Not-for-Profits – to merge or not to merge?

by Dentons
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Dentons

[co-author: Eshan Khot]

With over 600,000 entities in the Not-for-Profit sector (NFP) in Australia, including more than 55,000 registered charities, merging as a restructuring option is increasingly being considered by NFP boards across the country.

The need to merge in the NFP sector has been recently highlighted in a joint research paper published by RMIT University and CPA Australia, titled “Mergers, Amalgamation & Acquisitions in the Australian not-for-profit human services sector”.

The joint research paper supports mergers as an “alternative strategy for organisational growth, gaining scale efficiencies, wider revenue base and enhancing service choice within the NFP service sector” (pg. 4).

In the context of looking at the opportunities and risks of mergers in the Australian NFP sector, we highlight the:

  1. restructuring issues in considering a merger;
  2. the importance of collaboration before undertaking a merger; and
  3. the critical legal issues that need to be considered.

Restructuring issues in considering a merger

When considering a merger it is important to consider some of the restructuring issues that may arise. The merger of NFPs may involve various transactional structures, which will depend in part on the legal structure of the two NFPs that seek to combine. 

In some cases, one NFP may be wound up, with the assets being distributed to the “continuing” NFP.

In considering how to “combine” the two or more NFPs, attention will need to be given to the following three questions when considering the destination entity of the merging NFPs.

1. The transfer of assets and liabilities

How will the continuing NFP acquire all of the assets and (possibly) liabilities of the other NFP?

2.The transfer of membership

How will members of the “dissolving” NFP become members of the continuing NFP?

It is worthwhile noting that NFPs may be reluctant to consider merging, given their deep commitment to their purposes and objectives and the fact that membership to the NFPs is often based on that commitment.

In addressing any potential membership issues, the NFP board consult with members and other stakeholders at an early stage.

The consultation should highlight how any proposed merger will promote and align the cultural values, purposes and identity of the merging NFPs in addition to the economic benefits.

3. The creation of a new NFP

Is it preferable for the merging NFPs to transfer their assets and liabilities into the new NFP entity?

These benefits may stem from the tax implications of a universal transfer of assets and liabilities.

Additionally, the merging NFPs may transfer specific assets which may enhance the asset structure and long-term capacity of the new NFP entity as well as areas where cost savings were most evident.

Having considered these preliminary restructuring issues, the next step is to consider how the merging NFPs may collaborate effectively prior to undertaking the merger.

Collaboration between NFPs before the merger

Prior to a legal merger there are various ways that NFPs can “test the waters” to determine whether a merger is likely to meet the needs of the NFPS. This includes:

1. Collaboration

The NFPs could collaborate around the sharing of “back office” administrative support with sales and promotional activities, office space sharing and collaborative strategic outlook having regard to shared purposes and values.

2. Auspicing

Auspicing can take several forms. A fairly typical auspicing arrangement arises when an incorporated NFP takes an unincorporated NFP under its wing for a specific project that the unincorporated NFP wishes to undertake.

While each auspicing agreement will differ, it is generally the case that the incorporated NFP will agree to receive funding for the project on behalf of the unincorporated NFP, and will hold relevant registrations for the activities of the unincorporated NFP relating to the project to be undertaken.

3. Strategic Alliance

This may involve a memorandum of understanding or joint venture agreement where there will be more formally documented alliance between the NFPs with a view to a merger.

A strategic alliance ensures that both NFPs continue to operate independently but collaborate more formally around specific projects and funding initiatives.

Critical legal issues that arise as part of the due diligence process

As NFPs progress towards merger discussions, and before any legal frameworks can be considered, due diligence will need to be undertaken by both organisations to address a number of critical legal issues. Some key issues for consideration include

1. Review of membership register

Typically, as part of a merger, the NFP to be dissolved would require a 75% member approval of the winding-up and the distribution of assets to the continuing NFP.

The continuing NFP may also need member approval to update its governance and membership structure.

Often registers of members are out of date and do not accurately record the number and class of members. Updating the membership registers so that they are accurate is fundamental to any merger.

2. Impact on major sponsorship contracts and donor support including any government contracts

All major sponsorship contracts, donor support arrangements and government contracts need to be reviewed and the steps required to ensure that financial support is transferred to the new merged NFP entity must be identified.

This will involve a review of any donation conditions to ensure that the acquiring NFP’s charitable purpose is consistent with what the donors consented so that the donations can be transferred to the acquiring NFP.

3. Foundations

Some charities and NFPs have separate foundations as their primary fund raisers and managers of their investment portfolio and investment income. Such entities often have separate governance arrangements to the merging NFP.

Careful examination of the trust deed or constitution of the foundation, and how its assets may be transferred for the benefit of the acquiring NFP or to the acquiring NFP’s foundation, is essential.

A follow-on consideration for the acquiring NFP is whether it should take the investment assets onto its own balance sheet or set up its own foundation.

4. Board and CEO roles

Consideration will need to be given to the new board structure and will require agreement about the loss of any existing board positions.

Early agreement as to the composition of the new board and its chairman will greatly assist in progressing merger discussions between the NFPs.

Further, early agreement as to the new CEO and the role of the departing CEO in ensuring continuity is a key matter for successful NFP mergers.

5. Employment arrangements

Employment arrangements including employment contracts, contractor arrangements and any Enterprise Bargaining Agreements will need to be reviewed.

The review process will involve consideration of any redundancy arrangements, notice requirements and any scope for renegotiation of workplace staffing arrangements.

6. DGR endorsement, tax considerations and continuity of purpose

The DGR endorsement and tax concession status are generally critical to the NFP business model.

A review of these matters would also include a general constitutional due diligence review and possible amendment of the continuing NFP’s structure and purposes to maintain the DGR endorsement and tax concessions.

NFPs should also consider whether any transfer of assets or assumption of liabilities has other adverse tax or stamp duty implications.

7. Third party obligations

Third party obligations to landlords, suppliers and any material business contracts need to be identified and renegotiated as appropriate. Consideration needs to be given to whether the contracts should be assigned or novated.

8. Legal claims made against the NFPs and insurance

NFPs should identify whether there are any legal claims threatened or on foot against the other NFP.

If claims are identified, the NFP should notify their insurer and seek confirmation that the insurer will indemnify the NFP in respect of any such claims.

Any significant uninsured legal claims against the NFPs are likely to inhibit the progression of any merger.

9. Intellectual Property review

A review of trademarks, copyrights, domain names and any patents needs to be undertaken. Consideration needs to be given to the transferring of intellectual property to the new merged NFP entity.

10. Social media

A review of all existing social media channels and their merger compatibility should also be undertaken, having regard to the size of their social media following and how followers can be transferred.

This list is not exhaustive and is provided as a general guide only.

Conclusion

A merger in the NFP sector provides an opportunity for long term sustainability and growth for the relevant NFP entities. Identifying at an early stage a roadmap for mergers having regard to both the legal and non-legal issues is critical to a successful merger.

 

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