Mergers and Due Diligence

While the idea of a merger can seem like a promising avenue for increased efficiency, increased fundraising, and the like, merging is a multi-step process with important legal implications. As Jerald A. Jacobs explains in his article, "All About Mergers of Nonprofit Organizations," every organization should consider the mechanics and the consequences thereof before formally committing to a merger. It is risky business to assume one knows all the answers given that "mergers are sophisticated business transactions, likely the most sophisticated that a nonprofit will ever undertake."

One of the most important stages for merging organizations is the exercise of due diligence during the planning stage. Jacobs describes due diligence as a type of "legal audit," a process of "systematically reviewing the legal and financial situation of one's potential merger." Due diligence is not a matter of approving only "perfect mergers." As Jacobs explains, boards can approve and recommend a "less-than-perfect merger partner" such as an organization facing litigation challenges. The goal of due diligence is to assure that the board has engaged in sufficient inquiry and acquired enough information to make an informed decision. Similarly, La Piana Associates, Inc., a management consulting firm helping nonprofits and foundations with strategic issues, explains in their "Tips and Answers to Due Diligence," that "[t]he essence of the due diligence process is an effort to make everyone... on each board, as aware as a prudent board member can be of any liabilities the other party may bring to the transaction" in order to create a "'no surprises' situation so that... no one can claim that [a] matter was hidden."

Collectively, Jacobs and La Piana provide an extensive list of the types of information to be investigated: IRS records, incorporation, contracts, licenses, claims or litigation, personnel policies and structure, agreements and affiliations, real estate, marketing materials, programs activities, current and potential liabilities, and so forth. Financial due diligence may not reach the level of a full financial audit but should still acquire what is necessary to determine the merging corporation's "true financial position."

Due diligence reviews are costly and intensive efforts but they are necessary. The surviving organization must realize that it will absorb both the assets and liabilities of the dissolving organization. Additionally, given that courts have held boards of directors of a corporation personally and individually responsible for adverse results due to unfounded recommendations to merge, the reports from due diligence reviews will serve not only as an objective premise for the board's approval and recommendation of the merger but also as a type of "insurance policy" against personal liability of directors of both governing boards involved.

Organizations can satisfy their duty of due diligence while lowering the risk of unnecessary costs by heeding Jacobs' advice to undertake this legal endeavor once it seems more likely the merger will occur (e.g. the governing boards of the merging organizations are interested in a formal merger proposal). However, organizations should not unduly delay this time consuming process, as La Piana explains, "[t]he document exchange should happen early in the process so that there is adequate time for the parties to digest the packages (often several inches thick) formulate their questions, and seek answers."

As a final note, organizations should remember that due diligence is only one, albeit crucial step in the merger process. As John Emmeus Davis emphasizes in the Neighborhood Works Founder's publication, " Bridging the Organizational Divide: The Making of a Nonprofit Merger," the seeds for success (or failure) of any potential merger will probably be sown in the early stages: "What happens during the process of exploring, negotiating and joining together the merger organizations will determine to a large degree how well they will work together, how long they will stay together, and how effectively and efficiently they will use the resources made available to them during their time together."

To learn more about the various types of mergers, please view another Jerald A. Jacobs' publication, "Association Mergers and Consolidations: Strategic Considerations."

Dan H. McCormick's book, "Nonprofit Mergers: The Power of Successful Partnerships" is also available for preview through the Google Book Search here.

Additional information can be found in the Local Initiatives Support Corporation's presentation, “To Merge or Not to Merge.”

- Emily Chan