The New Dawn of the Nonprofit Merger


best-merge

Mergers – never easy.

It used to be that the idea of one nonprofit taking over another was simply anathema.  Nonprofits didn’t, you know, do that to one another. Mergers and acquisitions were the territory of national banks, energy companies and pharmaceutical giants with oversized ambitions and possibly malevolent intent. Nonprofits weren’t motivated by “creating efficiencies,” particularly at the expense of their own staff members – many of whom came from the very low-income communities those same nonprofits were seeking to serve.

But, oh, the times they are a-changin’. Nonprofit mergers are on the rise in NYC, and we’re going to see many more of them. Whether you like the reasons or not, you’d better know what they are because this, my friend, could happen to you.

The complexification of the nonprofit sector

I’ve noted in previous posts that a leadership group of “complex nonprofits” have grown dramatically in the past few decades. They have a number of characteristics in common:

  • They are big: typically over $50 million in annual revenues.
  • They combine nonprofit and for-profit entities: frequently with for-profit, revenue generating subsidiaries that flow up to a nonprofit parent.
  • They know how to use structured finance: this mostly happens in affordable housing transactions, but also through insurance captives, commercial developments, and (yes) acquisitions.
  • They embrace private sector management practices: many employ experienced for-profit executives as CEO’s, CFO’s and COO’s.
  • Earned income drives a good chunk of their revenues: developer fees, management fees, consulting services, and performance-based contracts are just a few of the examples.

So if you want to grow your $50 million nonprofit to, say, $80 million, how do you do it? You certainly double down on earned revenue strategies and you probably also get really good at securing government contracts. You might even shake down a few high net-worth pop stars or hedge fund managers.

But you know what else? You step in to help out that nonprofit up the road that’s gotten in over its head on their expiring use affordable housing portfolio. Or that long-time social service organization with the legendary executive director who’s about to retire. Or that really capable mid-sized organization that’s wrestled with a structural deficit for the past few years and just can’t seem to find its way clear.

And this, my friend, is where you come in.

Voulez vous coucher avec moi?

Chic-Chic

Yes, this really is the album cover.

After all, you may work for one of these groups. Each is a slightly different flavor and worthy of a bit more scrutiny. Wouldn’t you like to know the signs?

The quick and the moribund: In the 1970’s and 80’s, during some of the toughest times for inner cities in the US, thousands of tiny nonprofits took wing. There are legendary stories of the inspired recent college grad, the recently returned veteran, the nun or the local family doctor who decided they weren’t going to give up on their self-immolating neighborhood. They didn’t quite know what they were doing, but they organized a group of neighbors, picked up hammers and spackling paste and started reclaiming abandoned properties for affordable housing. They grew to play essential roles in rebuilding their communities, turning wasted blocks into large-scale multi-family housing that relied on low income housing tax credits and federal section 8 subsidies, among other supports. They also realized housing wasn’t enough, and they grew daycare centers, job training programs, alcohol and drug abuse treatment clinics, and a myriad of other social services that saved lives and strengthened communities. They swelled in size.

But over the years, tax credit allocations began to expire. The service contracts and housing subsidies diminished. Staff were let go, programs shuttered, and the capacity of the organization to service its housing portfolio began to wane. These units are now greatly at risk of being lost – acquired and converted to market rate housing no longer affordable to current residents. They badly need re-capitalization and renovation, but the internal capacity just isn’t there.

And the sector has seen these situations coming. Intermediaries like LISC and Enterprise, local elected officials, housing commissioners and funders have been nudging these nonprofits to look at merging with a more established organization as a way to save their housing stock. In some cases, highly distressed housing stock is simply transferred outright to a higher capacity group – a kind of forced acquisition. Depending on how you count, there are hundreds of thousands of housing units facing this situation. So if you happen to be one of the big boys, it’s a good time to be out shopping.

The retiring founder – mind the gap!

Hole

Stay calm and mind the gap!

There are big personalities in the nonprofit sector. I mean really, you’d have to have a pretty sizable ego and a determined will to take on some of the bitter, heartbreaking challenges distressed neighborhoods have struggled with. But that feisty nun or idealistic college kid who founded the organization way back when is now in their late 60s or early 70s. They still have plenty of vim and vinegar, so to speak, but sooner or later they are going to have to retire. What’s worse, there’s a bulge bracket of nonprofit executive leaders in the sector now who are baby booming their way into emeritus status.

The problem is, that ED was, perhaps, not the greatest at delegating and distributing leadership. Or their board has been afraid of bringing up the topic of succession planning and staff development. As a result, there’s an organizational gap between the single manager at the top, and the next layer of program management who’ve labored two or three levels down on the totem pole. These folks haven’t been prepared to lead the organization, and even if they were there’s no road map to follow. So when the ED goes, they will leave behind a big hole in capacity and institutional memory. And guess who’s increasingly likely to step into that gap? Why, the experienced ED two neighborhoods over who’s got a deep bench of highly skilled second-line management and the ability to absorb the complexities of the former organization.

Not too big to fail:

There are many nonprofits that are too big to be little, and too little to be big. This is in part because on the way to becoming a complex nonprofit, organizations tend to grow in spurts. They land a big performance-based contract, or take on a major development, or receive a major grant to deliver an emergency response program. But a year or two into

Too big to fail.  Or not.

Too big to fail. Or not.

the expansion, cracks begin to show. The performance-based contract doesn’t cover the full cost of service delivery and overhead. The development stalls because of a complicated land use issue or a snafu with the financing. The new program had only short-term funding and the increased staff is burning a hole in the budget.

Organizations in this position have to either cut their losses and retract (probably to a size even smaller than they were before), or grow their way out of the tight spot. These are both tricky to do, and leave an organization vulnerable. Throw in an executive transition, or the loss of a major funder, or a fire in one of their properties, and you’ve got an organization that’s on the rocks.

You’ve also got a hot property for a merger. These groups have substantial operational capacity and quality – they’re just in a tight spot right now. Merge them with an organization 2-3 times their size and you could capture efficiencies that smooth out these rough spots.

You’re chocolate is in my peanut butter!

Choco PBLook, all this is to say that conditions are right in the nonprofit sector for more mergers to occur. You’ve got big groups looking to build horizontal scale, and a number of existing smaller groups with structural vulnerabilities that make them appealing targets (or “partners” if you prefer). There are still plenty of cultural barriers to nonprofit mergers (stay tuned for more on that subject), but with organizations like SeaChange Capital Partners and the Patterson Foundation actively shaping both collaboration culture and actual acquisitions some of the reluctance is being worn away. For an interesting review of the state of nonprofit mergers, it’s also worth checking out this juicy SSIR post from the good folks over at Bridgespan.

Until next time, stay strong, stay dapper.

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