and to more productively leverage their workers and charitable assets.

What elements should a nonprofit’s leaders consider for a potential merger? What are the appropriate merger steps? This article provides a brief overview of critical elements and major steps for the merger process. 

As an initial matter, it is important to understand what a merger is and what it is not. When two nonprofits merge, the “mergee” corporation - together with its assets and liabilities - are transferred by operation of law to the surviving corporation. Thus, there are no deed transfers or corporate dissolutions. Rather, the “mergee” corporation effectively continues its existence through the surviving corporation. As a result, any bequests, gifts or contract rights belonging to the “mergee” corporation become those of the surviving corporation. Correspondingly, any liabilities of the “mergee” corporation are inherited, so to speak, by the surviving corporation.

In light of these legal consequences, the key to any successful merger is due diligence. The potential surviving corporation’s leaders should thus undertake due diligence sufficient to confirm that the resulting asset value and operational benefits will exceed the potential liabilities and other drawbacks. If the risks are too great, other asset transfer options may provide better alternatives.

A nonprofit board’s initial merger consideration steps include the following:

  1. Evaluate the nonprofit’s goals (e.g., expand into new areas, develop new programs, eliminate “competitors”, increase assets).
  2. Begin assessing how the organization and operations will work post-merger.
  3. Gauge each other’s needs and interests, with prudent and creative diplomacy as needed.
  4. Carefully consider the labels used. The terms “merger”, “reorganization” or “takeover” may be uncomfortable for the nonprofit being absorbed into the surviving corporation.
  5. Use a non-disclosure agreement to protect confidential organizational information.
  6. A letter of intent or similar preliminary initial agreement may be useful to identify the parties’ goals and to establish a merger timeline.

In addition, specific state laws affecting nonprofit mergers warrant careful evaluation by experienced legal counsel. Multiple jurisdictions may be involved, with varying legal requirements for board and membership approval. In particular, careful attention needs to be paid to notice and voting requirements, to ensure legal compliance and to avoid potential later challenges. If charitable assets are involved, approval of the state Attorney General is required in some jurisdictions.

The due diligence process is likewise a critical component for a merger. Through such process the surviving corporation’s leaders should develop a comprehensive understanding of all assets and liabilities prior to consummating the merger, as well as other issues that may affect post-merger operations. Due diligence includes not only legal aspects, but also evaluation of cultural, financial, operational, governance and fundraising concerns. A detailed list should be used for the numerous due diligence items to be considered. A board committee may be a useful tool for working through such items with guidance from legal counsel.

At the end of the due diligence process, the parties’ boards should have a solid understanding of whether or not to merge and how to do so. It may be more appropriate to use an asset transfer arrangement so that the surviving corporation can carry on the other nonprofit’s activities and/or receive its assets but not its liabilities. Alternatively, restructuring the “mergee” entity such as a subsidiary entity allows both corporations to continue, which may be better from a wise management standpoint or to address governance goals.

And then there is the final corporate paperwork to be completed. A written plan of merger must be developed and approved as required by state law and the nonprofits’ bylaws. In addition, articles of merger must be filed with the applicable state’s (or states’) Secretary of State office.

Last, diverse legal and operational matters will remain to be addressed post-merger. Among other things, new employment law considerations may apply, particularly with an increased employee census that may trigger previously inapplicable employment discrimination, unemployment, health benefits, and pension benefits laws. In addition, final tax reports may be due for the merged corporation, such as an IRS Form 990, W-2s and 941s. Real estate tax exemption should be reviewed as well, with either clarifying affidavits of ownership or new exemption applications filed as required by law. Assumed name registrations may be appropriate too, especially so that bequests and other gifts to the “mergee” corporations can find their way to the surviving corporation.

Nonprofit mergers and other strategic consolidations may well be worth serious consideration. When proceeding forward, a prudent and responsible nonprofit board should well understand the goals involved, the potential risks and rewards, the due diligence needed upon appropriate evaluation, the accompanying procedural steps, what will happen post-merger, and available alternatives.