United States: Collaboration Strategies For Nonprofit Organizations

Newspapers are often full of stories about big corporate mergers. It's not as common to read about mergers of nonprofit organizations, however. That's probably because nonprofits are mission–driven, and not many organizations conclude that their missions will be fulfilled by combining with another nonprofit. But mergers or other strategic alliances will become increasingly common as resources continue shrinking. Nonprofits will be forced to consider combining with other organizations to maximize resources and to complement each other's capabilities. The method of collaborating will depend on how integrated with one another the participants wish to become and how extensive the collaboration is. The broader the collaboration, the more thought will have to go into the structure of the collaborative effort.

This article briefly examines the preliminary questions that all nonprofit organizations should address before any collaborative effort, then outlines combination strategies available to nonprofits. Which one is best? The answer depends largely on individual circumstances. Consultation with qualified advisers can help identify the preferable approach.

Before deciding on the form of the collaboration, a nonprofit considering a strategic alliance must first determine whether the benefits of allying with another organization outweigh the risks and the possible negative consequences. In weighing the benefits and pitfalls of an alliance, both organizations must find out if they are compatible. This examination includes a review of the corporate purposes of both entities, analysis of tax exemption issues, review of liabilities, determining what third–party consents are needed, as well as how the entities will operate after the alliance is formed. A brief outline of each of these follows.

A. Corporate Purposes. Both organizations should conclude that their corporate purposes are consistent or at least not mutually exclusive. Organizations should not find themselves on the opposite side of an issue. The ideal collaboration happens when each participant brings an element the other lacks. How does collaboration fit within the organization's corporate purposes? Does it help achieve a purpose that is not currently being fulfilled? Does it take the organization in a different direction? This is an opportunity to review the organization's mission statement. Is the collaboration consistent with the mission statement? Is it part of the strategic plan? Does the collaboration result in or require a change of corporate purposes for one or both organizations?

The answers to these questions may depend on the breadth of the collaboration. Some strategic ventures are more involved than others. For example, a housing developer may wish to contract with a home health agency provide social services at one of its properties. In that instance, the collaboration will cover a discrete subject and may not require an involved reexamination of both organizations' corporate purposes. Another collaboration might be between a mental health provider that serves only children and another that serves only adults. In this example, a much closer look at corporate purposes would be required, and the form of the strategic venture becomes much more significant. Should these entities merge? Can they achieve their goals without losing their separate identities?

B. Tax Exemption Issues. If both entities are exempt under Section 501(c)(3) of the Internal Revenue Code, their exempt status must be in full force and effect, their respective determination letters must not have been revoked or suspended, the IRS must have been notified of all changes in operations, organizational documents and corporate purposes, and both organizations' operations must still be as represented to the IRS when it granted their respective exemptions. It is not uncommon for a nonprofit's mission to change over time, but frequently nonprofits neglect to inform the IRS of the changes.

Next, both organizations must determine that the collaboration will further their exempt purposes and will not result in inconsistent bases for exemption. This analysis is similar to the corporate purposes inquiry discussed earlier. The scope of the collaboration may require that the IRS be notified, but even if notification is not necessary, the collaboration must still be consistent with both organizations' exempt purposes. Loss of the tax exemption for one or both entities is not likely to be one of the desired outcomes of the collaboration.

Both parties should also determine whether the collaboration will result in unrelated business income tax ("UBIT") to either party. If a careful examination of exempt purposes leads to the conclusion that both organizations will continue to fulfill their exempt purposes, then the collaboration should not result in UBIT. The answer will again depend on the nature and extent of the collaboration. Consultation with a qualified advisor or a private letter ruling from the IRS should seriously be considered.

Collaborations between for-profit entities and nonprofits raise significant exemption issues that are beyond the scope of this outline. The collaboration cannot result in private inurement in favor of the for-profit.

C. Liabilities. In a merger, the surviving corporation assumes the liabilities of the target corporation. It's therefore crucial to know what liabilities are being assumed. Make sure that all liabilities are fully disclosed. Liabilities to consider include bank loans, equipment leases, real estate leases, trade payables and litigation. While all liabilities should be disclosed on financial statements, other information, such as lien searches at the Secretary of State's office, should also be obtained.

If the collaborative effort less than a merger, then each party should remain responsible for its own debts, and the parties will want to make it clear that neither is responsible for the obligations of the other. If the venture involves one organization assuming some or all of another's liabilities, this should be spelled out in detail.

D. Third Party Consents. Are there third parties that need to consent to the collaboration? If there is a merger, it is more likely third party consents will be needed. Consent may be required from lenders, landlords, governmental agencies, funding sources and stakeholders or other parties granted approval rights in the organizational documents. Whatever the form of collaboration, organizations need to make sure that consent is obtained if needed.

E. Governing Documents. Each nonprofit's bylaws and articles of incorporation must be reviewed to determine what corporate approvals are needed. Under Maine law, directors control the day-to-day operations of a nonprofit corporation, but the bylaws or articles of incorporation may reserve to the members powers beyond simply electing the board of directors. Board approval will also be required, and the bylaws may specify by what margin the board must approve the collaboration. Do the organizational documents give approval rights to parties who no longer have any connection to or interest in the organization?

F. Operational Issues. What effect will the collaboration have upon the operation of both organizations? After a merger, quite often there are changes to the surviving corporation's governance structure resulting from the addition of new board members or new committees. As a result of the collaboration, will there be any duplication of functions that might also lead to reductions in staff? Will the collaboration result in redundant business locations? What will be the effect on funding sources or government contracts?

If the organization has a desired answer to any of the questions posed in Sections A. through F. above, that answer may dictate what form the collaboration takes. The next section examines several common collaboration structures.

There are four ways of structuring a collaborative effort between organizations: by contract, by acquisition of assets/dissolution, by one organization acquiring control of the other, and by merger. The advantages and disadvantages of each structure is discussed below.

A. Collaboration by Contract. Collaboration can be done by contract. In its simplest form, one organization contracts to buy goods or services from another on mutually-agreed terms. Collaboration by contract can be more complex, however, such as by forming a joint venture between organizations to pursue a common goal. The desired goal will often dictate how involved the structure must be.

• Collaboration by contract is simple and results in the least loss of autonomy for both organizations. Each participant maintains its corporate existence and continues to pursue its mission.
• It allows for venture-specific collaboration, e.g., it permits two (or more) organizations to combine strengths to pursue an objective.
• This form is best for projects that have a beginning, middle and end.
• There are several ways to structure the collaboration, ranging from a straight contract for delivery of services to the formation of a jointly-owned corporation, partnership or limited liability company.

• Collaborating by contract creates liability under the contract. The organization must follow through on the commitment made in the contract, even if the project no longer is viable. One way to minimize risk is through careful drafting of the contract, such as by adding a provision allowing termination if circumstances change or if a default occurs.
• Both organizations must determine that the project is (i) within the corporate and exempt purposes of both organizations and (ii) will not result in UBIT. Contracts between nonprofits and for-profit entities require additional close scrutiny to make sure they don't cause inurement issues for the nonprofit, threatening its tax-exempt status.
• Control issues may be difficult to negotiate.
• Collaboration by contract doesn't solve organizational issues such as board dysfunction, staff inadequacies or lack of funding sources.

B. Sale of Assets/Dissolution. A nonprofit may conclude that its mission may best be accomplished by another organization and that allowing the other organization to take over its mission completely is the best approach. Sales of nonprofits are unusual because it is often hard to determine an eligible recipient for the sale proceeds. Both the law and most organizations' governing documents require that the net sale proceeds be distributed to another nonprofit or a governmental agency.

Alternatively, a nonprofit may simply liquidate and dissolve. State law prevents corporations from dissolving unless all creditors are paid or arrangements are made to pay them. If the dissolving corporation has identified another nonprofit that is willing and able to carry on the mission, then, after creditors are satisfied, the assets can be distributed to the survivor, assuming it is tax exempt. Alternatively, the survivor could agree in writing to become liable for the debts of the dissolving corporation.

• Dissolution, or a sale of assets combined with dissolution, are effective methods of closing the doors permanently if that's what's desired.

• If an organization is in a difficult financial situation, there may be pressure to unload assets at fire sale prices, which might conflict with board members' fiduciary duties. The board has some obligation to obtain the best possible price for sale of assets, which could be difficult if the organization is in tenuous shape or if the assets are hard to value. Dissolution and distribution of assets might work better, assuming liabilities can be paid or provided for.
• The net proceeds of sale, after deducting liabilities, can only be distributed to another exempt organization. It may be difficult to find an appropriate recipient.

C. Acquisition of Control. Since nonprofits don't have stock, they can't be "owned" by others. They can, however, be controlled by other organizations, usually through the other entity's ability to elect all or a majority of the directors. Control can be accomplished either through having the "acquirer" be the sole member or by adding bylaws provisions stating that the acquirer shall elect members of the board.

• Effecting a change of control is simple: it requires changing the bylaws of the target corporation to establish that the acquiring corporation is the sole member or has the sole right to choose the target's directors.
• The acquirer's operations continue as before, and if the target's staff stays on, the target's affairs can also continue to run as they have; the only difference is the target's board is appointed by and therefore is answerable to the acquirer.
• Each entity maintains its existence and exempt status; each continues to pursue its respective mission. This is especially beneficial if one goal is minimizing the acquirer's liability, since the target retains its separate existence and all of its liabilities.

• If the same staff stays on, the board may feel it needs to engage in more oversight due to worries about staff loyalty, morale, etc.
• Acquiring control is not a good restructuring method if tight integration is desired or if major operational or structural changes or changes in purposes are contemplated, because the separate nature of the target makes managing these changes somewhat unwieldy.

D. Merger or Consolidation. Merger or consolidation are the ultimate in integration. In a merger, one or more corporations are subsumed into another, with the other continuing as the surviving corporation. In a consolidation, two or more corporations are combined into a new corporation. In the case of a merger, the survivor ends up with all assets of the participating corporations and is responsible for all liabilities, whereas in a consolidation, the new corporation receives all the assets of the participants and becomes responsible for all their liabilities.

• Assuming the corporate and exempt purposes of the participants are consistent, mergers or consolidations allow seamless integration of operations and mission fulfillment.
• Mergers and consolidations allow for reduction of duplicative services and redundant locations.
• They permit the weaker organization's mission to continue to be fulfilled, instead of closing it down, and allow both organizations to pool their resources.

• Mergers and consolidations can be expensive because most organizations will need professional assistance to do it right.
• Numerous issues must be analyzed, such as tax exemption and UBIT issues, third party consents, harmonizing corporate and exempt purposes of both organizations, staff utilization and space requirements.
• Merger or consolidation can cause significant friction if it is determined afterwards that the participants are incompatible.

There are many ways to structure a collaborative venture between nonprofit organizations. The methods outlined above, and permutations of those methods, can involve minimal or complete integration. Organizations considering collaboration must start with a goal, or desired outcome of the venture. The appropriate collaboration structure may then become apparent as that goal is discussed by board members and staff. Major, complicated initiatives require careful analysis of the items listed in Section I above before a structure is chosen.