The final option we will discuss in this series is the creation of a mutual parent entity. Under this merger/reorganization structure, the two nonprofit entities wishing to affiliate with one another both convert into member, nonprofit corporations and create a new nonprofit corporation to serve as their sole member/parent ("NewCo").
As we discussed in our last post, NewCo, as the target nonprofits' sole member, will have the power to appoint and remove each target entity's directors and to approve any fundamental transactions the target entities desire to effectuate. Thus, NewCo will act as the target nonprofits' parent organization, and the target entities will act as brother/sister organizations to one another.
The advantage of this structure is that the target entities and NewCo remain separate legal entities, which results in limited liability for all entities. Additionally, no assets or liabilities need to be transferred, and the target nonprofits remain in existence to accept any unknown gifts. This structure also lays the groundwork for future affiliations because NewCo, once formed, can easily form or "acquire" additional subsidiaries.
The main disadvantage of this option is costs. There will be costs involved with forming NewCo and applying for tax-exempt status on behalf of NewCo. There will also be transaction costs to covert the target entities into membership corporations and to issue membership interests to NewCo. Post-reorganization, there will be triplicate costs of operating and maintain three separate legal entities (e.g., payroll costs, tax preparation fees, accounting costs, insurance premiums).
Additional considerations with this reorganization option include control, attribution and branding issues. In terms of control, the target entities will need to negotiate (I) their representation on NewCo's board and (ii) whether NewCo is limited to removing the target nonprofits' directors for-cause only.
Additionally, the three nonprofit entities should avoid having fully overlapping boards because that could cause piercing the corporate veil issues or attribution issues (e.g., one entity's lobbying or unrelated business activities could be attributed to the other entities and adversely affect each entity's tax-exempt status).
Finally, the nonprofit entities should give thought to post-reorganization branding/name issues so that donors can easily understand the new organizational structure.
In sum, there are numerous options for nonprofit entities seeking to merge/reorganize. The correct structure will likely be determined by the assets and liabilities at play, the existing relationship between the nonprofit entities, the transaction costs involved and post-transaction control and operational issues.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
