Updated: Mar 23
At the beginning of the global pandemic, many people expected to see a wave of mergers in the nonprofit sector in response to the downturn in the economy and the multitude of structural upheavals which accompanied it. It was thought that these forces might push nonprofits into merging in order to avoid bankruptcy.
While the fallout of the pandemic and its impact on nonprofits across the country is not yet fully known, it is clear that many nonprofits will continue to wrestle with questions about their structure and strategy as they attempt to adapt to the uncertainties created by the long-term effects of the pandemic on our economy, politics, culture, and, of course, nonprofit funding. According to an article in the Stanford Social Innovation Review, these uncertainties will place nonprofits in a “state of acute decision making and rapid adaptation” for many years. So, it seems an appropriate time to look at the reasons nonprofit organizations might choose to merge or consolidate with one another and the advantages and disadvantages of these statutory reorganizing structures.
Reasons for Nonprofits to Join. Merging or consolidating two nonprofits brings together their boards, management, and legal entities to form a single organization. Merging or consolidating organizations can introduce economies of scale, increase efficiency and improve effectiveness. One very common reason for nonprofits to join is to bring two complementary nonprofits together in order to take advantage of like programs, reduce redundancies, retain talent, and share infrastructure. But, merging or consolidating is not just about responding to economic necessity. Other excellent reasons for two nonprofits to join are the ability to increase their donor pool and create a greater impact, respond to funders’ preferences to support one organization over another, planning for or accommodating the retirement of existing leadership, or simply, the accomplishment of the original goals of the organization.
No matter what reason two or more nonprofit corporations choose to become a single entity, state law governs the process. State law provides two alternative methods of merging nonprofits, but in reality the “statutory merger” method is far more common and easier to execute than the “consolidation” method prescribed by statute.
Merger. In the statutory merger process, typically, the dissolving organization transfers all or substantially all of its assets and liabilities to the “surviving” entity and the separate existence of the dissolving nonprofit ends. However, doing so requires due diligence consisting of a thorough inventory and analysis of the two entities. In addition, it is often necessary to review documents that are identified during this due diligence process to make sure there are no required approvals or consents, potential hidden liabilities, objectionable contract language, redundant services (e.g. it is likely both organizations have D&O policies; only one will be required post-merger), or contract provisions which do not make sense or are disadvantageous to the surviving organization. When the due diligence is complete, then an asset transfer agreement must be negotiated and approved by the respective boards of the two organizations, notice of intent to merge must be provided to the Office of the Attorney General, and articles of merger are filed with the Secretary of State. When the merger becomes effective, the asset and liability transfers happen automatically by operation of law, and the dissolving nonprofit ceases to exist.
Consolidation. In comparison to “statutory merger”, under the statutory “consolidation” method, both existing entities dissolve and merge into a newly formed, third entity. The statutory consolidation process is similar to the merger process in that the nonprofits’ respective boards of directors must undergo a due diligence process, negotiate asset transfer agreements, provide notice to the Attorney General and file articles with the Secretary of State. Also, like the merger process, when the combined articles of consolidation are filed with and accepted by the Secretary of State, the assets and liabilities of the dissolving nonprofits automatically transfer to the new company by operation of law.
However, this is where the similarities stop. Because the consolidation process requires the dissolution of two existing entities and the creation of a new nonprofit, the consolidation process is more complicated and costly than merger. Creating a new entity and folding the two existing entities into one requires two asset transfer agreements (each entity will need one, with the new entity, transferring their respective assets to the new entity) and the new organization may need to enter into new contracts (because many contracts will not be assignable). A new entity would also lack a credit history, an operating history, a fundraising track record, and name recognition. These would need to be rebuilt and could make fundraising (both from individual donors and from granting organizations) more challenging. There will also be additional costs, and probable delays, to form the new company and apply for tax-exempt status. A further drawback of consolidation is that both of the dissolving entities no longer exist to accept gifts as opposed to merger, where one entity remains. While nonprofits may be attracted to the idea of consolidation when they are seeking a “fresh start” or there is conflict between the two dissolving entities’ missions or the entities cannot agree on which nonprofit organization will survive, who will control, or whose name will be used, it is important to weigh these desires against the significant additional costs involved in consolidation. Moreover, with good communication and a well facilitated negotiation process, all of these objectives can be accomplished within the merger process. For instance, the surviving organization can change its name and re-define its mission. Board members can negotiate the control and operating structure of the surviving entity.
As nonprofits continue to assess how best to adapt to the long-term effects of the pandemic on our economy and the nonprofit funding landscape, they may find it advantageous to legally join with other nonprofits with similar missions. In making this decision, these organizations will need to go through the due diligence process of considering the best structure for combining their operations, taking into account each organization’s assets and liabilities, the prior and existing relationships between the two organizations, and the transaction costs of either a merger or a consolidation. Because there are stringent fiduciary responsibilities on the members of nonprofit organizations’ governing bodies, it is advisable to seek legal assistance when considering a merger or consolidation and conducting the due diligence process.