In today’s economy, nonprofit organizations must constantly assess their operations and missions in order to maximize their impact with the limited resources available. One option that offers many benefits to a nonprofit organization is a strategic merger. When one or more nonprofit organizations merge or consolidate, they can proactively strengthen the effectiveness of the organizations while leveraging assets and contacts to expand their reach, improve quality of services and achieve efficiencies. In addition to the typical issues that come with a traditional M&A deal, nonprofit organization M&A has added complexity because of the tax implications presented as well as the fact there are no owners bargaining for value.
One of the first considerations that distinguishes nonprofit M&A transactions from for-profit deals is that maximizing value or “profit” to the equity holders is not the ultimate goal. Instead, most of the deal points in nonprofit M&A deals relate to the governance of the combined organization(s) going forward. All parties will focus on the size and composition of the board of directors of the resulting or surviving nonprofit organization, the representation of the constituents from each organization, and the allocation of governance rights. Additionally, there will be a strong emphasis on program service commitments going forward and the adherence to a joint mission.
If a for-profit organization is acquiring a nonprofit organization, the use of existing charitable assets will be an incredibly important deal factor. When a for-profit organization purchases a non-profit, a non-profit valuation expert should be retained to determine the fair market value of the non-profit organization. The sale price for the non-profit should be at least fair market value. The proceeds from the sale must remain dedicated to charitable purposes.
Non-profit organizations typically have two key features. First, they have been formed as a nonprofit legal entity under state law. Most are formed as corporations, but some are formed as LLCs, unincorporated nonprofit associations, or charitable trusts. Second, most have been determined by the IRS to be public charities under section 501(c)(3) of the Internal Revenue Code. Section 501(c)(3) status exempts nonprofit organizations from paying federal income tax on its activities and allows donors (either individuals, business firms or private foundations) who donate to the nonprofit organization to characterize such donations as charitable contribution deductions on their tax returns. Nonprofit organizations considering a merger with another nonprofit should work closely with both their legal and tax professionals to understand the classifications of each entity and any implications of the classifications on the proposed merger.
State Laws and Oversight
Depending upon the nature of the nonprofit and/or the state of formation, there may be additional considerations. Some states may require oversight of the nonprofit by a regulatory agency, such as the attorney general, within the state of formation. Such oversight may require the nonprofit organization to obtain permission from the Attorney General or other government authority within state government to proceed with the proposed merger. It is best to understand which laws and oversight are in play before the deal proceeds too far to prevent any surprises or issues down the road.
When nonprofit organizations are evaluating a possible merger, the members of the board of directors of each nonprofit organization will need to evaluate and determine if the combination of the two organizations will help to further advance the mission of both. Both boards will have to consider the effect of the merger on the constituents of each organization. In some instances, a combination of organizations may help to further advance the mission of both and provide more efficient services to constituents. Nonprofit organizations considering a merger should test the effects of the proposed deal to the mission regularly to ensure both entities’ mission is upheld.
In addition to the myriad of issues a typical M&A transaction brings, nonprofit M&A deals add another layer of complexity. Nonprofit organizations must take additional factors into consideration and keep the organizations’ missions at the forefront of the deal to ensure the end goal is to enhance services to constituents through the most efficient combination of services and resources. It is critical that such entities engage the services of experienced professionals to assist with negotiating the complex waters of nonprofit M&A transactions.
For almost 20 years Kim Lowe has lawyered from the trenches. Kim lawyers from experience, using her knowledge of the law and understanding of how both for-profit and nonprofit business enterprises operate.
Rachell Henning is a third-year student at Mitchell-Hamline School of Law's innovative Hybrid program. Rachell is an Avisen Fellow alum who enjoys spending time with her husband and two young daughters when she is not working or studying.