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Due diligence, merger structure and more

Once you've negotiated an agreement to merge with another organization, it's time for a lawyer to step in. The lawyer's job is to transform your agreement — a "deal in principle" — into the necessary legal documents, and then file those documents with the appropriate government agencies. During this process, the lawyer will review your agreement, suggest refinements and ensure that the agreement complies with state and federal laws. All these steps are needed to protect your organization's nonprofit status with the IRS.

Be sure to hire a lawyer who knows the law governing nonprofit mergers in your state. Don't assume that lawyers specializing in for-profit mergers and acquisition have the necessary knowledge. Although many of the rules governing mergers for nonprofit and for-profit entities overlap, there are significant distinctions in the legal requirements for each.

Once you've found a lawyer with nonprofit experience, ask for assistance with two key issues — due diligence and merger structure.

Performing due diligence

One major benefit of hiring a lawyer is ensuring that a merger agreement is based on due diligence — sharing all the relevant legal and financial information about your organizations. The goal of due diligence is to avoid unpleasant surprises such as pending lawsuits, government investigations, undisclosed debts and employees that are mistakenly classified as independent contractors.

On a concrete level, due diligence involves the exchange of:

  • Corporate documents: incorporation papers, bylaws, 990 forms, federal and state exemption letters
  • Real estate documents: leases, deeds, mortgages, zoning permits
  • Financial documents: audited financial statements, budgets, tax filings, insurance policies, lists of assets and liabilities
  • Fundraising documents: list of grants (with restrictions and expiration dates), confidential descriptions of gifts from individual donors
  • Personnel documents: policies and procedures, job descriptions, list of employees and details about their compensation

Structuring your merger

How long will it take to legally implement your merger? Mergers can be structured in various ways, some more complex than others. Options include:

  • Outright merger. This can take two forms. One is to dissolve one organization into the other, which creates the challenge of deciding which organization will ultimately survive. The second is to dissolve both organizations into a new corporation. This is usually the most complex, expensive and time-consuming method of merging.
  • Asset transfer. This option dissolves one organization as if it were going out of business and "sells" its assets — such as money, property and name — to the other organization. In some states, this type of merger automatically triggers a review by the attorney general or secretary of state.
  • Parent-subsidiary relationship. In this transaction, one organization becomes a membership organization (parent) while the other becomes the only member (subsidiary). Although the organizations technically remain separate, the parent legally controls the subsidiary.
  • Interlocking boards. Organizations that want to merge but need to keep their corporations separate for a period of time may choose to combine their boards. In other words, the same board of directors oversees both organizations. This is a relatively simple way to join two corporations.

Many nonprofits opt for a parent-subsidiary relationship or interlocking boards as a short-term merger strategy — for example, delaying the official merger until one of the organizations acquires an additional license or certification or waits for a current contract or grant to expire.

If your merger committee opts for a parent-subsidiary relationship or interlocking boards, keep in mind that the IRS might view your two organizations as one for tax purposes. You could also be legally liable for each other's actions. These are matters to discuss with your lawyer.

Saving money on legal fees

You can reduce legal fees by hiring a single lawyer to represent both you and your merger partner. While this isn't typically done in the private sector, it's entirely appropriate for nonprofits that don't have an adversarial relationship (so there's no conflict of interest for the lawyer). This is especially true for organizations that wish to join forces and have already resolved the key issues during premerger negotiations.

One legal tool for allowing a single lawyer to serve in this dual role is a "waiver of conflict" form that's signed by both organizations. Lawyers who regularly work with nonprofits are likely to be familiar with this form and be open to using it.

One exception to this guideline is the need for expert legal advice on a specific issue. If your merger partner has a collective bargaining agreement, for example, then consider an additional lawyer with special expertise in this area.

You can also save money by letting your merger committee negotiate an agreement instead of hiring a lawyer for this purpose. Besides reducing legal fees, this strategy allows you and your partner organization to learn about each other during the negotiation process — which can foster a successful long-term relationship.

This article draws on the expertise of Grace Davies, a Minneapolis-based attorney with special interest in product liability, medical malpractice and employment discrimination.

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Disclaimer

MissionBox editorial content is offered as guidance only, and is not meant, nor should it be construed as, a replacement for certified, professional expertise.

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References

CompassPoint: The M word: A board member's guide to mergers by Alfredo Vergara-Lobo, Jan Masaoka and Sabrina L. Smith (2005)

The nonprofit mergers workbook part I: The leader's guide to considering, negotiating, and executing a merger by David La Piana and Robert Harrington (2008)

The nonprofit mergers workbook part II: Unifying the organization after a merger by La Piana Associates (2004)

References

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Writer and editor fascinated by knowledge management, behavior change and technology for nonprofits