At La Piana Consulting, we know that organizations come to partnerships with different levels of merger experience and with varying needs for support. This post is one of a short series we have in the works that take a deeper dive on some of the finer points. Our hope is that this empowers organizations with more information to make proactive choices about their partnership processes and in their relationships with consultants or other advisors. So buckle up because it’s about to get a little wonky in here!
When nonprofits contemplate some sort of formal partnership or merger, they need to understand the financial impact on their organization, but they often struggle with what analysis is needed and how to incorporate it into the negotiations and decision-making process.
Although no two situations are identical, the conventional approach to mergers or restructurings involves two (or more) organizations who agree on a strategic opportunity that can be achieved through formal integration. They understand each other’s motivations and have a unity of purpose. They have addressed operational concerns such as branding, staff configurations and board governance.
Once there is clarity of strategy for the merger and agreement on moving forward, they wish to understand each other’s financial condition and history to confirm the basis from which they will move forward. We call this type of analysis financial due diligence and it is a retrospective look at each organization’s financial trends using audits, management letters, internally prepared financial statements, budgets, aging reports for receivables and payables, loan documents, mortgages/deeds, leases, contracts and other program information. This creates the foundation for a comparison of the organizations’ financial trends and drivers.
Financial due diligence is important because it helps both organizations understand what resources are available for a newly combined entity, what commitments exist that will become shared, and what risks and contingencies must be mitigated.
In the traditional approach, financial due diligence is completed toward the end of the negotiation period, to confirm financial conditions and to make sure there are no unanticipated surprises.
More and more frequently, especially among smaller nonprofits interested in mergers or restructurings, there is interest in an additional financial analysis as part of the decision-making process.
The organizations may perceive potential for a strategic opportunity through merger/restructuring but need a future-oriented financial analysis first to explore what costs might be involved and what resources would be needed. For instance, recent arts-based clients had come together with a sense that a formal collaboration or merger made sense but needed to do an analysis of their various revenue streams and how they might be affected by a potential merger. Likewise, they wanted to closely examine their respective cost centers to see what efficiencies would be possible when combined and how quickly savings might be realized. They decided to undertake this financial analysis as part of the process before negotiating the final terms of a merger.
This type of financial modeling is more akin to a mini-business plan that includes assumptions about revenue generation (earned income, fundraising, etc), program/business lines, salaries and benefits, staffing levels (including whether staff are shared or separate), as well as other cost structures and allocations.
Since such analysis could require a significant investment of time and effort, it is often a high-level analysis to test assumptions and determine whether to move forward or not. This type of financial modeling can be repeated later in the process, if needed, after there is agreement on the strategic direction and form of restructuring.
The “Flexible Approach” involving future-oriented financial analysis doesn’t pre-empt the need for a traditional financial due diligence process for the organizations involved. However, financial due diligence would be completed after a decision is made to move forward. So, in this case the organizations would use a forward-looking analysis (financial modeling) to clarify if and how they want to merge/restructure and a historical analysis (financial due diligence) to confirm their understanding of their partner’s financial condition.
Every merger/strategic restructuring is different and the financial analysis needs will vary. Nonprofits contemplating this type of strategic realignment should be well-versed in the types of financial analyses that will support their decisions and create a foundation for success.