Practical Considerations for Nonprofit Mergers and Acquisitions
Authors: Michael Lehmann | Jeffrey A. Mannisto | Matthew Portnoff
State of the U.S. Nonprofit Sector
The once-robust nonprofit sector is currently in the midst of an economic shakeout whereby many nonprofits are faced with an unprecedented decision of Darwinian significance - either come up with a viable plan of survival or disappear into the annals of history. Survival, in many cases, may hinge upon the completion of a merger, acquisition or consolidation.
How did nonprofits end up in this predicament? Nonprofits, like their for-profit counterparts, have been adversely impacted by weakened credit and capital markets. This has led to drastic declines in charitable contributions, grants and asset values. With no immediate rebound in sight, universities, hospitals, arts councils, animal shelters, and everything in between, are now considering mergers and acquisitions ("M&A") as a way to preserve their overall business plan and charitable mission. A nonprofit M&A transaction, properly implemented, can shore up funding sources, reduce overhead, extend charitable reach, address staff and management deficiencies, and yes, do all of these things more cost-effectively with fewer resources.
On the other hand, nonprofit M&A is by no means the panacea for the many and varied challenges facing the U.S. nonprofit sector. The unique issues associated with nonprofit M&A, as discussed below, make nonprofit M&A transactions difficult, and in the absence of traditional buyer-seller incentives found in a commercial setting, nonprofits face greater difficulty identifying, exploring and completing M&A transactions. Further, the U.S. nonprofit sector remains highly fragmented, where, according to recent IRS statistics, more than 1.5 million U.S. nonprofit organizations currently operate. This means that consolidation, although overdue, is likely not easy to achieve given vast disparities in organizational assets, geography, exempt purposes, etc.
Practical Considerations for Nonprofit M&A Transactions
For those nonprofits contemplating M&A transactions, the following is a non-exhaustive list of relevant tax and non-tax considerations:
- Most corporate and legal issues associated with for-profit M&A are relevant to nonprofit M&A transactions, e.g., conducting extensive due diligence, fulfilling director/trustee fiduciary obligations in evaluating merger proposals, obtaining requisite consents, filing certificates and/or plans of merger and amending charter documents. Certain issues, however, are unique to nonprofits. Examples may include obtaining approvals from endowments, trusts, or donors regarding certain asset transfers, evaluating potential conflicts of interest, lobbying activities and unrelated business taxable income in the context of maintaining exemptions, and confirming various state exemptions and charitable solicitation registrations.
- Merging nonprofits may be required to notify and/or obtain the approval of a state attorney general(s). That is, merging nonprofits may be required to obtain a "no objection" letter from a state attorney general(s) confirming that nonprofit assets continue to be irrevocably dedicated to charitable and public purposes post-merger.
- Nonprofits should obtain the written consent from the IRS for any M&A transaction potentially impacting a nonprofit's tax-exempt status, classification under the Internal Revenue Code, receipt of charitable contributions, or that which otherwise results in recognition of unrelated business taxable income, gain, loss or other taxable income. In certain cases, merged nonprofits may be required to obtain exemption for a new corporation created in an M&A transaction. In some cases, a private letter ruling request may be advisable.
- Nonprofits are required to comply with state and federal rules designed to ensure nonprofits are organized and operated for the benefit of the public, not private interests. These rules must be carefully evaluated in the context of an M&A transaction to ensure that payments made to directors, officers and other individuals do not result in excise taxes, penalties or loss of exemption.
- As provided above, nonprofits must obtain requisite consents. However, because nonprofits generally do not have shareholders, consent must be obtained from the nonprofit's members, directors or trustees. Typically, a majority of a nonprofit's members, directors or trustees must approve any dissolution, merger, sale or transfer of charitable assets and liabilities.
- A merger may affect a nonprofit's annual accounting period, method for maintaining books and records and filing of tax returns, especially in the case of an interspecies nonprofit merger, e.g., a merger between a private foundation and a public charity. Nonprofits are advised to consult accountants specializing in nonprofit return preparation. IRS consent, as provided above, also may be required.
- Nonprofits must carefully evaluate the conduct of their exempt activities post-merger, especially where merging nonprofits have varying exempt purposes. Resource constraints, in particular, may require a material modification of the surviving entity's exempt activities consistent with amended and restated exempt purposes.
Nonprofit M&A should increase substantially for the remainder of 2010 and beyond. As in the case of for-profit M&A, completing a nonprofit M&A transaction is never a simple matter. That said, a properly structured M&A transaction can strengthen a nonprofit's general efficacy, charitable reach, and financial health. Nonprofits considering M&A transactions are strongly urged to retain tax and accounting professionals with appropriate expertise.