Whatever your preferred source of information, discussions about the financial crisis of the past two years are unavoidable.
Stories of struggling businesses and growing individual needs are omnipresent. The housing and investment markets collapsed. Unemployment ballooned to long-forgotten levels. Bank credit seized up and became increasingly difficult to obtain. These factors, among others, contributed to a 31.4 percent increase in U.S. business bankruptcies through the third quarter of 2009 as compared to the same period from the prior year, according to the Administrative Office of the U.S. Courts.
Nonprofit organizations are not immune. They, too, have been hit hard, taking their unwanted turn in the financial headlines. Many entities already work wonders with limited resources, and now they've been pinched even more. Severely impaired endowments and investment portfolios - many entities experienced asset value declines exceeding 30 percent - combined with decreased funding from corporate and individual philanthropy and governments at a time of increased need are compounding the difficulties for nonprofit organizations.
Nonprofit organizations - in areas such as health care delivery, education, arts and culture, human needs, and social welfare - represent a significant portion of the economic engine of this country, although they measure success by metrics such as people served, as opposed to bottom-line growth. The negative forces affecting financial stability and the delivery of results may require a shift from the old operating norms for some nonprofits to survive and thrive.
These organizations were already competing for a limited pool of available donors, foundation or corporate contributions, and government funding. The number of 501(c)(3) organizations with income greater than $25,000 has grown more than 32 percent, to over 1.5 million, in the past 10 years. Now, when money is at its tightest, needs are also increasing in many communities as federal, state and local governments have cut their programs due to budget deficits.
MORE REGULATORY REQUIREMENTS
Many may not realize the volume of ever-expanding compliance requirements attached to government grants and the continuation of tax-exempt status. Nonprofits are experiencing greater scrutiny from state attorneys-general, government regulators, and requests for more information from the Internal Revenue Service in the redesigned Form 990.
Now may be the time when business relationships of different forms represent an opportunity for many not-for-profits to enhance financial and operational stability and broaden their reach and impact. Many not-for-profits may want to view today's economic environment as a buyer's market, an opportunity to invest in future growth and development where it was previously unattainable.
After years of debate, a new accounting standard recently went into effect. FASB Statement of Financial Accounting Standards No. 164, Not-for-Profit Entities: Mergers and Acquisitions (FASB ASC 810-158), provides specific guidance on how business combinations should be accounted for, with prescriptive guidance on what would qualify as a true merger, versus an acquisition. The statement is effective for reporting periods beginning on or after Dec. 15, 2009. The accounting rules do not affect the economics of the transaction; however, acquisition or merger of another nonprofit may set off significant emotional responses as struggling entities come to terms with the possibility that being acquired, or losing control of their operational structure, is a potential reality.
When it comes to mergers, nonprofit entities often eagerly wish to maximize mission delivery and minimize costs, but few want to give up control of the decisions related to mission execution. Each has a fiduciary responsibility to the population it serves, its donors, and, as a tax-exempt organization, the general public. Also, employees and volunteers often have significant personal interest in the entity they are affiliated with. Boards are often quite loyal to the management and employees that have served the organization over time and contributed so much in terms of past successes. These factors make some reluctant to seek or undertake necessary changes, believing they have the best interest of the organization and their constituents at heart.
Unlike ordinary business combinations that are presumed to be bargained business exchanges, as indicated in SFAS 164 (ASC 810-158), nonprofit combinations may be motivated by public interest and mission-driven considerations. The intent of a transaction is likely to be focused on degree of public good, rather than individual wealth, but within the context of the standard, there is more often than not an acquirer and an acquiree, rather than a pooling of resources, as allowed under the old standards. The new standards do not address other types of business relationships such as joint ventures or asset transfers/sales.
The health care sector accounts for the greatest business combination activity among nonprofits. This sector can provide many lessons for other organizations. Although large deals have declined during the tightened credit market, activity among smaller community hospitals has been on the rise. This activity is expected to continue as many small hospitals struggle to compete in this difficult economic environment. Many community hospitals are losing market share and are unable to compete financially with larger, stronger systems. Challenges include increases in uncompensated care and constricted access to credit. These hamper their ability to re-invest the capital required to compete with more liquid organizations.
Troubled institutions generally have some common factors - few days' cash on hand, debt-to-capitalization ratio below average, and earnings before interest and depreciation below 5 percent.
Joining with a stronger organization can ensure that the patient population continues to be served and that most of the work force remains employed. Too often, though, the onset of significant financial distress or bankruptcy occurs before the merger option is considered. At that point, with any potential financial or other leverage gone, often all that is left to do is to turn over the keys.
It does not have to be that way. A thoughtful planning and implementation of an integration between entities will drive efficiencies, reduce costs and increase effectiveness. Increased availability and reduced costs make leveraging technology platforms easier, often resulting in significant savings opportunities. Other areas include back-office functions, such as finance, legal, risk management, compliance, and other administrative support functions. A larger organization may also be able to use its greater leverage for better supplies pricing.
Business combinations also can provide quicker opportunities than organic growth for expanding an entity's geographic reach; developing new relationships with funders, volunteers and advisors; accessing capital; and fulfilling its mission. The keys to ensuring that an acquiring organization is in a position to realize these benefits are to negotiate from a position of strength and to bring something positive to the relationship.
MANAGING THE MERGER
For nonprofits that aren't affiliated with a larger network, finding the right organization to align with can prove challenging. Far fewer resources are available and dedicated to the nonprofit industry to help this sector identify partner organizations that would be a good fit in terms of mission, size, culture, or services provided.
Often, existing relationships help introduce the possibilities. Some organizations are part of a network of affiliated entities; some may have board members, funders, past executives or other stakeholders in common; or some may be competitors in the same market. Sometimes creditors or other funders can help identify other organizations with complementary missions, similar populations served, or familiar cultures, among other criteria that come into play in these decisions. They likely have a broader view of the community, its needs, and the key players. Finding the right organization with which to join forces via consolidation, venture or other vehicle is merely the first in countless critical decisions if success is to be achieved.
The right advisors are critical for ensuring appropriate consideration of all factors. Numerous matters require careful deliberation for a successful transaction, and they are universally applicable across all organizations. One is the fact that SFAS 164 (ASC 810-158) may increase the costs of transactions that are considered acquisitions, since fair value needs to be determined for acquired assets and liabilities. Aside from the valuation requirements, the financial value of an organization's operations and its assets and obligations are critical considerations.
Use of net assets of the organization may be restricted by donor agreement or law. Evaluation of employee pay, benefits, contracts and titles - and how to align them in a new organization - can be a trial. Handling communications to various stakeholders to stave off rumors and ensure a consistent and positive message is a full-time effort.
Another area that is commonly overlooked or underestimated in terms of effort and importance is an assessment of the internal cultures of the combining entities. Then the culture of the new organization needs to be outlined. A great deal of work is required to get everyone to agree to a well-defined vision and value proposition that can be clearly and consistently articulated internally and externally. Well-defined metrics and goals will ensure a path to success. Monitoring will be necessary so adjustments can be made and the transition period can be minimized.
There are many different legal structures that may be employed in a business combination. The entities could opt for dissolution of each of the merging entities and the creation of a new one, maintenance of the original entities and the formation of a new entity on top, or absorption of one into the other, to name a few. Each structure will have implications on branding and name recognition in the market. Employees, volunteers, donors, creditors and board members will all be affected, and they all should feel that they have a voice. The state attorney-general or another state entity with responsibility for charitable organizations may also have authority over approving important aspects of these mergers, especially with respect to continuing tax-exempt status.
The setting of the governing body is critical to the future functionality of a joined organization. A structure that makes decision-making difficult and requires consensus or a 50-50 board makeup from the predecessor entities can create a clunky, cumbersome governing structure that precludes the timely execution and implementation of a successful integration. The desire to give all parties an equal voice will slow the process if there is no effective leadership to listen, make decisions and move the organization forward.
In business combinations between nonprofits, efficiency isn't everything at the end of the day. Nonprofits truly have different needs, different operational characteristics, and very different missions. No nonprofit should ever lose sight of its important quantitative metrics - meals served, children mentored, or the underserved supported - but efficiency and financial measures do matter. Nonprofits are businesses in the end, and, in many ways, they need to run like any other business. Without proper fiscal concern, organizations can fail, and all their intended good works would go unfinished.
A financially strong nonprofit organization can weather more storms, increase its reach, and afford important stewardship and compliance processes without devoting an unbalanced portion of its efforts. Periodic evaluation of financial and operational performance metrics is key to ensuring the health and success of an organization, and provides a chance to reconsider or re-affirm its strategy and direction.
For those that are struggling, now may be the time to look to strategically align with an organization that shares their values, culture and mission, while maintaining continuity of service.
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