By Michael Ward, CPA, CGMA
With more than 1.5 million nonprofit organizations in the United States, it is not unusual to find two organizations serving the same or a related purpose in a given catchment area. This is particularly true in the areas of social services and healthcare, in which numerous organizations have been created to serve various sub-segments, such as individuals with disabilities or those with mental health needs. As community needs evolve and shift, organizations with narrower target populations may not be able to sustain themselves. The 2008 economic downturn placed significant pressure on endowments, donors, foundations and government resources, but organizations serving the neediest populations have been struggling for years.
In 2004, I was serving as the President and CEO of the Lt. Joseph P. Kennedy Institute (the Institute), one of several social concerns agencies in the Archdiocese of Washington. The Institute provided services to children and adults with developmental disabilities. Another organization served individuals with mental health needs and yet another focused resources on the Latino immigrant community. Having several Catholic agencies addressing different segments of the community resulted in the same donors being asked to give to numerous causes, redundancy in administrative and back office functions, and less leverage when approaching state and local governments on contracting and collaboration. After months of planning and deliberation, these three agencies were merged into a larger one designed to meet a broader array of needs. Because few, if any, services were overlapping, the consolidation was primarily in governance and administration. Today, a stronger agency addressing a range of community needs can reach out to donors and government funding services with a unified message and a comparatively leaner organizational structure.
However, a merger may not be the only solution to respond to economic pressure. In 2008, a group of Chicago-based nonprofit organizations considered the possibility of collectively purchasing shared back-office services, creating The Back Office Cooperative. While they ultimately determined there were too many unique accounting and reporting requirements to share in one accounting and finance solution, their efforts coalesced into a group-buying solution, allowing them to gain leverage in negotiating with suppliers, which has already saved several million dollars for its members. The participating organizations offer a broad array of services headquartered in the Chicago area, but some operate in multiple states. A merger was not a solution for these organizations but they nonetheless found immense benefits in combining some of their efforts.
Cost pressure is just one motivator in considering a merger. Integration of services and the ability to better allocate real estate and other resources are also outcomes that can be realized through mergers. The improved outcomes and related growth of in-home support services have fundamentally changed how healthcare for individuals with certain chronic conditions is met. Not too many years ago, lengthy stays in hospitals or intermediate care or rehabilitation facilities were common. Today, organizations constrained to a certain treatment modality struggle to shift to a decline in demand, with in-home services replacing inpatient and ambulatory services at substantially lower costs. Either by merger or diversification, such organizations need to increase their leverage to remain viable. Combinations in the nonprofit healthcare sector may become more prevalent as these organizations seek to maximize the value of their assets and guard against obsolescence.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 958-805, Business Combinations, governs the accounting for nonprofit business combinations, with distinctly different treatments for a merger versus an acquisition. Under a strict merger, in which a new governing body takes control over the combined activities of the merging organizations, the assets and liabilities of each merging entity are carried forward from their respective balance sheets. Should one governing body take control of the other entity, that combination is treated as an acquisition and the acquired entity’s assets and liabilities are recorded at fair value in the balance sheet of the acquiring entity. The difference between the fair values of the assets and liabilities is recorded either as goodwill or as a non-operating item of income or expense depending on the nature of the revenue streams of the acquired entity. This divergence in accounting can be leveraged to extract value on an otherwise cost-constrained balance sheet. If one entity has significantly depreciated real estate used in its operations with a much higher market value, that value could be recognized on the balance sheet if the entity is acquired.
Nonprofit boards and executives will continue to grapple with the best way to generate the greatest value from their assets, seeking to achieve their mission while preserving portfolios from the impact of operating losses. With many nonprofit executives approaching retirement, there may be one less barrier to a business combination—the career path of the current leadership. With over 40 million Americans in retirement (more than at any point in U.S. history and a number that is expected to double over the next 30-40 years), we will need a strong and robust nonprofit sector to address the unique needs of our aging population while still serving the myriad needs of our children and younger adults. It is incumbent upon the leaders in this sector to determine the best structure to achieve that goal.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2016). Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com