Smart Merging

Following up on Friday’s post on the possible merger of two local arts groups, here is an article by one of the major experts on nonprofit mergers, David La Piana, published last year in the Stanford Social Innovation Review.

An excerpt.

“In the midst of the worldwide financial crisis, funders are increasingly suggesting that nonprofits consider merging—that is, fusing their boards, management, and legal entities to form a single organization. In 2009 alone, my consulting firm delivered nearly 60 presentations and workshops on mergers and other partnership forms to more than 6,000 participants—double the previous year’s tally. Similarly, our strategic restructuring practice (which handles mergers and other partnerships) grew 60 percent last year, during the worst part of the recession.

“Now 2010 is upon us, and the urge to merge shows no signs of abating. Underlying this trend are two core beliefs: The nonprofit sector has too many organizations, and most nonprofits are too small and are therefore inefficient. Mergers, the thinking goes, would reduce the intense competition for scarce funding. Consolidating organizations would also introduce economies of scale to the sector, increasing efficiency and improving effectiveness.

“Yet a closer look at the nonprofit sector suggests that this thinking is too simplistic. Mergers are risky business. They sometimes fail, although not so frequently as in the corporate world. They usually cost more than anticipated. They sometimes create more problems than they solve. And the problems that they allegedly solve—too many nonprofits, too small in size—may not be problems after all.

“Instead of reflexively pulling out the biggest gun in the partnership arsenal, nonprofits should consider a variety of ways of working together. After facilitating some 200 nonprofit restructurings (including mergers, administrative consolidations, and other partnerships), my colleagues and I have developed a few rules of thumb for when nonprofits should merge, when they should remain fully independent, and when they should undertake unions that lie between these two poles.1 We’ve also identified how funders can help—or hurt—the formation of nonprofit partnerships.

“THE RIGHT NUMBER OF NONPROFITS

“A familiar cry in the nonprofit sector, particularly among funders, is that there are just too many organizations competing for too few dollars. The sector has allowed not only thousands of flowers to bloom, but also quite a few weeds, the critics say. With the recession upon us, they conclude, the time has come to prune.

“But are there indeed too many nonprofits? Let’s take a look at the numbers. When funders talk about mergers to reduce competition for funding, they are usually discussing the small subset of nonprofits that have annual operating budgets above $100,000. They aren’t discussing the myriad small, mostly volunteer groups that make up the bulk of the sector, because these organizations are not filling funders’ inboxes with grant requests.

“In 2005, only 170,000 of 1.4 million U.S. nonprofits reported expenses of more than $100,000.2 And only 55,000 nonprofits had expenses greater than $1 million, including the 5,000 hospitals and colleges that are typically not included in discussions of the sector.

“In contrast, 6.7 million of the nearly 30 million U.S. businesses had receipts of at least $100,000, and 1.4 million had receipts greater than $1 million.3 Compared to business, the nonprofit sector is tiny, in both overall number and average size of organizations. Thus the cause of the sector’s current feverish competition for funding would not appear to be “too many actors” in the marketplace. Instead, the principal reason for the run on funding is that, as if by some fiendish design, there are too few dollars available to support the vital services that nonprofits offer and that communities need.

“Most nonprofits respond to what economists call market failure: Nonprofits provide desperately needed services to constituents who lack the means to pay the full cost. Government and private funders must then bridge the funding gap. In bad economic times these third-party payers pull back, leaving nonprofits with inadequate funding—often at the very moment that they are experiencing increased demand for their services.”