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To Merge or Not to Merge: That is the Question

Increasingly, churches and nonprofits are thinking about mergers and “acquisitions” due to the challenging financial times, increased tax exempt regulations and aging membership/decreased donations. While there appear to be some resources which discuss whether a church or nonprofit should merge or not, there is little guidance about practical applications and/or how to legally effectuate such a merger or acquisition.

Mergers of churches and nonprofits generally fall under three categories: 1) a financially ailing church with an aging membership and physical or financial assets that is merging with a younger/stronger growing church or nonprofit to strengthen its ministry, 2) a church or nonprofit that is dissolving but wants to use its remaining assets for Kingdom and charitable work, or 3) two or more churches or nonprofits that have similar vision, ministry and focus who foresee that they will be stronger together (e.g. leadership, physical assets, membership, money and complimentary ministries).

While the terminology used in mergers and acquisitions is common in the for profit world, it has only recently been introduced to the nonprofit and church sphere, invoking many different images and emotions. For example, sometimes hostile takeovers come to mind, while others times declining churches that are dissolving and donating everything to a new church that will carry on its ministries, and yet others envision a smooth joining of resources and people to do more and better charitable, God-honoring work. Regardless of the picture the terms engender, the watchword for all mergers and acquisition is “careful due diligence” to make sure that the transaction is what is best for the church or nonprofit and will accomplish what is intended. The best merger is when everybody makes a well-informed decision knowing all the pertinent information and potential outcomes.

Due Diligence.

Let’s review the process of due diligence, discuss the various options, and outline the best process for merging churches or nonprofits. First, it is important to review the legal, financial and spiritual information of each church or nonprofit involved before committing to any option in the merger or acquisition scenario.  Types of information that must be investigated during this due diligence period are: 1) governing documents (articles constitution and bylaws); financial statements, 2) IRS Form 990s and/or audited statements for last 3 years; 3) IRS filings and documents, 4) contracts and vendor agreements, 4) real estate documents, 5) all polices including employment handbooks, child protection and other key policies, 6) marketing materials including website and Facebook, 7) licenses, 8)  past, potential and current litigation and disputes, 9) debt and liability details, and 10) any membership numbers and other indicators of relative health of the organization.  You should also share statement of faith, vision, mission and core values to see if you would be compatible should members join with one another.

At the end of the due diligence, there should be an in person meeting, first, with the key contacts and then with the leadership of each group to make certain that the goals of merger/acquisition are consistent and similar/identical to one another.  “Dating” is a good description of the due diligence and pre-merger process, since marriage will be the best way to describe two churches with its members merging together.  Obviously, if the groups are Christian, as most faith based nonprofits and churches will be, the goal is for the new church community or nonprofit ministry to be able to minister more broadly and effectively together than as separate entities.  Thus, all the participants should be always looking for “win-win” propositions and unity in the body of Christ.

Process of defining what best end result will be.

After that in person meeting, the leaders of the two groups should create a joint written statement of how it will look to merge and what the organization will look like after the merger going forward and have it agreed to in writing to resolve future issues and possible disputes. In that joint document, identify the motivations of the merger or acquisition since economic crisis, political pressure within the churches, real property issues, litigation/legal issues or other negative motivations are generally not the best atmosphere but if identified they can be turned to the positive and worked through for the best outcome.

Compare values and beliefs. If the core purposes are too far apart then the merger will run aground later in the process.  Merging is a marathon, rather than a sprint, so be patient for the good and bad times and do not rush the process, despite any pressure. Huge mistakes are made when the parties rush the process and do not focus on the mission of the merger, but instead concentrate on how quickly one can accomplish it.  That speed and frustration is generally driven by underlying negative motivations.

In this process, allow each party, the leadership, and the stakeholders of each church and nonprofit sufficient time for discussion together and separately about their expectations and make sure that the expectations are reasonable and can be accomplished in the merger.  If not, then adjust expectations and make sure all parties are on the same page before going forward.

During that process and on this written statement, choose wisely the leadership and governing principles for the new entity which most if not all leadership on all sides can buy into and embrace. Pick a moderator to help further the discussions. This moderator should be someone who is influential and a wise peacemaker, but does not have a financial or power stake in the outcome.

Look underneath and behind the information to do your homework well. Clearly, any for profit company that is buying or merging with another company will look into and behind the liabilities, assets, creditors leases, contracts, agreements and governing documents and policies to learn well how the organization is actually run and how healthy(or not) it is at the present time.

Keep the end result in mind throughout the negotiations. In short, what will things ideally look like when the deal is complete? The church/nonprofit must decide which employees will remain on staff after the deal is done and who will be the leadership of the surviving church or nonprofit. What outreach, internal programs and ministries will remain and how will they be adequately funded?  What members of the dissolving or merged church will join the new entity or surviving church how will their talents, passions and gifting be used effectively?

In your homework, discover other churches and nonprofits that have undertaken this type of merger and learn what they did well and what mistakes did they make so that you do not make their same mistake.  Obviously, if some have merged unsuccessfully, that could be the most important information gathered to discern how to make sure that these series of events and mistakes are not repeated in this merger.

Finally, though this process should not be rushed, you need a realistic time frame that moves the process along and does not take years when months will nicely accomplish the tasks.  Generally, 3-9 months is an appropriate time frame.

Legal Options for Mergers and Acquisitions

The companion article in the next newsletter will explore the pros and cons of each option and practical steps but let’s summarize to set the stage.

Mergers. Mergers are when two churches and/or nonprofits merge members, assets, liabilities and legal entities to become one church or nonprofit that will be much stronger than the two apart.  Such mergers will require articles of merger filed with the state, board resolutions and plan of merger presented to both boards and members of both churches/nonprofit for approval at the final stages. Legal mergers are generally the last resort option and only to be used in certain instances where the known liabilities cannot be extinguished or ignored such as existing loans or pending lawsuits, which may make a donation/dissolution or asset purchase impossible or inadvisable.

Donation/Dissolution of One Church to Another. Generally, this is the preferred option if one church has little liabilities, since they can be paid off and the remaining assets can be donated to the surviving church.  This option works best when one church is weaker financially, member wise, or without strong leadership and the other church possesses the structure to accomplish the overall task of assimilating the members, assets and ministries. It also works when one church is going out of existence for lack of members but has important assets to contribute and some other attributes that make such donations valuable.  Because only assets are donated, the existing church after the dissolution will not have to fear the risk of absorbing liabilities of the joining church or taking on unknown liabilities with the assets or members from the dissolving church.  However, if real estate is involved, the church should do a title search and “look a gift horse in the mouth” closely. This option is excellent when a struggling church in decreasing attendance and finances wants to be absorbed by a healthier church or wants to become a satellite campus of a larger church.

Donation/Dissolution of Both Entities and Creation of A New Entity. Sometimes, it is politically easier to jettison the culture and traditions of both churches/nonprofits and all the liabilities and baggage and create a new church or nonprofit entity. This particular transaction is a great option to consider since it may be appropriate in a wide variety of situations to start something brand new. Of course, this option is only useful when both churches can pay off the outstanding mortgages or debts and resolve any pending lawsuits or liabilities since a nonprofit/church cannot dissolve without paying off all debts and liabilities.

Asset Purchase With or Without Dissolution. This final option is where the healthy church buys whatever assets it desires from a failing or declining church through a contact call an asset purchase agreement. By paying cash to the declining church, it can provide the needed capital to pay off crippling debts and mortgages to either wind down and dissolve completely or reconstitute to create a new church perhaps with some relationship to the buying church.  Of course, if all assets are paid off then the joining church will be a mere shell of its former self, existing only long enough to pay off any remaining liability and file the appropriate dissolution paperwork to then have its members join the remaining church that purchased its assets.

Conclusion

While future companion articles will cover the pros and cons of each of the 4 options, practical steps and other legal considerations, this framework discussed above should give a church or nonprofit some good material to begin the process.  However, a knowledgeable tax exempt lawyer who has done numerous mergers and acquisitions is needed to successfully accomplish the legal aspects and practical steps to give this merger/acquisition the best chance of success. Other important consideration will be discussed in the follow-up article concerning corporate documents, restricted gifts, employees, real and personal property concerns, deed restrictions, tax reporting, state corporate reporting and other legal concerns.  However, mergers and acquisitions of churches and nonprofits are not only becoming a staple but can be the most valuable avenue to have successful ministries and charities for the future which will continue to have challenging financial and other struggles. Stay tuned!

 


 

Disclaimer: This memorandum is provided for general information purposes only and is not a substitute for legal advice particular to your situation. No recipients of this memo should act or refrain from acting solely on the basis of this memorandum without seeking professional legal counsel. Simms Showers LLP expressly disclaims all liability relating to actions taken or not taken based solely on the content of this memorandum.  Please contact Robert Showers at hrs@simmsshowerslaw.com or Justin Coleman at jrc@simmsshowerslaw.com for legal advice that will meet your specific needs.

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