Mergers of not-for-profit organizations are becoming popular in the wake of funding cutbacks. Organizations often site the ability both to offer better and more comprehensive services and to reduce overhead and administration costs as reasons for merging. While the motivations may be valid, improvements in service and savings may not always be realized.
This article provides both an overview of the merger process and a guide to help you merge successfully.
Does a merger make sense for your organization?
As with any major change in direction, your organization and its board of directors should first determine whether a merger is desirable and/or appropriate. Continuing to fulfil your organization’s mission and goals should be a primary consideration in any merger.
Positive outcomes of a merger
- A larger entity is able to spread volunteer hours over a broader base thereby reducing the burden on existing volunteers.
- A larger organization can often reach a broader public than a smaller entity.
- With a strategic merger your organization may be able to offer additional services with a consistent philosophy. For example, a children’s mental health organization might consider merging with a similarly sized not-for-profit childcare operation. The organization would then have regular childcare facilities to offer to clients of the mental health branch and, conversely, families needing ongoing childcare could take advantage of the mental health services. Clients receiving services in one area could expect to receive services with similar standards and philosophy in other areas.
- Merging organizations may reduce administrative costs. The bulk of these cost savings typically result from a reduction in senior personnel (e.g. the elimination of one executive director position and possibly the reduction of one or more senior mangers in non-program areas) as well as a reduction in occupancy costs. In our experience, savings in administrative areas are often significantly less than expected as most organizations have already aggressively cut these costs.
- Maintaining funding can sometimes be dependant on organizations merging. We are aware of several recent instances in Toronto where continued funding was contingent on a group of organizations merging into one. The motivation for the “forced” merger was ostensibly to reduce administrative costs.
- A well chosen merger can often revitalize a waning organization. Organizations sometimes just run out of steam. A merger can bring new creative energy along with financial stability to programs.
Possible negative effects of a merger
- Having dissimilar philosophies at the board and staff levels of prospective merger partners is the most significant barrier to a successful union. Community-based organizations are usually created to fulfill the needs of a very specific public. Finding another community with compatible needs and desires can be difficult. If two entities with incompatible philosophies are forced to merge the result could well be the death of both organizations.
- So-called mergers of entities of dissimilar size, financial wealth or social stature can be more akin to a takeover by the dominant entity. The “weaker” of the two entities may wither and die from disenfranchisement. In this situation it may be better for an entity to wind-up and let its community seek services elsewhere.
- The whole organization can suffer in situations where one arm of a merged organization is not financially viable at the outset. For a merger to be successful, each entity should be solvent in its own right for the foreseeable future.
How to structure a merger
Once organizations have decided they are compatible they need to consider how to best structure the joining. There are at least three distinctly different ways of merging. Each will result in an organization with a distinct and unique flavor. We strongly advise you to get legal advice to determine the responsibilities and liability positions of the boards of directors of each of the merging entities.
Two or more not-for-profit organizations can be legally amalgamated into one. In this process the assets, liabilities and all other attributes (both positive and negative) of each of the organizations are melded into one organization, the amalgamated entity. Legally speaking this “new” entity is not new at all. It is the sum of the parts of all the amalgamating entities. The amalgamated entity fully inherits all the pre-amalgamation entities’ duties and obligations in existence prior to the start of the amalgamation. As an example, liabilities for severance pay, in the event that employees are terminated, are not extinguished by an amalgamation. The pay equity obligations of all entities are also fully passed on to the amalgamated entity.
A legal amalgamation is most appropriate when organizations with similar abilities, attributes and risk profiles want to join together. Significant due diligence should be carried out by boards and senior staff of both organizations prior to amalgamation. This process will help the boards of each of the organizations ensure they are not inheriting a closet full of legal liability skeletons.
Transfer of assets:
An alternative to amalgamation is the scenario where one organization is chosen as the successor organization and the other organization(s) sell or transfer all assets to the successor. The other organizations are then formally wound up. Only the assets are generally transferred to the new entity. Major funders should be contacted well in advance to determine whether services and related funding can be transferred from one entity to the other without undue effort.
This form of merger works best in situations where one or more of the entities has significant liabilities and/or future obligations that the merged organization does not want to assume. Make sure you get legal advice as to how best to deal with the liabilities left behind.
Note that a transfer of assets only works where the successor organization is registered as a charity as articles of incorporation clauses often state that not-for-profit organizations can only transfer assets to a registered charity.
A friendly takeover:
A third option is the friendly takeover where the board of directors of the successor organization replaces the board(s) of the other organization(s). All legal entities continue to exist and operate although they would be managed by one board of directors. The associated organizations may be able to share space and combine certain non-program staff costs in order to save money.
This setup is often of biggest advantage in situations where it is either not possible or extremely inconvenient to have program funding contracts transferred from one organization to another. Discussions with funders are, again, critical well in advance of committing your organization to such a “merger”.
Executing the merger
Following is a practical guide to aid in the merger process. The guide must be tailored to your specific situation and, again, getting good legal advice is essential.
Are the organizations compatible?
Organizations planning to merge should first determine the primary objectives for merging. Are the objectives diversification of services, becoming financial solvent, broadening the membership base of the organization etc.? If merging will better accomplish reaching these goals then consider setting up a committee to seek out an acceptable partner and initiate the process.
To facilitate a smooth merger process we recommend that formal joint strategic planning sessions be initiated at both the board and staff levels of all entities to be merged. Consider then holding a joint session at the completion of the two processes for all participants. These meetings will help determine whether a merger will meet the needs and objectives of both entities. We strongly recommend that an individual independent of both organizations facilitate this process to bring to it some objectivity and clarity.
In successful mergers that we have been associated with, these discussions have occurred over a significant period of time, often up to a year or more prior to the joining. The discussions can be intense and serve to test the ability of the entities to get along. It is always better to call off a questionable merger before the deal has been signed than to suffer through a poor partnership, which may lead to a deterioration of services provided by both of the entities. If you can’t get through the betrothal period you will probably face difficulties after the marriage.
Will the new entity be financially viable?
You must determine whether the entity to be created by the merger will be financially viable. You can, however, only evaluate the financial viability after you have determined what services will be offered. As a result, the financial implications of a merger should follow the often more difficult determination of the strategic objectives of the new entity. Regretfully, many organizations often jump to analyzing the finances first.
To analyze the financial implications of a merger we recommend that all of the involved organizations prepare budgets for the upcoming three year period under their existing service models. Using existing models as a base, adjustments can be made to reflect changes in the service model. Typically, staff costs amount to in excess of 70% of budgets for not-for-profit service organizations. Consequently, much of the financial exercise will be to determine the optimal staff complement and estimate salary levels.
To prepare the budgets we suggest you break operations down on a service program by service program basis. Administration and fundraising can be handled as separate program-like departments. For each of the departments estimate direct revenue from known sources (e.g. grants, membership fees, and fundraising campaigns where outcomes can be reasonably estimated). Costs should then be estimated based on the organization’s future service plans. You will end up with an estimated excess (deficiency) of revenue over expenses for each of the departments. Hopefully the combined budget for the amalgamated entity will have a positive cash flow. The following chart illustrates what a completed budget might look like. For illustrative purposes only one service program has been included. Your budget will undoubtedly have many more.
Note that to minimize arbitrary allocations among departments, costs should be directly allocated to departments wherever possible. For example, even though the executive director works on services, albeit indirectly, the whole salary could be allocated to administration for purposes of the internal budget. This will generally result in a less complex and more easily understood internal budget and should make it easier to spot costs that could be shared by organizations planning to merge.
This form of budget will generally not be appropriate for presentation to external funders as it is often both critical and appropriate to include a share of administration in program costs when reporting to outsiders.
Once the individual budgets of all the departments have been prepared, they can then be combined and analyzed to determine whether the combined entities will be solvent and whether savings can be realized.
Administrative steps to execute a merger
Following is a list of steps that should be performed in the execution of a merger. Again, the list must be customized for your specific situation.
Setting up “Lights-Out” Committees
We suggest that for each merger entity you consider setting up a small committee to manage the orderly closing down of operations. After the merger date, each of these committees would be responsible for paying pre-amalgamation bills, collecting receivables and dealing with the administrative tasks and inevitable headaches associated with the closing of any operation. Each of these committees would ideally include the executive director of the pre-amalgamation entity together with its chair and possibly its treasurer.
All petty cash on hand should be deposited in the bank accounts of the respective entities just prior to the date of the merger. New petty cash funds can be started where needed and these should be funded out of the bank account of the merged entity.
All bank accounts should be reconciled as at the date of the merger. All unusual reconciling items should be identified and followed up as soon as possible.
An estimate should be made of the amount of cash needed for finalization of the pre-merger affairs of each merging organization. This cash, managed by the lights-out committee, should be kept in a bank account specifically for the purpose of settling those obligations. The remaining contents of pre-merger bank accounts should be transferred to the main operating account of the merged entity on the effective date of the merger.
Consider leaving the name of the pre-merger entity on the wind-up account and leaving this account open for a while to make it easier to deposit cheques made out in the “old” name. Late deposits such as GST refunds and other items in the name of the pre-merger entity can more easily be deposited in an account bearing that name.
Compile a list of all term deposits and other investments held by each of the organizations as at the merger date. Prepare written notification of any name change for the financial institution(s) holding the investments. In cases of amalgamation, Articles of Amalgamation may have to be submitted to each of the institutions together with a revised list of signing officers.
Identify all amounts owing to each of the pre-merger organizations just prior to the date of merger. Determine when each amount is expected to be collected and identify those for which collection is doubtful.
File for a GST refund, where applicable, as at the date of amalgamation for each for the pre-merger entities.
Insurance and capital assets
Write to all insurers requesting cancellation of insurance effective as of the merger date. Prepare a list of all capital assets of the new amalgamated entity and forward this to the insurer of the merged entity.
Prepare a list of all equipment under lease (telephones, photocopiers, vehicles, etc.) for each of the individual entities. The planning committee should review lease terms of all equipment under lease and determine what options for use and/or disposal are available to the organization.
Obtain copies of all premises’ leases. Review your options, preferably with a real estate lawyer.
On or before the merger date pay all invoices relating to the period up to the date of the merger. Prepare a list for the new entity’s administrator of amounts to be paid for which invoices will not be received by the date of merger. All other amounts should be referred back to the lights-out committee.
A list of all amounts payable as at the date of amalgamation that are in dispute or in the process of being negotiated/settled should also be prepared. This list should be reviewed periodically by the board of the new entity.
Payroll related items for pre-merger entities
There are a number of often difficult merger tasks specifically related to personnel and payroll. Seniority, pay equity and collective bargaining agreements are just a few of the issues that need to be dealt with early on in the process. We strongly advise that all organizations attempting a merger seek the counsel of a lawyer experienced in labour law generally and in the nuances of the not-for-profit sector specifically.
- Prepare notices of name change of the employer and/or termination for all employees of the pre-merger entities.
- Arrange for all staff and the Receiver General to be paid up to the date of merger. The staff should be paid by their respective pre-merger entities.
- Cancel all but one of the payroll services used effective the date of the merger.
- Transfer all personnel files to the new location.
b. Non-statutory benefits
- Advise all benefit plans of termination of existing coverage effective the date of the merger
- Advise all employees of their change in benefits plan coverage and procedures on or before the merger date.
c. Revenue Canada
- Prepare T4 and T4A supplementaries and summaries for all employees and merging entities from January 1 to the date of merger.
- Prepare the last payroll remittance to Revenue Canada and arrange for it to be received at the appropriate date (e.g. by the 10th or 15th of the month following the last payroll date).
- Cancel the Revenue Canada payroll number for all pre-merger entities but one, effective the date of the merger. Written notification on the back of the payroll remittance form is usually sufficient for Revenue Canada.
d. Ministry of Finance of Ontario
- Prepare the EHT return(s) effective the date of the merger.
- Cancel all EHT number(s) but one effective the date of the merger.
e. Workplace Safety and Insurance Board
- Determine which entities are covered. Arrange for coverage to be transferred to the new entity.
- If coverage is to be cancelled, contact the WSIB in advance to determine the amount of the cancellation penalty.
Post merger payroll tasks
- Prepare employment contracts for all full and part-time staff effective the date of the merger.
- Establish the pay period (e.g. bi-weekly, semi-monthly etc.).
- Have all employees complete and sign TD(1) forms establishing the amount of tax to be withheld.
- Set up direct deposit accounts for employees, if applicable.
- Set up personnel files.
- Set up all new employees on the payroll service (internal or external).
- If a semi-weekly payroll period is adopted, set the second Friday of January as the first bi-weekly pay day of every year.
b. Non-statutory benefits
- Contract with an insurance carrier to provide benefit coverage effective the date of the merger.
c. Government requirements
- Obtain a business number from Revenue Canada for the merged entity. With an amalgamation Revenue Canada will generally allow the continuation of one of the business numbers provided a copy of the articles of amalgamation are filed with them.
- There is also generally no need to obtain a new Ministry of Finance of Ontario EHT account number. Again, the Ministry will generally allow the continuation of one of the EHT numbers provided a copy of the articles of amalgamation are submitted.
- Set a year end for the amalgamated entity that makes sense for business purposes. Factors to consider include when you would like to hold your annual board of directors elections (i.e. the AGM) and the year end of the organization’s major funders.
- Appoint an auditor for the year end audit.