In the wake of the new tax law and other developments, many nonprofits are looking for ways to solidify their financial footing — including the possibility of merging with another organization. But a merger isn’t something to be entered into lightly. It’s a big step that requires careful planning and consideration.
The term “merger” is a bit of a catchall, and your organization may opt to pursue a different type of collaboration. In an actual merger, all the assets and rights of one organization transfer to the surviving organization. And the former nonprofit no longer exists as a legal entity. Notably, the surviving organization assumes all the merged-out organization’s liabilities. There are several other popular ways to combine forces:
Consolidations are like mergers, except that both organizations are dissolved, and an entirely new entity is created that assumes all assets and liabilities of both former organizations. The new entity will need to apply for tax-exempt status.
In an asset acquisition, one nonprofit acquires identified assets — and possibly liabilities — of another. When dealing with two nonprofits, you could simply structure the transaction as a gift from one to the other. This approach usually is permitted if the transferring organization’s creditors are either transferred, or paid in full, before it dissolves.
Alternatively, two nonprofits could enter into a parent-subsidiary arrangement. The “parent” doesn’t own the other organization. But it takes control, for example, by serving as the sole voting member of the subsidiary’s board or having the right to appoint the board members. Notably, though, the parent doesn’t assume the subsidiary’s liabilities. Each organization continues to function individually, with separate IRS filing obligations and boards of directors.
The parent-subsidiary arrangement — also known as an affiliation of nonprofits — can be implemented by amending the subsidiary’s articles of incorporation and bylaws to describe the parent’s control. If the arrangement doesn’t work out as hoped, it can be reversed simply by amending the documents again. The organizations usually also enter an affiliation agreement that addresses a variety of topics, such as the subsidiary’s activities.
State nonprofit corporation acts generally govern the processes and requirements for each of these transactions. Both state and federal laws must be considered when structuring the combination.
Each nonprofit should conduct a thorough investigation into the other organization’s history, finances and operations before entering into a collaborative agreement. Neither party can afford to take due diligence lightly — the board members for the nonsurviving organization have a fiduciary duty to obtain reasonable assurances that the surviving organization can properly steward the nonsurvivor’s assets postmerger.
The organizations should exchange a wide range of information, including corporate documents (for example, charters, bylaws and policies); financial statements and audit reports; and fundraising records and donor lists. They should also share third-party contracts, including grants and other funding; HR records; and meeting minutes.
Moreover, the two organizations should look at IRS determination letters and filings; documentation of exemptions from property, sales and other state or local taxes; real estate records; and current and pending litigation. Due diligence can be performed in phases so that more confidential or sensitive information isn’t exchanged until further along in the process, as the combination becomes more likely. Final approval must come from each organization’s board of directors and possibly its members.
Nonprofits often consider collaborations for financial reasons. But the process can come with significant costs, some of which aren’t always obvious. Potential expenses include:
- Staff time, severance pay and professional fees (attorneys, accountants and consultants),
- Audit and filing fees,
- Rebranding and replacement of promotional materials,
- Moving expenses and infrastructure upgrades,
- Lease and loan buyouts, and
- Lost funding.
Other possible staff-related costs could include a need to increase some salaries to achieve organizationwide pay parity. This could happen if one of the nonprofits paid its employees significantly more than the other did.
Don’t forget to report
Most nonprofits that end their operations by merging with another nonprofit must inform the IRS by filing a final Form 990, 990-EZ or 990-N. It must be filed within four months and 15 days of the organization’s termination. Certain states also require notification to the state attorney general or other appropriate office. Keep in mind that a merger can be complex.