Exempt Magazine

With nonprofit mergers in full swing -- one state association executive recently pronounced them “trendy” -- this is a good time to be clear about their costs. The benefits of mergers are what motivate organizations to consider this option, but the costs are not always clear at the outset.

To make things easier, following are suggested ways to account for and track merger costs. Actual merger costs will vary greatly by location and circumstance.

First, here is a caveat. Only the out-of-pocket costs that can be measured and attributed directly to the merger will be considered. This excludes things like opportunity costs, staff and board members’ time (unless both nonprofits already have detailed hourly time reporting systems), and the psychic cost of “are-we-doing-the-right-thing?” worries.

Phase One: Feasibility Determination

To help identify and track costs, think of a merger process as having three distinct phases. The first phase is feasibility, during which participants determine whether and how to undertake the merger. The second phase is implementation planning, which is the process of detailing exactly how the organizations will come together. The final stage is integration, which begins as soon as the merger is official.

The early part of feasibility determination consists largely of discussions and some amount of information sharing. The very earliest stages of the feasibility phase are usually cost free, as long as one doesn’t count the bills from the coffee shops or sandwich places that are frequently the site of meetings between board members and executives from both organizations. These discussions tend to be very informal, with no commitments exchanged.

The next part of feasibility determination is a more rigorous look, which some call “due diligence.” This is where many people familiar with for-profit mergers get confused, because the nonprofit process looks very different from this point onward.

For-profit company executives are often under a legal obligation of secrecy because of the laws limiting information disclosures in a publicly-held company. As a result, they must make the merger decision first and begin their “due diligence” processes later. This is why the deals are carefully hedged when announced. It is also reasonable to speculate that this way of doing things tends to put a bit more pressure on all parties to go ahead with the deal no matter what was found during the due diligence process.

This is backwards, and nonprofits are fortunate enough to be able to do things differently. The real investigative energies should be devoted to the feasibility determination process because the more effort that goes into the front part of the process, the more likely there will be a successful the outcome.

The better term is “mutual learning,” not due diligence because that is exactly what is needed at this stage. The term “due diligence” has rightfully taken on connotations of a check-the-box exercise done by disinterested outsiders and handed to the merger planners. This is not learning; it’s report reading. Leaders of the merger feasibility process at this stage must try to learn as much as possible about the other organization, especially about those things that aren’t quantifiable, such as organizational values and culture.

Costs at this stage tend to be largely for facilitation and supportive research and analyses. Organizations might even try to do this on their own, although the hit-or-miss quality of most such efforts can actually end up costing more money than using experienced assistance while lowering the odds of success.

Phase Two: Implementation Planning

The objective of the implementation-planning phase is to operationalize the lessons of the feasibility phase. How large should the board be? What programs should be emphasized? How will the CEO of the merged entity be selected? What will be the salary and benefit structure of the new organization?

Costs in the implementation planning stage might be greater, but still tend to not be unmanageable for most organizations. Early stage implementation planning is still heavily dependent on staff and board time. Again, facilitative and support consulting will be the largest expenditure.

In some instances, legal and/or financial complications might require special assistance. For example, an unresolved financial obligation on the part of one organization could lead to the need for specialized accounting services. The same could be true of legal matters.

Phase Three: Integration

Once the merger has been planned, voted on by the participating boards, and accepted by the governing legal authority, the integration phase starts. This is where the biggest expenses will almost always be incurred.

Here’s why that is so. Managers will find that most of their revenue sources and expenses will change in a fairly predictable way. If one were to graph the behavior of most revenue sources and expense types, the graph would be a more or less straight line going either up or down. Neither the amount nor the rate of the change would be significant. We can refer to these items as experiencing linear change.

On the other hand, in many years something changes dramatically. The organization buys its second building, and occupancy costs double overnight. A major new, five-year grant comes through, and that revenue line shoots up. These are abrupt, or discontinuous changes. They might be good or bad, but at some point a line graph of the events would show a sharp spike up or down.

In nonprofit mergers, discontinuous change abounds. If, as is frequently the case today, one of the two CEO’s pre-announces retirement as of the merger date, then that expense will drop precipitously. Information technology costs could also decline since the new organization might be able to consolidate licenses or eliminate expensive pieces of suddenly redundant equipment.
On the other hand, the cost of benefits will almost always increase because of pragmatic reasons (not to mention a typically admirable ethic of social responsibility). Most nonprofits will choose to raise some employees to the higher level of benefits rather than cutting everyone to the lower of the two benefits policies.

The accompanying chart summarizes the common areas of greatest discontinuous changes. Those interested in the “all-in” cost of a merger will do well to pay careful attention to these possible sources of lost revenue or increased expense. Most of these potential problem areas can be dealt with, so the important thing is to plan for these developments from the beginning.

Nonprofit mergers will not generally provide immediate cost reductions. In fact, the net effect is likely to be increased costs in the beginning, with the financial benefits taking longer to emerge. But careful management and an understanding of the behaviors of revenues and costs before and after a merger process can position streetsmart managers to capitalize on all the opportunities that arise.

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Thomas A. McLaughlin is director of consulting services, Nonprofit Finance Fund, and a member of the faculty at the Heller School for Social Policy at Brandeis University. His email address is tom.mclaughlin@nffusa.org