052: Mergers, Acquisitions & Strategic Options for Nonprofits in Uncertain Times (Part 1)

With many nonprofits facing existential threats due to revenue loss, federal funding freezes, and policy shifts, organizations are forced to operate on reserves while waiting for clarity that may never come. Now more than ever, it is crucial that nonprofits reframe their views on mergers and acquisitions—as well as the many alternatives.

On today’s episode, Atrómitos president, founder, and CEO Michealle Gady is joined once more by Michaela Kay of BDO and Jacob Ferrari of Apex Law Group. Julie Morris, interim executive director of Wellspring Family Services, rounds out our panel of experts to discuss the complexities of nonprofit mergers and structural changes in the current challenging landscape.

Want a refresher on Michealle, Jacob, and Michaela and their conversation detailing the report on the sustainability of human services contracting in Washington state? Listen (and read) here.

Julie Morris is the Interim Executive Director at Wellspring Family Services in Seattle, WA. As a professional interim leader, she specializes in helping organizations navigate periods of change and transition. Julie has practical experience leading a nonprofit through a program and asset transfer and is deeply committed to solutions that prioritize community impact and long-term sustainability over organizational ego.

Key Takeaways

• What are our experts seeing right now in terms of organizational stability and financial health in the nonprofit sector, and when should a nonprofit leader start considering structural changes rather than weathering the storm?
• What's the difference between a merger, an acquisition, and an asset transfer in the nonprofit context? When do the alternatives—such as fiscal sponsorship, management services agreements, collaborative partnerships—make the most sense?
• What does financial due diligence look like for nonprofit transactions? How do restricted funds and grant obligations complicate these transactions?

This episode is part one of a two part deep-dive, so be sure to tune in next month to hear the rest of this conversation. If you’re an executive director listening to this episode and thinking, “This might be us,” you won’t want to miss it.

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Transcript

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Narrator 0:40

Welcome to the Andromeda's Way podcast, where we candidly discuss the everyday challenges facing health and human service providers, including government agencies, philanthropies, and advocates. With many nonprofits facing existential threats due to revenue loss, federal funding freezes, and policy shifts, organizations are forced to operate on reserves while waiting for clarity that may never come. Now more than ever, it is crucial that nonprofits reframe their views on mergers and acquisitions, as well as the many alternatives. Today's episode is the first in a two-part conversation about the complexities of nonprofit mergers and structural changes in the current, challenging landscape. Andromeda's president, founder, and CEO Michelle Gady is joined once more by previous guests Michaela Kay of BDL and Jacob Ferrari of Apex Law Group. Julie Morris, interim executive director of Wellspring Family Services, rounds out our panel of experts to discuss the financial, legal, and human challenges and considerations for nonprofits navigating a potential merger, acquisition, or joint venture.

Michealle Gady 1:59

Welcome to the Adromatus Way. I'm Michelle Gady, the founder, president, and CEO of Adromatus, a boutique consulting firm driven to cultivate lasting change in our communities. In the fall of 2016, I got a phone call from the executive director of a nonprofit organization. And he asked me, What do you know about mergers of nonprofits? And I said, Why? And he responded, because we need to merge with a neighboring organization. And I asked, Do you? And he paused and then he said, Well, we're each facing a loss of revenue of about 90% within the next 18 months. So we have to do something. And I said, Well, I'd first start by examining all of your options. Merger is an option, but it's not the only one. So that's what we did. These were two community-based care management organizations in North Carolina, both facing an existential threat as the state shifted its Medicaid program from primary care case management to managed care. I worked with both organizations and their boards over the next several months to identify the best path forward. We landed on a joint venture rather than a merger. For those unfamiliar with the distinction, let me start with definitions. So in a merger, two organizations combine to form a single entity, typically with one organization dissolving into the other. A joint venture, by contrast, allows two organizations to collaborate on specific activities or projects while maintaining their separate legal identities. So as we dug into what a merger would actually require, it became clear that the challenges of staff and cultural integration were significant. These were two organizations with different histories, different leadership styles, and different ways of doing things. A merger would have forced immediate integration that neither organization was prepared to navigate. They were also managing a massive operational transition, and the two organizations still had to fulfill their responsibilities under state contracts and various grant agreements. The joint venture gave them a structure to work together, preserve services, and buy time, but even with that structure, staff and cultural integration remained a source of strain and conflict throughout the partnership. These challenges don't disappear just because you choose a different legal structure. They have to be actively acknowledged and continuously managed. Over several years, the arrangement evolved. Ultimately, in late 2023, the joint venture organization discontinued operations, and at the start of 2024, its Medicaid business was acquired by a larger organization, ensuring uninterrupted service for clients and patients. From that first phone call to the final transition, eight years transpired. I share this story because the question that the executive director asked me in 2016 is one that I'm hearing more and more frequently today. And the environment nonprofits are operating in now is in many ways even more challenging. Over 80% of government contracts cover only 75% or less of actual service delivery costs. Many nonprofits are technically insolvent because of chronic underfunding. Federal funding freezes and policy shifts are creating unprecedented certainty, and many organizations are operating on reserves while waiting for clarity that may never come. So today we're going to dig into this topic with three experts who bring complementary perspectives. Michaela Kay from BDO will help us understand the financial and operational considerations, including due diligence, valuation, the impact on government contracts, and the realities of post-transaction integration. Jacob Ferrari from Apex Law Group will talk, will walk us through the legal frameworks, including board fiduciary duties, regulatory requirements, donor restrictions, and the proper structure of these transactions. Morris, interim executive director at Wellspring Family Services, will provide the essential perspective of a leader who specializes in guiding organizations through change. With more than two decades of cross-sector experience navigating leadership transition, strategic growth, and operational transformation, Julie understands what it takes to lead through uncertainty. Whether you're a nonprofit leader sensing trouble on the horizon, a board member trying to understand your responsibilities, or an advisor supporting organizations through these decisions, this conversation will give you a framework for thinking through your options. Because that's the first lesson from my story. Merger is an option, but it's not the only one. And the second lesson, one I cannot emphasize enough, is do not underestimate the challenges of staff and cultural integration. The legal and financial structures matter very much, but the human dimensions of these transitions will determine whether they succeed or fail. So, Michaela, Julie, Jacob, thank you for joining me today. And let's go ahead and jump in. Michaela, let's start with you. Why don't you tell me about your practice at BDO and your work with nonprofits?

SPEAKER_06 7:15

Thanks, Michelle. I've been with BDO for about six years, and my practice focuses entirely on tax-exempt organizations, nonprofits of all different shapes and sizes. And they mostly are up and down the West Coast, primarily in the Seattle area and also in California. A lot of those organizations are human service organizations, which I think is often the focus of what we're talking about when we or thinking about when we look at the nonprofit sector. But I also work with associations and healthcare entities, behavioral health, a whole wide variety of different organizations. Okay.

Michealle Gady 7:52

Jacob, what about your practice at Apex Law Group?

SPEAKER_02 7:55

Yeah, I'm I'm basically the same as Mikhail, only doing the law side of it. Um I'm uh most most of my clients, 99% of them are tax exempt, either 501c3 or otherwise, mainly human service providers, actually, but I do it also a lot of associations as well. And we do everything. Uh or we we build ourselves out as outside general counsel to these organizations, but we also deal with specific issues regarding tax exemption, governance, and mergers and acquisitions, as we're talking about today.

Michealle Gady 8:21

Wonderful. And Julie, talk to us about your nonprofit leader experience.

SPEAKER_04 8:26

Yeah, so I work um professionally as an NRM executive director. So I go into organizations in a moment of change. So typically it's where there is some challenge or reason why they wouldn't want to immediately hire their next permanent executive director. And then I come in to try to either clean things up or realign or um find some solutions and then hand things over to a new permanent leader. Wonderful.

Michealle Gady 8:58

Thank you, Julie. Uh, all right, so let's start by talking about the current environment and why this topic matters. For our listeners, you'll remember that Michaela Jacob and I chatted last month. And at the end of that, we discussed the really important necessity of having this conversation. And so we're gonna jump into that by talking about the temperature of the nonprofit sector. Uh so let's start with you, Julie, and then Jacob, and then Michaela, from your respective vantage points, what are you seeing right now in terms of organizational stability and financial health? Um, are you seeing more organizations reaching out for help that this year than you have in previous years, et cetera?

SPEAKER_04 9:46

Yeah, so I think from from my perspective, like in the actual practice of nonprofits, the um I am definitely seeing more nonprofits in a state of significant distress. And part of that I believe comes from we're on the other side of COVID. And I believe that all of the financial interventions that were part of COVID were fantastic in the moment, but served also to hide existing problems. And so I think where um where the funding landscape is also changing right now, and that was really evident in your last podcast. On top of that, where an organization was already struggling, COVID then sort of came in and obscured financial problems so that now we're on the other side trying to figure out what to do. Jacob?

SPEAKER_02 10:43

Yeah, I uh I I agree with Julie. I think funding is uh at a very interesting space right now. Uh there's not a lot of dollars out there, quite honestly, when you compare it to how many nonprofits are out there. Uh what funding is out there, different models for how to fund these organizations have changed, especially considering COVID and what we saw in COVID. You also have different political dynamics out there right now. Uh, you have a government that is very much keyed in on specific political issues that nonprofits are dealing with and, you know, antagonistic towards some might might say. And that puts a different leveraging power on smaller to mid-sized nonprofits and what they do about that.

SPEAKER_06 11:21

Michaela, I would agree with everything Julie and Jacob just said. We're in a really unique spot in history right now, coming out of the pandemic, where we had huge amounts of government funding come in, which, like Julie said, really either exasperated certain funding issues we already had, they were already systemic issues, but it also massed them a lot because there was a huge influx of cash coming into organizations. And I tell people all the time that managing a reduction in funding is far more difficult than managing really quick growth that we saw towards the early end of the pandemic. Managing these reductions and managing the cash flow can be nearly impossible. Just, you know, to put that mildly. But, you know, as as grants and contracts end, the funding dries up often before all of the costs dry up. You still have staffing costs. It takes a while to wrap up these programs. So you see a pretty long trail of the cost of running a program after that funding has evaporated. So I think having such a large influx of funding related to the pandemic really has exasperated that problem, which has always been a problem in the nonprofit sector. And it's just really huge right now. But to layer on top of that, it's not just the federal funding that came from the pandemic, our state funding also has shifted dramatically. Here in the state of Washington, we saw a really large budget deficit and a lot of cuts through the state budget earlier this year. Additionally, we also saw a pretty significant tax increase, which wasn't directly aimed at nonprofits, but it certainly is impacting nonprofits with increases to sales tax and things like that. Um, and then, you know, layer in private funding from our grantors and our private donors, and that's all in a state of fluctuation as well. We're constantly hearing from foundations that they're shifting their focus or they're taking a break, or, you know, they have a nice way of saying it, but you know, really what they're saying is they're not making that grant this year, or it's coming in at a reduced level. So nonprofits are really just being hammered from all sides, and it's it's a tough spot for sure.

Michealle Gady 13:43

So when should a nonprofit leader start considering a structural change rather than weathering the storm? So, what are the warning signs that suggest more fundamental action is needed? And kind of said differently, how do you distinguish between a cash flow problem and a sustainability problem? Julie, you want to start us off?

SPEAKER_04 14:04

Yeah, so I think one thing that I've started doing, because I think to be able to look back at really the last four years doesn't tell a clear picture. So there's a little bit, I I think there was a time where, at least for me personally, I felt like, gosh, I don't even like what is happening. It's hard to think. And so what I've started doing is looking at um, what do assets and liabilities look like going back, you know, 10 years? So, you know, five plus years prior to the pandemic, so whatever, 2012 to 2020. And if you can look at that and start to see is there a persistent long-term issue where assets have been dwindling like steadily over time. Um, and then the pandemic came, and then there's this big nishmash, and now we're like, oh my gosh, we have a big problem. Then it's likely not like a new thing. It is that is a continuation of a line of a systemic issue. Um, and I think that's for me, that's when I am talking to boards to say, like, hey, this is not you just lost one funder, this is not, hey, you got unlucky in that ask. This is you're, you know, you have a structural problem in how your organization is running.

Michealle Gady 15:23

Jacob?

SPEAKER_02 15:26

Yeah, so as far as the cash flow, I'm gonna leave that to Michael and Julie. I I think, but I think from a legal end, governance end, I think there's key indicators of when when change is needed. I think when the board starts to get um too comfortable in its own skin, begins to not pay attention, you'll see that documents aren't saved correctly. Honestly, like it's as small as that. When uh when when I call it, I kind of I kind of call it the rot starts to seep into the in that case you sort of have a situation where you have a governance structure that's not gonna that is not gonna be sustainable in the long run. And you need to start thinking of ways that to change it up, uh, whether it be a structural change, whether it be somewhere from the outside, to make sure that the board you know kind of regains the sustainability to actually manage the organization in a way that uh they can deal with these cash flow issues, that they can deal with these funding issues. Um but on top of that, this is gonna be my reframe today. I think structural change should actually be always at the beginning of any conversation, quite honestly. Whether it's at a board conversation, I don't know. But leaders of an organization need to constantly actually be thinking about structural change, mergers and acquisitions, partnerships, always thinking about what is the next step for this organization. Because you actually don't necessarily want to be um starting to think about this when things go downhill.

unknown 16:47

Right.

SPEAKER_02 16:47

I think you want to start to be thinking of these things as on the uptick. And I think that creates the most sustainable nonprofit environment between organizations and among organizations.

Michealle Gady 16:56

I think those are fabulous points. I mean, we tend to get stuck in in the financial side of things when we talk about these, but I think those are really important perspectives. Michaela, what do you want to add to that?

SPEAKER_03 17:08

Yeah.

SPEAKER_06 17:08

And Jacobs, I'm so glad you brought this up as uh something we should always be talking about because I really want to bring it back to the organization's mission. Ultimately, a nonprofit organization doesn't exist just because they exist to fulfill a very specific mission statement. And we need to be constantly thinking as leaders how can we best achieve that mission with the ultimate goal of putting ourselves out of business because we are no longer needed. We have solved the problem that we came to solve. And I think, you know, so often we deal with really big issues that are gonna be really, really hard and again, nearly impossible to solve. So maybe that won't happen within our lifetime. But if we look back in history, we can see examples of where nonprofits existed and ultimately that problem was solved. For example, tuberculosis is no longer a disease that kills thousands and thousands of people and is uncurable, right? We have for tuberculosis. So endowment funds that were set up to take care of people with tuberculosis are are no longer needed.

Narrator 18:15

Right.

SPEAKER_06 18:16

So we can see examples in history of times where nonprofits were created and thought that they were going to be needed forever, but then ultimately a cure was found and they're no longer needed. So we need to be looking at like, how can we make change that is lasting so that our organization isn't needed? And looking at the types of changes we're talking about today should be always part of the conversation. How can we best fulfill our mission? So often we think about mergers and acquisitions in nonprofits as a fix when an organization is failing because they don't have cash flow. But I think there's a really, really important part of the conversation that is mission-driven and mission focused. How are we going to work together as a community to best meet the needs of our community? Absolutely.

SPEAKER_02 19:08

Michelle, can I jump in real quick on the Oh yeah. I didn't think you could. Yeah, no, no, no worries. Um, I just I can't it's the one thing I've always been saying to my clients is, you know, what if we started looking at mergers and acquisitions sort of as the for-profit side looks at it, right? A lot of organizations literally form so that they can't be bought out. Um and of course, our mentality is always a little different and it has to be. But instead of looking at mergers' acquisitions as sort of a failure, and I think that's what a lot of boards are wont to do, is that they look at, oh, we did something wrong, someone has to come in and fix it. Whereas, you know, what I've been encouraging people is like, actually, what happened was you made yourself so good that someone wants to partner with you and join with you and make you even better. So we get this to a celebration rather than, you know, this this sucks, right?

SPEAKER_04 19:57

Can I can I add one other thing to that? Yes to everything y'all are saying. Um because I I love the idea of like starting with what's our end game. So there's um one nonprofit I worked with as part of our strategic planning process. We um there's a Stan Stanford Social Innovation Review article about what's your end game. And we started there. It was really helpful to think about like, do we want to close our doors? Do we want to partner? You know, how how do we do you know meet our mission more effectively, more efficiently, better, more powerfully? And I think, especially in the conversation we've had around what's going on in our government and the funding, who are our buddies that we can link arms with? I think that is that's sort of my song that I'm singing these days.

Michealle Gady 20:48

And so kind of building on that, um, really was kind of at the the crux of of my opening story is there are so many different ways to look at this, and there's so many different ways to pursue that that future structure. And so, Jacob, if you will, would you talk to us about the spectrum of um different structures from an informal partnership to a full-fledged merger, defining what some of these things are and what's the difference between a merger and an acquisition? What's an asset transfer? You know, what are all of these different ways that organizations can look at Michaela, as you said, continuing to fulfill their mission?

SPEAKER_02 21:34

Yeah. Uh and McCoy, can we stay here forever for this? No, so there's with what you just started with, there's unofficial partnerships. I mean, any organization can gather together with another organization and say, hey, let's just do something together. Let's do a uh a campaign together, let's see if we work well together just on an unofficial basis, and and we just go with that. Then you move into things like what I call affiliations or joint ventures, which are sort of two flavors of sort of the same strata of partnerships. With an affiliation, is what I always call it. That's where one organization perhaps becomes the sole member of the other organization, sort of a parent of the other organization, or some sort of overlapping board idea where one organization maybe has a level of control of the other organization because of what they do and how they're operating. I mean, that that could lead to some great partnerships because the organization stays separate. They remain uh you know, hold on to their own separate fiduciary duties and everything's separate, but they still get this sort of like formal, we're tied together. Doing this together. A joint venture, usually you see this more in the nonprofit with a for-profit, but two nonprofits can do this too, where they kind of join together in a formal business relationship. Oftentimes you see this as having an LLC together. They form an LC and they're the sole members of it. And that's a really cool thing too because then they can actually do some really cool things with that LLC, including for-profit work sometimes. Make sure it's not much, but they can um, you know, really take out a lot of benefit from that and kind of do things that normal a normal nonprofit couldn't do. Um and then you kind of reach into the strata of like the formal something's happening on a permanent basis here and there's kind of no going back. That's your asset transfers, your mergers, and uh consolidations. An asset transfer is one organization simply either transfers over without consideration or there is consideration, and they give it to the other organization. And for all intents and purposes, that other organization absorbs all of the assets of the other of this going away organization. The key there is that no liabilities go over. So that's a re that that's really an acquisition that is a surviving organization takes all the benefits, leaves all the downside with the organization that is probably dissolving right afterwards or going away in some way. It basically keeps hold of all of the issues with the organization. A merger is um one that requires a lot of trust. That is where one organization merges into and is completely absorbed by another organization. And the surviving organization takes both the assets and the liabilities. So there is a massive level of trust that goes into this relationship. One organization needs to be completely candid up front on what it's bringing into the relationship. Another organization needs to be completely canned up front about how it feels about that and what it's going to do about that, and what can be expected in the partnership going forward. Consolidation is a different flavor of a merger where another another nonprofit is created and both nonprofits are essentially absorbed into that other nonprof that that third nonprofit. And that one you really get at when there's this idea of, hey, we want this to really be a new thing. We want this to be completely new. We don't want either of our egos or either of our branding to really get in the way here. We just want to like combine and do something completely new together. Um, and we call that consolidation in the nonprofit room.

Michealle Gady 24:53

Julie, Michaela, anything you'd add to that? Rock on. All right. Well done, Jacob. All right, let's keep chatting with you. So you kind of talked through uh, you know, different alternatives to a merger or an acquisition like asset transfers, but what are some of these other uh concepts like fiscal sponsorship and management service agreements and collaborative partnerships? How are they the same or different from what you just talked about? And when might that make sense versus some of the other options you mentioned?

SPEAKER_02 25:26

Yeah, and I'll talk specifically about management service agreements and uh fiscal sponsorships. Um I think those are kind of they are different flavors in that first and second strata that I was talking about. The management service agreement usually happens when an organization wants to take advantage of perhaps the a bit of talent from another organization. Um, maybe they have someone like Julie working for them and they want Julie to come over and do some work for them because of the amazing thing Julie done for that organization. So they pay for those services or they they share those services through a managed service agreement where Julie's time is specifically split between the organizations. Someone pays her, maybe both pay for her, maybe one pays and the other gets reimbursed somehow, but that's all taken care of in a contractual relationship between the parties. That's a good way to sort of test waters of how a partnership works out. Hey, is this working? Is Julie an executive director that we'd actually like to have our organization be led by in a in a possible more formal relationship? And and it's very flexible. It's very contractual, so it's very flexible. Uh fiscal sponsorships are sort of that second-tier situation where you have this very formal sort of relationship with a what I call sort of a parent and a and a subsidiary, although it's a little different than I was talking about. You have someone who's being fiscally sponsored. Maybe this is a person that doesn't have a C3 status yet. Maybe they're not even a nonprofit yet. They could just be a loose organization of people. And they sort of want to test the waters about, hey, should we make a go of this as an organization? They link up with a bigger organization that has a C3 status, and the C3 says, We're gonna incubate you essentially. We're gonna, we're gonna be your C3. They can give to us to give to you, and they can take advantage of that C3 status. All the meantime, you need to be reporting to us, you need to be telling us that you're actually doing C3 purposes. And ideally, I mean, this isn't with every one of them, but ideally you're sort of working your way towards your own C3 and to a possible separation. Or, hey, if we really like you, then maybe maybe an absorption makes sense, and and we don't need to actually split. That's a that's a really uh good that those are really good models for organizations that I advocate for that that are really awesome and they do really cool things, but I don't think they're ready for C3 status. I think I think they need to kind of test the waters, make sure they're viable in a more business capacity respect, but but a very good model as well.

Michealle Gady 27:45

All right. Uh Michaela or Julie, any experience with any of those or thoughts you would add as kind of like these sort of intermediate options?

SPEAKER_04 27:56

I don't. I'm taking notes on everything that Jacob is saying.

SPEAKER_06 28:02

Like I think Jacob gave us a great overview. All right. I mean, we could we could do whole podcasts on each one of these on each elaborate highlights.

SPEAKER_02 28:14

There's as many more as you can think of because all these are contractual and you can think of many different phases of all these.

SPEAKER_04 28:21

And I, you know, go ahead, Julia. I was gonna say the one thing I would say is that uh I appreciate having people like Jacob in my life who are both like knowledgeable and creative, because I think that is what in you know, you know, is this conversation continues. I think one of the most important things is how can we hold space for many potential options.

Michealle Gady 28:43

And you know, the example I gave at the beginning, we went through that process to find what was going to work in that moment. And then the new organization, the joint venture, was formed. The other two continued, but then we did many of the things that Jacob just described. There was a man, you know, there was there were service agreements between the new entity and and the forming entities, the joint venturers, and exactly that the staff who you know could do certain things came over. All of that happened, and then eventually um one of as the Medicaid transformation in North Carolina happened, one of the organizations did an asset transfer over to the joint venture and wound down. So all of these, you know, it's can be a very iterative process to get to some, you know, final formation. And I think that's really important for organizations to understand that there are options out there. And so because there are options, as Jacob said, thinking about these things in kind of this continuous ongoing way is always important rather than being that moment of panic at the end of, oh my God, what are we gonna do now?

SPEAKER_02 29:50

Yeah. So some of the most successful full mergers I've done, if you go back through the history, actually probably have flavors of everything. So there's there's joint ventures that they have, there's affiliations that they have, maybe not with each other, but previously they've tried them out, right? So when I look at that, I say, wow, that's really complicated and it's gonna make this somewhat complicated. But it also tells me that this organization understands, right? They've they've done iterations of this and they know what they're getting them into it ultimately, you know.

Michealle Gady 30:17

Yeah. All right, Michaela. Um let's talk about the other end of the spectrum, a plan dissolution. And when is that a responsible choice? You kind of alluded to this a little while ago, this idea that not all nonprofits are necessary into perpetuity. So when does that make sense and kind of what does that process look like?

SPEAKER_06 30:40

Yeah. I think there's a couple different things you need to look at. One, and this is clearly the better option, is you've achieved your mission and your organization is no longer needed in your community. That obviously is the best case scenario. You've done what you've set out to do. And at that point, I think it's the responsible choice for the board to say, okay, we've done what we set out to do. Let's close our doors. And that can really be a relatively simple process where you pay any liabilities that have come due or that you owe. And then whatever your remaining assets are, typically those are donated to another organization. Um, obviously, as a tax-exempt organization, those can't just be given to um enrich specific individuals. There's no private endurement allowed. Um, so typically they're donated to another organization with an adjacent mission that will continue to work in a similar space. On the other end of the spectrum, sometimes an organization needs to dissolve because it is no longer financially viable. And typically those are more difficult to manage through, you know, you're really kind of facing a bankruptcy where liabilities are greater than the assets or the cash that's available to pay those liabilities. And my biggest piece of advice for boards and leaders in the nonprofit space is to really closely monitor cash flow, because the absolute worst thing is that your employees are considered unsecured creditors. So if you have people continuing to work for you and you do not have money to pay them, that is a highly irresponsible place to be because your employer, employees may not get paid at the end of the day. And I think for the individuals that are on your staff, they have families to support. You know, they're working for a paycheck for a reason. So keeping them on and having them work, if you know that you may not be able to pay them, is just it frankly, it's not okay. So you need to closely monitor cash flow. And if you're facing a situation where your revenues are not going to meet uh the costs that are required to run your organization and you're not going to pay able to pay your liabilities, you need to look at how to handle that in the most responsible way. And that might be closing down your organization.

Michealle Gady 33:18

Um Julie, how do you help wards kind of pass that that stick, you know, work past that stick that potential stigma of failure when dissolution is the right answer for whatever reason it's the right answer? How do you help them work through that?

SPEAKER_04 33:35

Yeah, and you say potential stigma. I think it is like a very entrenched, like massive feeling. Um, and it's a big deal. I've heard not on my watch in boardrooms, or like this will not fail as long as I'm on the board and we will not close these doors. And I'm like, oh my friends. So I think a big part, frankly, and and Michaela, you were just talking about like we're about to run out of money. I've been in front of a board saying we're about to run out of money, we can't parrot employees, and I get gosh, who's gonna help that out, right? So I think for me, the thing that I found really to be successful is first of all, like number one, these are in order data, like really showing the numbers of this is when we run out. And here's a picture. Like, for those of you who are numbers nerds, here's the chart. For those of you who are not number nerds, here's the picture of when we run. And I find that that is like that concrete, tangible numbers is essential. Um and the second thing is to personalize it. So what Michaela was saying, like, do you want you know that Jane has three kids, she's a single mom. And so if we don't do this, Jane's not gonna have a job in two months. So and I think also, yeah. So I I think, and then I would say then show the numbers again. I think that was that that's my approach. And I think that there needs to be just also a lot of work. Jacob talked at the beginning around like when to think about this and and and what boards look like that need to have look at restructuring. And so I think there's a lot from it, just an education of a board around like this is a public charity, like this is here's what we're here to do, and this is why this matters. It's hard.

Michealle Gady 35:28

So, you know, we've talked uh a lot about the staff and the impact on them, both kind of pre-dissolution. So whoever wants to start can can start. But the my question is what are those legal considerations for staff when dissolving a nonprofit? So when you think about separation packages and notice periods, and um, you know, what are some of those employee protections that exist?

SPEAKER_02 35:58

So I I can kind of start here. I think um, you know, when you're talking about, let's let's go back, when you're talking about a partnership or merger situation specifically, that that's key because you have one you have one workforce that's getting that's going into the system of another workforce. Or you have a group of people that don't want anything to do with that, right? They say, like, I'm I'm out, I I signed up to be with company A, not company B. And those ones, you certainly have to make sure they're paid out everything they're owed. You have to make sure that they uh they understand all of their rights as it pertains to the old organization, and they have to they they need to understand that the new organization is liable for whatever the old organization would be, right? So you can't just kind of give them the sense of, well, we're gone, you can't do anything, right? Like there needs to be the sense of you do have recourse if if there is something. I always generally like to advise organizations in their as they're doing that, you know, give them give them something, right? Give them give them something for their years, oftentimes, of work, right? Send them off with a thank you from getting us here to this point that we're actually being absorbed in a good way. For those who are staying on, and sometimes that's by design, there's only one or two, maybe sometimes, make sure they understand that hey, your benefits you know need to transfer over in some way. Either you can like cash them out and bring them over sometimes, and you have everything in the legal term for that, or they can be converted over. And what I always recommend here is if it's big enough, you get benefits counsel. Like there are specific attorneys or counsel that deal with benefits. It can be very tricky. And then you also need to understand like what is the, you know, what are the simple things that change, like the stuff in the handbook, the leave policies, all that stuff, because you're coming in from something where, hey, I had a lot of rights under my PTO over here, over here rights. Um, and you need to understand how that sort of translates over and what rights remain and for what period of time.

Michealle Gady 37:50

In the context, Jacob, of an organization dissolving entirely, does that look different in terms of employee legal protections?

SPEAKER_02 37:59

Yes.

Michealle Gady 38:00

So there's okay.

SPEAKER_02 38:00

And then in prime well, it looks it looks different because they're obviously gone. There is no in some ways, what my original saying was there is sort of no recourse, but but there is, Michaela said it properly, they become creditors of the organization if you haven't paid them. And, you know, kind of my comment to the last conversation was in a in a dissolution, it's so hard because I think oftentimes organizations think solely money-wise about an organization. So that trigger happens where, you know, our our liabilities go over our assets. That triggers sort of a dissolution discussion. But the problem is you just said it, your, you know, you just said it in your mind, your liabilities can are no longer being paid for by your assets. So how are you gonna creatively do that? And those creative discussions are often more risky than the creative discussions we talked about from merchants and acquisitions. So you want to make sure you have options available to make sure your people are paid, but that you're also like taking care of liabilities on the other end. Think about loans that you get from banks, loans that you get from government contractors, all that stuff. And how do you balance all that while making sure that you know you don't have employment claims coming out of that?

Michealle Gady 39:07

Michaela, how do you advise nonprofits who are going through dissolution when it comes to kind of the number side of things for employees and separation packages, et cetera?

SPEAKER_06 39:18

Yeah, that's a good question. And it there's really a wide range depending on the solvency of the organization, the tenure of their employees, really just kind of looking at the greater picture. If an organization is able, if they have the assets available, I think it's great to give a separation package. And usually I advise that that varies based on the tenure of the employee. So people who've been with the organization longer would get a larger package upon separation. And then also kind of looking at the total dollar amount. You know, if you have a relatively highly compensated employee, just looking at the amount of time might not really be fair or equitable across the employee base. So depending on how long they've been there, you know, we advise at least a couple of weeks, but that could be a couple of months worth of compensation.

SPEAKER_04 40:09

And I will just add that I think that's again when I'm talking to boards of like, hey, the time to act is now months ahead, not two weeks before we about are about to run out of money. And part of that argument is many, many, many people in our town have worked in organizations that have gone through layoffs. And so we get that there are packages and people get severance and that kind of thing. And and they're they've joined a board because they do have a heart. And so to talk to people of like, do you want again, do you want Jane with three kids to just find out on Monday that she doesn't have a job on Tuesday? Like, is that what you want? Or like, can we be thoughtful and intentional and put some planning into this and act now so that we can come up with whatever you know Michaela was suggesting in terms of some kind of equitable severance package?

SPEAKER_02 40:58

I just wanted to kind of just respond to something Julie said and and something Michaela said, quite honestly, in terms of dissolution. And and why I think actually the discussion on mergers is so key here with dissolutions is there's a culture issue, right? When I hear a board member say, not on my watch, or this organization is too important to go down, right? In my opinion, and that type of culture has put the organization above the community. These organizations are actually meant to be extensions of community, they're tools of a community in order to serve some sort of community or public good. And an organization when you when you are thinking of an organization as for the organization's sake, that could be a problem. What more ultimately talking about?

Michealle Gady 41:42

So let's jump in um to some of the nuts and bolts of these transactions. Michaela, let's talk financial due diligence. What does that look like for a nonprofit transaction? Is it the same as in a for-profit context? Is it different? What are you examining beyond kind of just the basic financial statements when you're doing due diligence?

SPEAKER_06 42:07

I think first of all, let's acknowledge that we we say due diligence and it's like a thing that we do. And often I hear, what does that mean exactly? And we throw around this word all the time. Let's let's do our due diligence. So I think it's really important to break this down into like bite-sized pieces. I think step one, and Julie and I have had this conversation multiple times. One of the fortunate things in the nonprofit world is there's a lot of information that's publicly available about nonprofit organizations. So as soon as you start considering another organization that you want to do any type of business with, whether it's a joint venture or a full merger, pull up their 990. They're available on ProPublica or on Candid. It's free. Pull it up, take a look. What do their financials look like? Do they have more assets than liabilities? You know, just do a really high-level overview. How, and then I think another really smart thing to look at as you're looking at the 990, is you can see their executive compensation or their officer's compensation on the 990. Take a quick look at that and see how it compares with your own organization. Because that could be just a quick tipping point of do we have wildly different compensation philosophies, which is going to play a little bit into organizational culture and things like that that could come up farther down the line. But that's just a great place to start from a high level and just getting some basic information about the organization. Depending on what you find on their 990, and if there are any immediate concerns that pop up, is kind of gonna lead you down your next set of paths. Um, you know, for example, if you look at their 990 and you're like, oh, they only have $5,000 in the bank, according to this document. Cash flow is a major issue for them. That's gonna lead you down a different path than if you're like, oh wow, they have a significant endowment. They're well set up for success from a financial perspective. The next step that I always advise looking at is gaining an understanding of their liabilities. And this is more complicated because many liabilities are not in their financial statements. There are other things that are hidden. Uh, and Sometimes difficult to find out, but you need to understand the role they play in the community and their perception in the community. Do they have a good reputation? And this might be different with different constituents. What do former employees think of this organization? What do their clients think of them? What do granters and funders think of them? And they might have very different perspectives. There's also, and I think Jacob will probably dive into this more, thinking about contingent liabilities. You know, is there pending or threatened litigation? Are there outstanding employment claims? Especially on the West Coast, we have some pretty strict employment laws that can um create problems and they can be difficult to follow. Um, once I have a thorough understanding of the balance sheet, what are the assets? What are the liabilities? Again, including those that are not on the balance sheet, I would start diving into revenue streams. How is this organization funded? And depending on which one of the options we've talked about earlier that we're looking into, will that funding continue? Could it transfer to a new organization if we do a merger or some sort of consolidation? There's a lot of feelings that get wrapped up in funding. It's not as simple as we all wish it was. But especially when we're talking about private funding sources, there could be relationships behind those fundings that have a huge part of why that particular grant or donation is made to the organization. You would think it would all be about the mission, but sometimes it's more about relationships. Will that be able to transfer? And then the last place I would dive into, I shouldn't say last, but the last I'm gonna cover today, would be diving into expenses. Often when we look at a consolidated or combined organization, there's efficiencies that can be gained as we combine sort of those back office functions. You know, one HR department might be less expensive to run than two HR departments. However, it's gonna take a while before you start realizing any of those cost savings. The reality is most likely your costs are gonna go up before they go down because you're gonna have to pay for people like Jacob and people like me and people like Julie to help along the way and help make this transition a possibility. So that's why I put costs kind of at the bottom of the list, is because really there's gonna be probably pretty significant transaction costs in in going through a thoughtful process to make this happen before you're gonna realize potential cost savings on the other side.

Michealle Gady 47:14

Julie, anything that you would want nonprofit leaders to understand about the the financial due diligence process.

SPEAKER_04 47:23

Yeah, I think um I think the the two other things that I was thinking about, um, Michaela, as you were talking about that, it number one, you talk about all the costs of this process. I think trying to engage some key like donors early on to say, hey, I gotta bring on Michaela and Jacob. Can you give us a little bit of money to help us because you love both of these organizations and we're not sure we're gonna be, you know, this is gonna work, but can you help us explore this? And I think that's really important. And then the other thing is because it's kind of part, I think it's part of the due diligence. And Jacob, maybe you can help clarify this, but talking to key vendors and key funders at the right time along the way. So there's certain points where you've done enough due diligence that you can say, okay, vendor so-and-so, we understand we're looking at this. Would you be able to transfer over to this person? I think finding the right timing to bring in uh your supporters is important.

Michealle Gady 48:30

Jacob, did you want to add?

SPEAKER_02 48:32

Many things. Um due diligence and a transaction is for legal and I'm sure Mikhail would say this, takes up probably like a majority of the whole transaction. Um and it's something that uh something every young attorney as they grow into their firm has to like go through at least once to their stripes. Um so, but but the key one of the key things with due diligence is first helping the client understand the culture of the two organizations. That's like first step. Does this culture match, right? And I think the Kayle and Julie were both getting at that. Is this something that you're gonna be happy with in the long run? Because it doesn't do me any good to go through all of your contingent liabilities, to go through all of your governance documents, to go through every you know, scrap of contract. If at the end of the day you're just not getting along and this isn't working, we could do other you like I said, there's 5,000 different options that we could do that don't require this. So that's that's first key. Transaction costs are also key. I do like to say you're not just hiring me and Michaela, there's also the other side that has to hire me and Michaela as well, right? And one of the biggest cringe parts of these transactions with me is they say, Jake, we're gonna hire you, but can you write the other side's documents too? Or can you like advise that like absolutely not? I that is makes me completely uncomfortable. I beg the other side to get an attorney. And it ultimately makes it run smoother. It actually saves money. They think it's gonna double it. It it doesn't, I wouldn't say that it retracts the money already paid, but it doesn't double it, right? It's like you're you're paying 1.5 instead of two. Um, and and I think that helps also if it's big enough, having a strong consultant to sort of manage the whole deal usually a lot of sense when both organizations pay for half of it. Um, that kind of helps it because attorneys and and accounts they see things through a very specific lens and very black and white. They don't want to go outside their purview. A consultant is free to sort of be a little bit more creative, sort of bring people back to the table when frustrations rise and frustrations will rise. A transaction big enough usually goes through the full gamut of human emotion. Um and and that's you need someone to sort of be like the non-human in the room to like bring someone back to the table and to kind of discuss this. As far as due diligence goes, everything Michaela and Julie said is absolutely correct. From a legal end, I want to know about contingent liabilities. I want to know about what possible lawsuits there are, employment issues there are. You know, I always want to know the real estate issues, the liens. I think people just give, like, I can just give this property over here. Well, did you know that there's a lien on it that someone doesn't let you do? Did we know about that five months ahead of time? Because now we're two weeks away from closing and we have to deal with that, right? So again, just full open disclosure, be willing to make sure, like in your entire books are open and given to the attorneys for review or given to whoever's doing the due diligence review for review and make sure everyone knows what's going on. Now I will say this there are different levels of review for what type of transaction it is. Obviously, as we talk about those tiers, it's less, it's it's less important for due diligence, this more separate you are. As you go into the more formal merger, it becomes more key for due diligence for one side. The person who's not being acquired, and I often get this with clients the person being acquired needs to give more due diligence than the person acquiring. Um, and I think that's always sometimes like, you know, I've held clients that's unfair. Why shouldn't we ask for all that? Well, it's because it's your liabilities that are being absorbed by them at the end of the day, right? But it does become more due diligence as you go up in those tiers.

Michealle Gady 52:01

Uh-huh. So let's talk about a very specific part of kind of that due diligence and evaluation part, and that's government contracts. Uh, and I raise this because so many nonprofits, particularly safety net health organizations and human service providers, a lot of what they have are government contracts. We're not going to argue about whether they're service agreements or grants, they're government contracts. And so, how do we think about so those often can't just simply be transferred? So, how should organizations think about their contract portfolios when they're considering either a full merger or an acquisition or some other um, you know, run on that on that ladder? What do you think about in terms of dealing with performance obligations and compliance requirements and other components of the contracts? Um, Jacob, I'll have you kick us off with that.

SPEAKER_02 52:56

Yeah, government contracts are always those things. I I feel like they're in a way of sort of a boogeyman when it comes to these types of transactions. I've had clients go to me, like, we need to start years out so that we can get these contracts transferred, or they don't even think about them because they think of them as simple grants that they could just sign over. The the truth has always lies somewhere in the middle there. But I think what you always have to realize is for any contract, government contracts and any contract, you always have to understand, is this transferable and does it need consent to transfer? And government contracts, they always need consent or some sort of a some sort of process. What I've learned though in working with government contracts is there's always a person on the other side that you could talk to, right? Always divulge what's going on in accordance with any NDA you've entered into with the other side. They're allowing it. Say, hey, we're doing this merger. We need help getting this this contract transferred over. Again, if the merger actually makes sense financially, the the government contractor will probably understand that. They'll say, Oh, that they're an even better person to be doing business with because they they can pay better because they're bigger than you, and we make that makes sense to us. Um, you know, again, working them with in sort of a human way to get that transferred over and get that in the process. Uh, it's also important to understand that mergers take place in what I call two phases. They take place at the execution phase, i.e., you are actually structuring the deal for what it'll be, and you're executing a document, a merger agreement, an asset transfer agreement, something. You're executing an agreement that says we're gonna do this. But then there's an outside closing date out after that. Months and maybe six months out, there's gonna be a closing. That is order in order to give the parties that six months lead time to actually get those contracts uh transferred over in in a contractually defined way. Um, so make sure we're utilizing our time timelines appropriately to make sure we can get the most out of getting, again, not just government contracts, although those are the hardest, all these contracts and liabilities and whatnot transferred to where they need to be at the end of the day.

Michealle Gady 54:57

Because the same considerations would apply, whether you're talking about a foundation grant or a corporate grant or that's correct.

SPEAKER_02 55:04

Foundation and corporate grants are usually easier because you know that it doesn't take as much. But I always say, let's just treat them all the same. The ones that come in earlier, come in earlier. The ones that come in right at the nick of time, they come in right at the nick of time.

Michealle Gady 55:18

You kind of mentioned um earlier in talking about due diligence, you know, this funds that are given based on relationships. Sometimes, oftentimes these come with like restricted restrictions on them. How do you handle um, you know, those kinds of when the funds have been restricted to a particular purpose? You know, how how does that get dealt with?

SPEAKER_06 55:39

That's definitely a part that's going to take its own special part of the due diligence process is understanding what those restrictions are, because the restriction doesn't go away through any one of these transactions. And so you need to do your best to honor that donor restriction um as it was originally intended or as it was originally written. So Jacob can probably talk more about the legal side of this, but oftentimes it doesn't need to be an exact one-for-one, but it's more about kind of the spirit of the restriction and making sure that is fulfilled. And I think if it's a donor that you have a continuing relationship with, bring them on the journey with you. And maybe with the new information since they originally made this gift, maybe they're willing to work with you and kind of update that restriction to better match the needs of the organization and the needs of the community. So don't be afraid to bring your donor along on the conversation. I find that when asked, donors are usually really happy to be part of the conversation and really happy to be involved and want to make it work best for the organization. So I think opening up those conversations usually sooner rather than later is a good idea. Of course, there are times when that donor can't be talked to for one reason or another. I think of that most often with endowment funds that have existed for a really long time. Maybe that donor has passed away. There's a whole variety of things. And that's where having solid documentation around your endowment and the purpose of that endowment is really important. This is a whole different discussion topic, but I often talk with my clients when they're looking at setting up endowments. And I'm like, make sure you have a thorough understanding of the purpose of this gift and the donor's intent. It doesn't need to be a long document, but there does need to be a document in place that will serve you really well or serve, you know, future generations really well. Because it might be 50 years from now that somebody's looking at this document and trying to understand, okay, what do we need to do with this money? Yeah. Um, and that can the more time that passes, the harder that gets. Um, there are even cases where the donor's not available and you might need to get the Secretary of State involved. Okay. Yeah, that's I've seen that. Yeah, it happens sometimes. So um, I guess the overarching advice here is don't go in alone.

Narrator 58:19

Thank you for listening to this episode of the Adromeda's Way. If you're an executive director listening to this episode and thinking, this might be us, be sure to tune in next month for part two of this conversation. This podcast is a production of Adromedists, a woman-owned boutique consulting firm that creates a better way for our health and human services provider clients to achieve their goals by strengthening internal operations, enhancing financial stability, and evaluating public policies. Please follow the show and leave a review. You can find previous episodes and more content on our website, Adromatas Consulting dot com slash Adromatas Dash Way. That's A-T-R-O M I T O S. We'll see you next time.