Merger and Acquisition Considerations for Nonprofits

Nonprofits may not be the first entities to come to mind when thinking about mergers and acquisitions (M&As). However, just as in the for-profit world, M&As can be a powerful strategy to capitalize on strengths, manage risks, and drive a nonprofit’s mission.

An M&A deal can enable a nonprofit to achieve geographical expansion, broaden its range of services, foster stronger community and funder partnerships, and facilitate cost-sharing for administrative functions. In certain scenarios, it may even be advantageous for a nonprofit organization to engage in an M&A transaction with a for-profit entity.

Distinguishing Between Mergers & Acquisitions

Making the determination between a merger or acquisition is crucial, as this dictates the accounting treatment that must be followed under accounting principles generally accepted in the United States (U.S. GAAP). Keep in mind that no one characteristic dictates whether the transaction is a merger or an acquisition for GAAP purposes.

Mergers

A merger occurs when two organizations combine to form a new entity, with both organizations relinquishing their independent legal identities. The result is a single organization that integrates the assets, liabilities, programs, and operations of the merging entities. In a merger, a new governing body is often formed, and a new name is established.

From an accounting standpoint, nonprofit mergers follow the guidance provided by the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 958, Topic 805 - Business Combinations. The assets and liabilities of the merging entities are recognized in a separate set of financial statements as of the merger date, with no additional assets recognized. Any classifications, designations, or restrictions are carried forward.

Acquisitions

An acquisition occurs when one organization obtains control over another organization. In an acquisition, the acquiring organization typically retains its legal identity, board of directors, and operating policies and practices, while integrating the acquired organization into its structure.

If a business combination is determined to be an acquisition, the acquisition method is used. This method includes five steps:

1. Identify the acquirer
2. Identify the acquisition date
3. Recognize identifiable assets, liabilities, and noncontrolling interest
4. Recognize goodwill or contribution received
5. Determine what is part of the acquisition transaction

The acquisition method can be very complex, which is why organizations should seek professional guidance when working through an acquisition transaction.

Navigating M&As Between Nonprofits and For-Profits

When considering potential M&A transactions, it is essential to differentiate between M&As involving two nonprofit organizations and those involving a nonprofit and a for-profit entity.

Nonprofit organizations are typically driven by their mission, while for-profit entities may prioritize profits. This fundamental distinction sets the stage for various considerations in M&A transactions.

One significant factor to consider is the availability of financial and human resources. Nonprofits often rely on distinct fundraising methods that differ from those of for-profit entities. Moreover, while people play a pivotal role in the success of both nonprofits and for-profit organizations, their mindsets and perspectives may vary.

Despite these differences, there are notable similarities to consider when deciding on an M&A transaction. Both nonprofits and for-profit entities may share similarities in terms of strategy, culture, business or financial disciplines, and relationships with external stakeholders such as funders, customers, bankers, and investors.

It is crucial to recognize that the tax status of a nonprofit is precisely that — a tax status — and not a definitive business model. While there may be instances where it is advantageous for two nonprofits to merge in an M&A, nonprofit managers and executives should not overlook the potential benefits of collaborating with a for-profit entity when it aligns with their objectives.

Tax Implications of a Nonprofit/For-Profit M&A Deal

When a transaction occurs between a nonprofit and a for-profit, the surviving entity usually retains its tax status.

If the surviving entity is tax-exempt, it maintains its exempt status after the transaction but must ensure that any merged for-profit activities align with the requirements for tax-exempt status. Any activities that are unrelated to the entity’s exempt purpose will be treated as unrelated business income and will be subject to tax. Additionally, the following activities — if conducted by the exempt after the transaction — could jeopardize exempt status:

• Not operating primarily for exempt purpose
• Substantial private benefit
• Inurement
• Political activities
• Substantial lobbying activities
• Excess unrelated business taxable income (UBI)

If the surviving entity is the for-profit entity, there may be significant state law and IRS considerations.

Most states and the IRS require charitable assets — or the fair market value of the assets — to be used for charitable purposes.

This typically will require the for-profit entity to either purchase the assets of the nonprofit, leaving the existing entity to use the proceeds for charitable purposes, or establish a charitable foundation to conduct charitable activities. In order to ensure the nonprofit does not provide private benefit to the for-profit, a valuation by an independent appraiser is likely necessary to ensure the fair value of the charitable assets is preserved.

By understanding these considerations and potential pitfalls, organizations can navigate M&As between nonprofits and for-profits more effectively, ensuring the preservation of their mission and tax status while maximizing the benefits of collaboration.

Preparing Your Nonprofit for an M&A Deal

There are six key factors to consider when preparing for an M&A deal:

1. Due Diligence

Due diligence is a critical step in the M&A process, involving a comprehensive assessment of the target organization. Nonprofits should thoroughly investigate the financial, legal, operational, and strategic aspects of the other entity involved. This includes examining financial statements, tax records, contracts, legal obligations, potential liabilities, and any risks associated with the merger.

2. People

People are at the heart of any organization, and their roles and perspectives play a vital role in the success of an M&A deal. Nonprofits should assess the compatibility of the teams, board members, and key stakeholders involved. It is important to consider the organizational culture, leadership styles, and potential challenges that may arise from differences in values, mission alignment, and decision-making processes.

3. Culture

Organizational culture encompasses shared values, beliefs, norms, and behaviors that shape the work environment. Assessing similarities and differences in culture can help identify potential challenges or opportunities for synergy.

4. Resources

Merging nonprofits should evaluate their combined resources, including financial, human, and technological assets. Financial resources may include funding sources, reserves, and assets, while human resources encompass staff expertise, skills, and capacity. Nonprofits should also consider any potential gaps in resources and develop strategies to address them, such as leveraging new funding opportunities or reallocating staff and volunteers to optimize efficiency.

5. Management

Effective management is essential for a successful merger or acquisition. Nonprofits should evaluate the leadership structures, management styles, and decision-making processes of both organizations. Establishing clear roles, responsibilities, and reporting lines in the merged entity promotes accountability and ensures a smooth transition.

6. Experienced Advisors

Professionals who are experienced in M&A transactions and who understand the nonprofit industry play a crucial role in the success of a deal by providing financial expertise, conducting financial audits, and ensuring compliance with accounting standards. Engaging these individuals early in the process helps nonprofits navigate complex financial considerations and ensures compliance with regulatory obligations.

Prepare Your Nonprofit for the Now – and the Next

Mergers and acquisitions (M&As) can be transformative and strategic ventures for nonprofit organizations. They offer exciting opportunities for growth, expansion, and increased impact. However, to ensure success, careful planning, thorough preparation, and effective communication are essential.