Merging for success, not survival

At a time when we are all adapting to an unsettled present and uncertain future, merging is one possibility being considered by a growing number of charities and social enterprises. Whilst it is challenging under the pressures of the moment, to ensure a sustainable future post-lockdown, charities considering merging should try to approach it in the context of a strategic opportunity that is in the best interests of their beneficiaries, and not an unplanned bid for survival. Whilst our vision of the future is still blurred, Clive Vergnaud takes a look back at last year’s Good Merger Index and the insights it provides into merger activity in the charity sector, and offers some thoughts of his own on what makes a successful merger.

Published each year since 2014 by charity and social enterprise consultancy Eastside Primetimers, the Good Merger Index provides insights into merger activity in the charity sector. It supplements information gathered from public registries and sector and organisation websites by interviewing trustees and chief executives of merging charities, as well as senior leaders of organisations that represent the sector and support the work of charities.

By “mergers”, it means a number of ways in which two or more charities combine their assets and activities to better advance their charitable purposes, including:
  • “mergers of equals” (two or more organisations coming together on an equal footing for strategic rather than financial reasons);
  • takeovers (one charity transfers its assets and activities to the other);
  • subsidiary models (one charity becomes a wholly-owned subsidiary of the other);
  • group structures (restructuring of activities into a new or existing group of entities); and
  • service or asset “swapping” (for example so that each charity can achieve a more balanced portfolio of activities, income and costs).
From a purely statistical perspective, two particularly interesting findings emerge from the twelve-month period from 1 May 2018 to 30 April 2019:
  • First, following year-on-year increases in the number of mergers since 2015/16, the number of charity mergers dropped from 81 in 2017/18 to 58 in 2018/19. This is surprising, considering the financial pressures experienced by many charities who find themselves operating in an increasingly challenging funding environment. It is possible, as the report notes, that this is because the uncertainty of the political and economic environment creates a reluctance to enter into a merger (even more uncertainty) that trumps the need for financial support which is often the driver. But more than the decrease, it is the low number that is noteworthy: only 58 mergers involving 116 organisations, out of around 168,000 registered charities!
  • Second, the predominant driver for charity mergers continues to be financial necessity. As the report points out, only 18% were “mergers of equals” whereas 63% were takeovers. Moreover, 69% of acquirer charities were in financial surplus whereas 52% of charities merging with or being taken over by another charity were in deficit.

In the for-profit sector, mergers and acquisitions are an established, often uncontentious feature of doing business. Strong businesses are able to grow their activities by merging with or taking over others; shareholders are bought out and either realise gains or cut their losses. Mergers and acquisitions happen when one business is struggling, of course, but they frequently happen for strategic reasons: expanding into a new geographic market; growing the range of products or services offered; augmenting capacity to better compete with a rival.

It is interesting to see that this culture is not replicated in our sector and that most charity boards and senior managers do not “discuss and debate mergers as a normal and standard tool for developing and improving the work of their charity”. The report suggests a number of possible reasons: merger fear, lack of resources, perception of mergers not as opportunities but as a sign of weakness, lack of experience or understanding, emotional factors, cultural differences, lack of sector support.

Advising on mergers and collaborations is a big part of the work we do at Stone King and our experience is consistent with the trends identified in the Good Merger Index. The majority of mergers we are involved in come about because one of the parties realises they will not be able to continue to deliver services to beneficiaries without support from another charity, or because one of their main funders is no longer able to fund multiple charities operating in the same space. In these contexts, where there is an imbalance of power, we observe the following trends.

  • There is a tendency to explore the merger reluctantly, with suspicion almost, with a focus on preserving a brand, an identity, a culture, rather than a focus on achieving better impact for beneficiaries.
  • The sense of takeover persists beyond the merger itself, making it more difficult to embed new staff or activities, and to develop a new culture, in turn affecting the merged charity’s ability to deliver improved impact to its beneficiaries.
  • It is rarely the case that the charity being absorbed is doing everything wrong. A takeover mentality in the dominant charity can result in the strengths of the target charity being lost.
  • Personal concerns come to the fore, with employees concerned about losing their jobs and trustees worried about their reputations, which can make the process all the more difficult.

All of these can result in the merger process being more complex, more acrimonious, more time-consuming, costlier and – ultimately and most importantly – less effective for beneficiaries.

Considering a merger as a strategic opportunity rather than a last resort creates the breathing room to allow the needs of beneficiaries to be the main consideration.

The charities may not have identical objects and it is important to consider the compatibility of both sets of objects and take steps to ensure that one set of beneficiaries does not lose out as a result of the merger, for example by applying to the Commission to broaden the objects of one or both of the charities.

Whilst in the current climate time may be a limited commodity, it is important to carry out appropriate due diligence, not just on financial elements but to understand as much as possible the culture, history and priorities of the other charity. We have seen mergers collapse at an advanced stage not because it did not make financial sense to continue or because the opportunities had ceased to exist but because charities had fundamentally different attitudes to the way in which services should be designed and delivered – for example because one charity insisted on the need to have beneficiaries represented on the board while the other insisted that the board should be made up of the best people for the job irrespective of whether they were beneficiaries or not.

Since last year, the Charity Commission has been actively encouraging charities to explore merger options as a matter of regular strategic business rather than as a last resort, citing the merger of Breast Cancer Care and Breast Cancer Now as an example of best practice.

The following suggestions to trustees or leadership teams considering or involved in a merger are taken from our own extensive experience of advising on them. Whilst current circumstances will add pressure and make some of these suggestions more challenging to follow.

We recommend carefully considering each of them:

  • From the outset, be clear about what you want to achieve and what the potential outcomes are. Unlike in commercial transactions where the agreed deal will be somewhere between the seller’s valuation and the buyer’s, in charity mergers the range of potential deals is much larger. Realistic expectations as to what can be achieved will help smooth the journey. If you have time and resources, starting with a small “test” collaboration to see what works and what doesn’t can be a useful first step.
  • Factor in exploration and transition costs. Many mergers do not materialise beyond the exploratory phase, and when they do, they can be costly. There will be cost in the staff-hours engaged, as well as in engaging advisors. Due diligence in particular can take up significant amounts of time. These costs should be carefully scoped at the outset – and then doubled to provide a cushion. You do not want your merger petering out after months of hard work because there is no more budget to commit to it. Note that funding may be available from grant funders or from sector bodies – either for the exploratory phase or to support the cost of the merger itself.
  • Agree a Memorandum of Understanding or Heads of Terms as early as possible in discussions. It is invariably the case that putting things in writing teases out issues that would otherwise remain unaddressed until the later stages, at which point they have the potential to derail the project. For example, the simple fact of writing out “The board of the merged charity will be composed of trustees from both organisations” may quickly lead up to the follow-up questions “which trustees?” and “in what proportions?”.
  • Structural considerations are important, of course, but they should not be the main driver. What matters most are the strategic elements of the deal. For example, how are activities going to be structured post-merger to deliver greater impact to beneficiaries?; how are complementary activities, structures and networks going to be blended to achieve greater reach?; what is the intended strategic focus of the merged charity, and might it result in some beneficiaries losing out? Once those points are agreed, good advisors will help you find the right structure to deliver the desired outcomes. Structure follows purpose!
  • From the outset, establish a strong leadership team with a clear mandate and delegated authority to explore the merger and its ramifications. Ultimately, it is the people involved that will make the merger a success. Ideally, there should be equal representation from both parties, or there may be a sense from those in the minority of being at uneven strength which can lead to an entrenchment of views and affect the team’s ability to work together cohesively. External consultants can provide an extremely helpful element of independent, non-partisan advice, as well as being able to turn their full attention to the merger (unlike staff, who have their day jobs to be getting on with as well).
  • Last but most importantly: trustees must always remember that their overarching duty is to their charity’s objects. That may seem like an obvious statement but in a merger scenario it is potentially a very difficult duty to reconcile with one’s emotional attachment to a charity and its history, culture and staff.

It is inevitably the case that a merger represents a lot of hard work and costs and it is important to be fully aware of the implications before entering this process. If done well, though, it can yield really significant benefits to the charities involved and their beneficiaries, generating cost efficiencies, increased coverage, and diversification and enhancement of services. And if approached as just one way of achieving better outcomes for beneficiaries, considered alongside traditional service delivery, mergers can become little more than routine transactions.

One client we work with, which has grown it's reach to beneficiaries as a result of merging with a number of other charities and which we have supported to implement a wide variety of merger models, has as a result developed an experienced in-house team with a sophisticated understanding of the merger process and only occasional need for external advice.

The law and practice referred to in this article or webinar has been paraphrased or summarised. It might not be up-to-date with changes in the law and we do not guarantee the accuracy of any information provided at the time of reading. It should not be construed or relied upon as legal advice in relation to a specific set of circumstances.

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