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Working Better Together

CAPLAW’s Guide to Mergers and Shared Services

Mergers

This section of CAPLAW’s shared services and mergers guide identifies some key issues for a CAA to consider before proceeding with a merger and provides an overview of the merger process.

What should we think about before moving forward with a merger?

When should we start thinking about merging?

It’s never too early for a CAA to explore the possibility of merging. Some CAA boards and executive directors may be reluctant to explore mergers because of a concern that their organizations will be labeled as failing. However, the best time for a CAA to consider a merger is before it finds itself in crisis. Although mergers may be used in certain cases to “rescue” troubled CAAs, many CAAs are considering and pursuing mergers as a forward-looking strategy to strengthen already solid organizations, accomplish specific mission goals, and increase impact. Indeed, nonprofit merger expert David La Piana has observed that “An organization will make a better candidate for a merger partner and will be more likely to carry such an endeavor to fruition when it:

  • Knows what it wants to accomplish;
  • Is clear on its mission;
  • Understands and agrees on its strategic challenges;
  • Is able, after full discussion and honest debate, to speak with one voice;
  • Has a strong, positive board/management relationship;
  • Is not in crisis;
  • Has a history of successful risk-taking; and
  • Is growth-oriented.”

(La Piana, “Nonprofit Mergers: Is Your Organization Ready for the Road?” (2000), p. 1)

In the current environment, it makes sense for CAA boards and management staff to consider whether merging is a viable sustainability strategy for their organization and, if so, to be constantly alert for potential merger partners. A particularly good time for a CAA to explore merging is when its executive director is planning to retire or otherwise depart, or when he or she has just done so.

Mergers are not a panacea for all challenges facing CAAs and should not be entered into lightly, simply because they are an available option. For example, merging two financially troubled CAAs is not likely to solve their problems; instead, it is likely to result in one larger, financially troubled CAA. Therefore, although it is a good idea for CAAs to be constantly open to exploring and pursuing mergers, they should not rush–or be rushed–into them.

Whether pursued to rescue an organization or as part of a long-term growth plan, a merger will produce better results if each potential merger partner has taken the time to assess its strengths and weaknesses and to clarify what it hopes to achieve by merging. At the outset of the process, each organization should ask not “‘Do we or do we not pursue [a merger]?’ but rather ‘How do we best fulfill our organization’s mission and strategy to be effective, and is [a merger] a better option than other alternatives?’” (The Bridgespan Group, Nonprofit M&A: More Than a Tool for Tough Times (2009), p. 5.)

How might merging benefit our CAA?

The real benefits of a merger are not short-term and tactical, but medium- to long-term and strategic, according to nonprofit merger expert David La Piana (La Piana, The Nonprofit Mergers Workbook Part I (2008), p. 4.). For example, a merger may enable a CAA to expand, improve, or preserve the programs it provides by growing its service area, attracting new clients, or integrating services. It may enable the CAA to strengthen its financial position by achieving economies of scale, diversifying its revenue streams, increasing its assets and its ability to borrow, or expanding its base of donors. A CAA may also expand its organizational capacity by merging, if the merger enables it to add new staff with experience and expertise not previously available at the organization; improve its internal administrative functions (such as finance, human resources, or IT); access expanded, improved or better located facilities; improve its branding and marketing; or build new relationships in the community.

What type of costs are involved in a merger?

Many CAAs (and their funders) are initially attracted to the idea of a merger because they think that it will resolve a current financial crisis with immediate cost savings. However, the cost savings, if any, produced by a CAA merger are unlikely to be realized immediately, due in part to the fact that there are often significant costs involved in merging.

Mergers involve two types of costs – financial costs and opportunity costs. Examples of financial costs involved in merging include:

  • Staff time spent planning and implementing the merger and integrating the two organizations
  • Professional fees for legal, accounting, merger facilitation, and communications/PR services
  • Systems integration expenses associated with combining (and, if needed, expanding) financial, HR, and IT systems
  • Human resources costs to review and make changes to personnel policies and benefit plans, and to onboard new staff
  • Facilities costs for lease changes, reconfiguring space, and moving
  • Re-branding costs (design of new logos, websites, signage, letterhead, business cards, communications)

Opportunity costs represent opportunities foregone because the CAA’s staff and resources were devoted to the merger process and not to pursuing other priorities, such as grant funding, program expansion, or collaborations with other organizations. The potential loss of these opportunities should be considered when deciding whether to pursue a merger.

The amount a particular CAA merger will cost depends on the circumstances of the merger. Some CAA mergers have resulted in only minimal costs (less than $5,000), while for others, costs have been much more significant (i.e., over $50,000).

How long does the merger process usually take?

Exploring and consummating a merger may take from several months to two years. Fully integrating the organizations after the merger can take another one to three years, or even more, depending on the circumstances.

Therefore, it is important to have a realistic timeline for merger. Finding an appropriate merger partner, conducting due diligence, negotiating the terms of the merger, drafting the merger documents, and planning for the integration of the two organizations may prove more complicated and take more time than anticipated. Factors that will impact the length of the process include the level of familiarity between the organizations and the challenges of integrating their corporate structures, operations, and organizational cultures.

What are some potential roadblocks to merging?

The following are some common road blocks that can derail a potentially beneficial merger:

  • Concern about loss of organizational identity and/or reduction in services to the community;
  • Concerns about merger costs;
  • Funding source rules;
  • A short-term focus on day-to-day operations and survival that prevents the pursuit of long-term, strategic goals;
  • Lack of interest or opposition from boards or staff;
  • Lack of a communication strategy;
  • Inattention to differences in organizational culture.

Anticipating and proactively addressing these and other obstacles can make the difference between success and failure. For example, if Rainbow County CAA’s board is concerned that a potential merger with a neighboring CAA will result in the loss of Rainbow County CAA’s identity and of services to Rainbow County residents, proponents of the merger might explain to the board that, even if Rainbow County CAA does not survive as a separate entity after the merger, its services in Rainbow County will continue to be provided by the merged entity, and could even be provided by the merged entity “doing business as” “Beautiful County CAA” so that clients will not even be aware that a merger has taken place.

What factors will improve the chances that a merger will succeed?

Vision, trust, communication and planning are key factors in the success of a merger.

Vision
A successful merger requires a shared vision of the results to be achieved by merging and the impact that merging will have on the community. This shared vision will enable merger champions to make the case for merging to the boards and staff of the merging organizations, as well as to funding sources. It will also help keep board members, executive directors, and staff motivated to overcome the hurdles that will inevitably arise while negotiating and planning the merger.

Trust
Trust between the merging organizations will play a critical role in helping overcome the challenges and obstacles that will inevitably arise during the merger process. At the outset, therefore, it is important for the boards and executive directors of the merging organizations to build relationships with each other. As the merger process proceeds, it is a good idea to involve middle management and other staff as appropriate in integration planning.

Communication
An effective internal communication plan will prove critical in keeping staff at all levels informed and reducing their anxiety about how the merger will affect them. Developing and implementing an external communications plan is also key – doing so will keep funding sources and other key stakeholders apprised of the merger process and allow the merging organizations to prevent the spread of rumors in the community about the merger.

Planning
Successful post-merger integration will depend on an accurate assessment of corporate cultures and effective planning during the exploration phase. It will also require flexibility and a commitment to the vision behind the merger.

What key legal issues should we consider at the outset?

How will merging impact our Community Service Block Grant (CSBG) funding?

The following are several CSBG issues for CAAs to consider when merging:

Designation
In the case of a merger between two CAAs, where one CAA will dissolve and the surviving CAA will take over its CSBG service area, the CAAs should discuss with the state CSBG office what process must be followed to obtain the state’s approval of the merger and of the expansion of the surviving CAA’s CSBG service area. The federal CSBG Act provides that if a geographic area ceases to be served by CAA, the state may solicit applications from nonprofit organizations located in the unserved area or in an area contiguous to the unserved area and designate from among those organizations a new entity to serve the area. See 42 USC § 9909(a)(1). HHS regulations defer to each state’s interpretation of the federal CSBG Act unless the interpretation is clearly erroneous. See 45 CFR § 96.50(e). A state thus has discretion to determine whether a geographic area is no longer being served and whether to use a competitive application process to designate a new entity to serve that area.

To avoid these issues in the case of a merger between a CAA and a non-CAA, the merger should be structured so that the CAA’s corporate status and tripartite board remain intact (even if its name may change).

Tripartite Board Size and Composition
In order to receive CSBG funds, a CAA must comply with the tripartite board requirements of the federal CSBG Act. See 42 USC § 9910. When a CAA merges with another organization, it must ensure that the board of the surviving entity will comply with these requirements. In the case of a merger of two CAAs, where one CAA will dissolve and the surviving CAA will take over its CSBG service area, the surviving CAA’s board will need to be expanded to include representation from the service area of the dissolving CAA. In many cases, this will require an increase in the size of the surviving CAA’s board – typically, by three seats, one for each of the three sectors. In some circumstances, if existing board members resign, the size of the board may not need to be increased. Whether or not the surviving CAA’s board size will increase, its bylaws will most likely need to be amended to describe the representation from the new service area.

Funding Level
When two CAAs propose to merge, they should work with their state CSBG office to determine the amount of CSBG funding that the surviving CAA will receive. Although CSBG funding is often tied to the size of the low-income population in a CAA’s service area, many states set a base level of funding that every CAA can expect to receive. Depending on the circumstances, it is possible that the level of funding that will be allocated to the surviving CAA in a merger of two CAAs will fall short of the level of funding that both CAAs had received as separate entities. This drop in funding can be a disincentive to merging. Some CSBG state offices will provide additional CSBG discretionary funding to make up for the decrease in CSBG funding. State CSBG offices should assess whether a change in their state CAA or CSBG laws or regulations may be needed to address this situation.  For example, the Minnesota legislature amended its Community Action statute in 2014 to specify that generally, when two CAAs merge, the merged entity will receive a base funding amount equal to the sum of the base funding amounts each of the merging CAAs had received before the merger. See Minnesota Statutes § 256E.30.

Amendment to State Plan
If a merger between two CAAs, in which one CAA will dissolve, takes place during the CSBG program year, the state CSBG office will need to amend the state CSBG plan and its contract with the surviving CAA to reflect the fact that the surviving CAA is taking over the dissolving CAA’s service area and funding. The state will also need to terminate its CSBG contract with the dissolving CAA.

Reporting
The surviving CAA will need to work with the state CSBG office to determine what additional information it will need to report to the state as a result of the merger and how to report that information.

How will merging impact our Head Start funding?

A significant obstacle to a merger of two CAAs with Head Start programs is the potential for competition of the non-surviving CAA’s Head Start program. The Administration for Children and Families (ACF, the agency within the U.S. Department of Health and Human Services that administers the Head Start program) takes the position that mergers of Head Start grantees usually require it to offer an open competition in the service area of the grantee being absorbed. This is because under the Head Start regulations, a grantee must have legal status – i.e., existence as a private nonprofit agency or organization as a legal entity recognized under the law of the State in which it is located; a grantee’s failure to maintain legal status is grounds for termination of its Head Start grant. See 45 Code of Federal Regulations (C.F.R.) §§ 1302.2, 1302.20 and 1302.22. In addition, a Head Start grantee’s voluntary relinquishment of its grant constitutes a termination of the grant. See 45 C.F.R. § 1303.2. ACF considers a grantee that dissolves to have lost its legal status and voluntarily relinquished its grant. Head Start regulations require ACF to select a replacement grantee through a competitive process when the grantee has lost its legal status or voluntarily relinquished its grant. 45 C.F.R. §§ 1302.1, 1302.10 and 1302.11.

A possible solution to this problem may be for one of the merging CAAs to become a corporate subsidiary of the other; the subsidiary corporation would thus retain its corporate existence and should be able to continue operating its Head Start program. An ACF official has indicated informally that this structure should not require competition; however, ACF has not issued any formal guidance on the matter. Therefore, CAAs facing this situation should discuss with ACF whether such a parent-subsidiary relationship would avoid the need for competition and, if so, work with an attorney to structure the merger accordingly.

A CAA that is not planning to dissolve but instead will change its name in a merger must provide ACF with advance notice of the name change; however, the name change will not affect the CAA’s continued eligibility for its Head Start grant. See HHS Grants Policy Statement, pp. II-51 and II-79.

How will merging impact our other government grants and our licenses or accreditations?

A CAA that is planning to merge with another organization but not be the surviving entity in the merger should work with its other funding sources and any entities from which it has obtained licenses or accreditation to facilitate the transfer of its other grants, licenses, or accreditations to the surviving organization.

Can the cost of merging be charged to a federal grant?

Under the federal cost principles, merger costs cannot be charged to a federal award without prior approval.  See 2 C.F.R. Part 230, App. B, par. 31 (OMB Circular A-122), 2 C.F.R. Part 225, App. B, par. 32 (OMB Circular A-87), and 2 C.F.R 200.455 (OMB “Super Circular”). However, in some cases a government funding source, such as a state CSBG office, may be willing to authorize the use of federal grant funds to pay for merger costs.  Therefore, a CAA contemplating merging should contact its state CSBG office to obtain prior approval to use CSBG funds to pay merger costs.

Will our CAA's unionized workforce impact a merger?

A unionized workforce may make a merger more complicated. A CAA with a unionized workforce should consult with a labor attorney to determine how its collective bargaining agreement will impact its plans to merge.

What are different ways of structuring a merger from a legal perspective?

The following is a brief description of common ways to structure mergers. When structuring a merger, keep in mind that form (choice of structure) should follow function (the vision for the merger) and be sure to consult with an attorney.

Merger
In a true merger, a surviving corporation (Corporation A) assumes the assets and liabilities of one or more other corporations (Corporation B) which then dissolve. In this scenario, Corporation A may modify its board size and composition to include board members from the board of Corporation B. Corporation A may also modify its name to reflect the absorption of Corporation B.

Consolidation
In a consolidation, a new corporation (Corporation C) is created, which assumes assets and liabilities of two or more other corporations (Corporations A and B), which then dissolve. Under this scenario, Corporation C will have to apply to the IRS to obtain tax-exempt status as a 501(c)(3) organization. Both Corporations A and B will need to arrange the transfer of their grants to Corporation C.

Parent-Subsidiary Relationship
In this scenario, one corporation (Corporation B) becomes a subsidiary of another corporation (Corporation A). In the context of a merger of two nonprofits, this is done by making Corporation A the sole corporate member of Corporation B.

Asset Transfer
In an asset transfer, one corporation (Corporation A) transfers all (or substantially all) of its assets – but not its liabilities – to another corporation (Corporation B) and then dissolves.

Program Transfer
In a program transfer, one or more programs run by one organization (Corporation A) are transferred to another organization (Corporation B).

How does the merger process work?

How do we start the merger process?

The first step in pursuing a merger is for a CAA to conduct an organizational assessment gathering information on and analyzing:

  • Its motivations for merging;
  • The goals it hopes to achieve by merging;
  • Critical issues facing the organization;
  • Potential obstacles and red flags to merging;
  • Its financial position; and
  • Strengths and weaknesses that may affect its attractiveness as a merger partner.

Once the CAA has looked inward at its motivations, strengths and weaknesses, the next step in the process is to look outward to identify possible merger partners and assess its compatibility with them.

What are some ways to identify a potential merger partner?

There are many ways to identify potential merger partners. Sometimes someone within the CAA, such as a board member or the executive director, will know of an organization that might make a suitable merger partner (for example, an organization with which the CAA has previously collaborated on programmatic efforts). Often this individual will have a good relationship with one of the leaders of the identified organization, and will be able to initiate a confidential conversation about the possibility of merging. Should the merger effort move forward, these individuals will likely play an important role in championing the merger.  Where pre-existing relationships that could lead to merger discussions do not already exist, a CAA may decide to hire a consultant to help identify potential partners and to initiate and facilitate conversations with those organizations. In other cases, a state CAA association or state CSBG office may recommend potential merger partners.

What should we look for in a partner?

A merger partner should bring strengths – such as resources, relationships, experience, or skills – to the table. An organization with a similar mission, compatible organizational culture, contiguous service area or a menu of services or client base that complements that of the CAA often will make an attractive partner.

In evaluating whether to merge with a potential partner, a CAA should consider questions such as:

  • Is there a history of collaboration or shared services between the two organizations?
  • What strengths would each organization bring to the merger? What weaknesses?
  • Are the organizations’ missions and organizational cultures compatible?
  • Will merging with this organization help the CAA fill gaps in services currently being provided or facilitate integration of services?
  • Will the merger open up new streams of funding or improve the CAA’s fundraising efforts?
  • Will it enhance the CAA’s outreach and connections to communities in the service area?
  • Will it provide opportunities for the CAA to improve its branding or reputation?
  • Will it aid in meeting emerging needs or trends?
  • Is merging with this organization financially feasible?

After identifying a partner, what are the next steps in the merger process?

Boards Vote on Intent to Merge and Form Joint Merger Committee

Once it is clear from preliminary, informal merger conversations with the other organization that both organizations are interested in pursuing a merger, a letter of intent to merge is drafted stating, for example, that: each organization will pursue merger exploration and negotiation in good faith; neither will pursue a merger with any other organization for the duration of the specified merger exploration period; the fact that the organizations are engaged in merger discussions and information shared during the merger exploration phase are confidential and may not be disclosed to third parties; and certain individuals from each organization are authorized to engage in merger exploration discussions and, if applicable, to negotiate proposed merger terms. The letter of intent might also specify how the two organizations will divide joint costs (such as the costs of a merger consultant or facilitator) incurred during the merger exploration phase

The organizations at this time may also consider entering into a separate confidentitality agreement to further protect any confidential information that may be shared or exposed during the exploratory phase and throughout the transaction. This sample confidentitality agreement developed by CAPLAW, is intended to be thoughtfully reviewed (preferably in consultation with an attorney licensed in the state) and modified as necessary to meet the individual needs of the organizations and comply with applicable laws.

The boards of both organizations will then meet separately to approve the signing of the letter of intent and confidentitality agreement (if applicable), and to appoint members to a joint merger committee, usually made up of the board chairs, executive directors and two or three other board members and/or other leadership team members from each organization. The joint merger committee will oversee negotiation and due diligence, act as a liaison between the two organizations, resolve details on issues such as governance, staffing, policies, and employee benefits, and, ultimately, make a recommend on whether or not to merge. In some cases, the committee members from both organizations will work together (for example, to develop a joint external communications plan or to negotiate the governance structure for the merged entity) and in other cases, they will work separately (for example, to conduct due diligence on the other organization). Members of the merger committee will regularly report back to their respective boards on the progress and the substance of their work.

The Merger Is Structured
After the letter of intent is signed, a simultaneous process of conducting due diligence, negotiating the details of the merger, drafting legal documents for the merger and planning the integration of the two organizations begins. It is during this phase that the organizations choose a legal structure for and work out the details of the merger. At the beginning of this phase, the merger committee will articulate a joint vision for the merger, establish a time frame for the remaining steps in the merger process and a target date for completion of that process, and outline a plan for internal and external communications about the merger.

Due Diligence
During this phase, each organization conducts due diligence on the other to identify issues that could derail the merger or that at least must be negotiated and to inform how the merger will be structured. (For example, if one of the merging organizations is burdened with substantial liabilities, it will generally make sense to structure the merger as an asset transfer so that those liabilities will not be transferred to the merged entity.) Due diligence may include evaluating the other organization’s financial statements, audit reports, grants and contracts, employee benefit plans, union contracts (if any), insurance policies, articles of incorporation, and bylaws and other records. It can also include contacting community partners and funding sources, and meeting with key employees from the other organization to verify information and ensure that future plans are realistic.

Negotiations
The merger committee will meet regularly to discuss and resolve key issues, including:

  • Corporate Structure: How will the merger be structured from a legal perspective? Will one of the organizations dissolve? If so, which one?
  • Governance: How will the board of the merged entity be structured? Will new seats need to be added to include representation from the non-surviving entity board or from its service area? What provisions will the bylaws of the merged entity include?
  • Executive Leadership: Who will fill the role of executive director of the merged entity? What will happen to the other executive director? Who will fill the other key leadership positions?
  • Other Staff: Will staff of the non-surviving entity be guaranteed positions with the merged entity or must they apply for positions with the merged entity and possibly not be hired?
  • Programs: Which programs will be retained? Which employees will staff the merged or remaining programs?
  • Organizational Name and Branding: What will be the name of the merged entity? What will the branding strategy be for the merged organization?
  • Location: Where will the headquarters for the merged entity be located? Should any current locations be closed?
  • Employee Benefits: What employee benefits will be offered to the staff of the merged entity?

Communications
During this phase, internal and external communication should be effectively managed. Staff should be kept apprised of the merger and important developments in the process. This will help alleviate anxiety and stress and will keep the merger process moving. The merger committee should decide whether, and to what extent, to notify the media and the community of the merger talks at this point and if a decision is made to do so, to carefully plan and craft any public statements on the merger.

In addition, the organizations should keep their funding sources apprised of the merger and should work closely with their funding sources to determine whether grants and contracts may be transferred to the merged entity and, if so, the steps required to effectuate the transfer and ensure continued post-merger funding.

Planning for Integration
The merger committee – in some cases with the assistance of additional staff from each organization – will prepare plans for the integration of the governance, administration, financial management, human resources, information technology, and programs of the two organizations. Depending on the circumstances, certain aspects of the integration process may begin before the merger formally occurs. For example, the organization that will not survive in the merger may transfer its financial information into the surviving organization’s financial software.

Preparation of Legal Documents
During this time, legal documents, including a merger agreement, should be drafted to facilitate the merger and effectuate the necessary corporate changes.

Boards Vote on Merger

After due diligence is completed and all outstanding issues are resolved by the merger committee, the committee votes on whether to recommend a merger and committee members from each organization present the recommendation to their respective boards. Each organization’s board then votes on whether to approve the merger.

Legal Documents Are Signed and Filed

After both organizations’ boards vote to approve the merger, the legal documents necessary for the merger are signed and, as necessary, filed with the state.

The Organizations Are Integrated

After the legal documents have been executed comes the difficult work of integrating the organizations, programs, or whatever it is the merger called for. It is at this point that boards are merged and management, employees, and programs are integrated. Depending on the merger, integration may encompass joining boards, management, staff, administrative departments, and programs, all while being mindful of differing corporate cultures. This can be the most difficult and lengthy of the steps as it can take years to fully integrate corporate culture and realize the vision behind the new organization. It is here where the planning conducted during the merger exploration phase will be put to the test, as well as the flexibility of leaders and staff in the new merged organization.

This resource is part of the National T/TA Strategy for Promoting Exemplary Practices and Risk Mitigation for the Community Services Block Grant (CSBG) program and is presented free of charge to CSBG grantees. It was created by Community Action Program Legal Services, Inc. (CAPLAW) in the performance of the U.S. Department of Health and Human Services, Administration for Children and Families, Office of Community Services Cooperative Agreement – Grant Award Number 90ET0433. Any opinion, findings, and conclusions, or recommendations expressed In this material are those of the author(s) and do not necessarily reflect the views of the U.S. Department of Health and Human Services, Administration for Children and Families.