Benevolent Takeovers, ctd.

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Earlier this year, I pondered the idea of non-profit mergers and acquisitions, and spoke of a small consulting project I was doing for a local non-profit, whereby I was tasked to explore the potential for such benevolent takeovers.

I analyzed organizations along criteria that included net asset balances, revenues, and efficiency ratios.  Out of the 60 similar service providers analyzed, I found seven that exhibited the minimum criteria for a takeover target.  Firstly, they were organizations with small asset balances, which meant that they were not only affordable but also in danger of going under; a few years of operating losses could wipe them out.  Second, these organizations were less efficient than my client organization, meaning they spent proportionally more on administrative expenses.  Presumably, if my client took over an organization’s revenue and operations, they would be able to do so at a lower cost and pocket the difference.  This is what is often referred to by business folk as synergies.

With the list narrowed down to seven, next came the tough political stuff: founders, funders and boards.  In the corporate world, mergers and acquisitions are often beneficial to the target company, since owners and management usually receive big payouts and a chance for the company to expand.  But in the non-profit world, unique barriers exist.

Exhibit A: Fame and Founderitis

Non-profit leaders are far more possessive about their organizations than corporate leaders.  Each wants to be the leader of the small grassroots organization, and will scoff at the notion of bringing outsiders in to lead or absorbing themselves into another larger bureaucracy.  Founders are often worse.  Among our list of organizations, we immediately scratched one because the family that founded the organization still had representation on the board.  It was not worth entertaining the idea of asking someone to take their name off of the building, even if we could promise better service and a path out of fiscal disaster.

Exhibit B: There’s always another funder

A struggling organization will look fiercely for new funders and can continue to tread water so long as it has the energy to keep chasing the dollars.  Fortunately, there are a lot of options for these organizations: fee for services, foundations, government grants, fundraising events, individual donations.  Only when all of these have been exhausted will the opportunity arise to discuss a takeover.

In the case of the organization’s under discussion, most were heavily government funded and shared many sources with my client.  As such, there is room for discussions with the city funders, who may be able to recognize one organization’s weaknesses vis-a-vis another one’s strengths.  The CEO of my client has already been in discussion with various city officials who are looking to reapportion their grants.  This could ultimately prove to be the key to loosening the grip over these struggling organizations.

Exhibit C: the politics

At the same time, organization’s that are heavily government funded might exhibit signs of patronage.  Their continued funding and support may come directly from strong relationships with important government officials and not much else.  One of the organizations that was in the worst shape was unfortunately dead-on-arrival because the board was full of community leaders and others with ties to government.  We felt there was little chance of getting them off of the government grant-roll.

Finding the one

The only thing that can overcome these hurdles is desperation, the reality that an organization will not survive much longer without some outside help.  For that, we had to narrow down the list to organizations that had lost money in recent years and didn’t have much of an asset cushion to survive similar losses.

Ultimately, only one organization fit the bill of an ideal takeover target.  It has low asset balances, had struggled in recent years, shares many funders with my client, and most importantly, the CEO was about to retire, creating a unique opportunity to enter into discussions.

Starting with 60 organizations and ending with one doesn’t particularly seem like a good rate of return, but I still stand behind the idea of non-profit mergers and acquisitions.  And there are other options, too.  While some of the organizations were too entrenched or too indebted to be considered takeover targets, we did flag two as potential management agreement targets.  Under such a scenario, our more efficient client could manage the operations of a piece of another organization’s business, thus doing it cheaper and potentially helping them to get out of their fiscal woes.

The point is that there are gains to at least sharing capacity across the non-profit sector and we need to find ways to allocate it best.  Many peoples’ lives depend on it.

Posted on May 28th 2010 in ideas

Benevolent Takeovers, ctd.

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In a previous post, I wrote about the potential for mergers and acquisitions in the non-profit sector and a project I am working on towards that end.  So how does one go about finding a suitable target?

First, I found all of the organizations in NYC that operate in the same business as the acquiring organization and looked up their Form 990, the tax form that must be filled out by any 501(c)(3) non-profit organization with more than $25,000 in revenue.  By law, these forms must be public.  I located the majority of them using Guidestar and began by analyzing the following criteria:

  • Revenues - the principal reason for absorbing another organization is to expand your reach.  The financial metric that corresponds to this is top-line revenues, which represents the money to be invested in organizational operations.  In the non-profit world, revenues are comprised of grants, donations and fees.  No matter what the source, this is what the acquiring organization stands to gain; the target’s grants, donors and fees would presumably carry over into the new organization.
  • Net Assets – this is essentially the cost of acquisition.  It represents the leftover assets of the organization, after liabilities have been paid.  If this value is too much for the acquiring organization to pay for out of their own assets, then they have to look to smaller organizations.
  • Revenue-to-Net Asset ratio – this gives you some perspective about the organizations you are purchasing.  If this ratio is high for a target, you are getting more bank for your buck, in the sense that the amount of revenue you acquire would be greater relative to the amount you’d have to spend to buy the assets.
  • Burn Rate - for organizations that are currently in trouble (i.e. carrying a net operating loss), this measure estimates the length of time they can survive if the continue in their current state.  It is basically net assets over net operating loss, thus telling you that if the organization continues losing this amount of money, it will burn through its assets in x years.
  • Operational Efficiency – this measure refers to the percentage of total expenses spent on program services , as opposed to overhead and fundraising.  Organizations that have high efficiency ratios can boast, for example, that 90 cents of every dollar is spent directly on program beneficiaries, and they do so loudly.

Using these, I filtered down the list of organizations to those that were viable based on our criteria.  Revenues must be large enough to make the transaction worthwhile in terms of time and money spent.  Net assets must be affordable enough for the acquiring organization.  The burn rate will be a proxy for organizations that are in greater danger of going under and may thus be open to being absorbed by another organization.  And operational efficiency gives an idea of where money can be saved.

There are plenty of valid criticisms of using operational efficiency as a non-profit metric, particularly for organizations like Kiva or Acumen Fund.  The most trenchant criticism is that efficiency has no direct correlation with impact.  But for the purposes of my project, operational efficiency is an important deciding factor.  For any target organization that is less efficient than the acquirer, the difference represents the savings that can be gained through the combination, which can be particularly attractive to funders and the organization itself, since it will pay a lot of money to expand its reach.

The filtered list only represents the viable.  Next I must figure out which organizations are ideal.  Here I will have to dig deeper into funding sources, governance and the people involved.  Stay tuned; that is when things may start to get dirty.

Posted on March 8th 2010 in ideas

Benevolent Takeovers

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We hear about mergers and acquisitions all the time in business news.  It almost seems as though private markets necessarily consolidate, a process that can help great companies achieve improved growth or operational efficiency.  Some of these deals are mutually beneficial arrangements that allow companies to achieve economies of scale and synergies (see HP-Compaq).  Many others represent attempts to diversify the product portfolio or extend the business model (see Apple-Lala).  And then there are the few that are hostile takeovers aimed at acquiring market share (see Kraft-Cadbury).

I’ve always felt there was a place for mergers and acquisitions in the non-profit world, where success is defined less by financial gain and more by developing effective, efficient solutions to pressing problems. One would assume that anyone truly seeking to solve problems would welcome convergences that would allow the best organizations to extend their reach and create more efficient impact. Yet the non-profit world is replete with anti-cooperative structures, despite the requisite non-compete proclamations. Organizations vie for the same talent. They fight for the same grants and funding. And even if they only care about the end result of eradicating the problem, they still face extinction-by-funders if their organizations are not playing some dominant role in the process. No matter what is said, we are not in this together.

Fortunately, there is hope. I am currently working on a consulting project for a non-profit organization that has given me an interesting task: find organizations to take over. The organization is engaged in services that are heavily financed by local government. The CEO, noting significant budget cuts now and in years to come, imagines that many similar organizations will be in danger of going under. I have been asked to identify those organizations and develop a plan for potential benevolent takeovers.

There is strong support for this idea. The Boston Consulting Group recently published a study that showed that the most successful mergers and acquisitions occur during periods of economic downturn. In times of crisis, many fundamentally strong companies enter periods of distress that threaten their sustainability, making them ripe for takeover. An acquiring organization can gain greater efficiency through operational synergies and economies of scale, as well as an opportunity to broaden their impact. The risk of inaction is letting a fundamentally strong organization fail.

There are barriers. Non-profit boards and founders are far more possessive about their organizations than their corporate counterparts. And finding the appropriate measures by which to identify suitable targets is always a challenge. Nonetheless, it will be very interesting.

I will chronicle this experience. Although I will not divulge specific information about any of the organizations, I will certainly share all lessons learned. Stay tuned.

Update: follow-ups here and here.

Posted on February 3rd 2010 in ideas
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