Case Studies
Mergers

David La Piana’s First Merger

Several years ago there existed in Oakland, California a small nonprofit known as PCC. PCC provided day treatment services for preschoolers who had been physically or sexually abused, as well as an outpatient counseling program for children and families. Its major sources of income were a county Medi-Cal contract for the day treatment program and fee-for-service Medi-Cal for the outpatient services. PCC also owned a building. Not unlike other small mental health agencies, PCC had deficits, staff/board conflicts, and turnover in leadership.

Ultimately, PCC's executive director resigned. We met together after he left and discussed PCC’s future, which was uncertain at best. I suggested a merger between PCC and my organization as a way to preserve PCC’s services. I directed the East Bay Agency for Children (EBAC) at the time, and PCC’s services filled a niche in which EBAC was interested.

Through a circuitous route redolent with conspiratorial overtones, including a talk with a 3rd party intermediary on an airplane bound for LA, the subject was broached with PCC’s board. Early discussions were somewhat difficult, as PCC’s board was divided on its commitment to the process. The trustees also had widely varying knowledge about the issues being considered.

The hottest issue was the population served by PCC. Their county funding source (the mental health department) was limited to children with emotional disturbances. Over the years, however, PCC had evolved into an organization primarily serving children with communication and developmental disabilities. They were very skilled in this area, and did a great job with the kids they served. To PCC the difference between emotional disturbance and developmental disability was small. It was no fine point to the county, however, and I noted the discrepancy between the population and the funding guidelines to the merger negotiating team early on in the process.

The negotiating committee was made up of management and trustees from both agencies, and the reaction was quick. Before we could even properly begin "negotiations," members of the PCC board who were opposed to a merger inflamed parents of the children in the day treatment program with threats that EBAC was planning to close down their program. A mob of angry parents descended on PCC's next board meeting, and the situation deteriorated.

A subtext that emerged during this time was, unfortunately, race: PCC's board and management were all African-American. While EBAC is and was a diverse organization, the leadership was predominately white. Both EBAC and myself were accused of many things. It was unpleasant, to say the least.

The PCC Board faction's guerilla action succeeded. EBAC backed off. My board wanted to throw in the towel, and we put the matter aside. Unfortunately, however, the activist PCC trustees went a step too far. Fearing an attempt at a "hostile takeover," and not understanding legal impossibility of this maneuver in a nonprofit organization, they called their funding source (the county mental health director), and said, essentially, "Don't let EBAC take us over and make us stop serving developmentally disabled kids."

The mental health director was shocked. How could they be serving developmentally disabled kids with Mental Health funding? She responded by ordering an audit of the program.

The result of the audit was devastating. In the end, 100% of PCC’s service units for the previous year were disallowed, because the children were found not eligible for the funding source. PCC was held to owe the county over $200,000.

PCC, with most of its board jumping ship, found itself unable even to assemble a quorum for its next meeting. With their situation deteriorating, they approached EBAC about the possibility of again considering a merger.

Past experience, combined with the pending doom heralded by the audit report, led me to believe that we needed to move quickly. I worked hard to persuade my board that a merger was the right way to go. It was not easy, however. In reviewing PCC's books we found that in addition to the audit disallowance, which they had no way to repay, the outpatient program was losing $60,000 a year. PCC had covered the past year's deficit by taking out an interest-only, 13% second mortgage on their building, with a balloon payment due in six months!

Now the question was, "What could be salvaged?" Our board members balked until we showed them that there was still enough equity in the PCC building to make the merger a good deal for EBAC, even if nothing beyond the building could be saved. Finally, they agreed to the merger, though only under an arrangement that, ironically, looked more like a takeover than merger. We dictated terms to PCC, and PCC's remaining board members accepted. The merger agreement was approved through a telephone poll of PCC’s remaining trustees.

And thus we went ahead. EBAC paid off the second mortgage from our reserves, and negotiated with the auditors that the PCC Day Treatment program would close down in exchange for not having to repay the $200,000 audit disallowance. One relatively new trustee from the PCC board joined the EBAC board. EBAC made a commitment to try to restore the services lost in PCC's demise, and began using its building, which was acquired for half its market value, for our own overflowing programs and staff. All remaining PCC staff were laid off prior to the merger's effective date, in order to tap PCC's unemployment insurance rather than EBAC's.

Things look much brighter now. Two years after the merger, EBAC resurrected the preschool day treatment program with county funding and a new partnership with Children’s Hospital Oakland. The former PCC board member who came to EBAC became the treasurer, and the PCC building is now home to EBAC’s growing administrative staff.

This is not a happy story. It probably fits your idea of a merger as little as it did mine. Thus, one of the great deterrents to merger: the leap into the unknown.

Nonetheless, viewed in retrospect, this merger was pretty successful. Though PCC’s program did ‘die’ for several years, it could have been saved if we had been able to come to an agreement on the first attempt. Unfortunately PCC's board was not ready at that point. They were only interested in a merger when it became clear, after the audit, that PCC was failing – that there would be unresolved debts and even a possible board liability in a potential legal action by a former executive director. (This last factor was no small matter, but we only learned of it after the merger. Fortunately, we resolved it cheaply and quietly).

Ultimately, however, PCC's building was kept out of the hands of its creditors, and after two years of hard work, the program was resurrected.

What did I learn from experience? Several things:

1. Never underestimate the power of group dynamics over rationality. People cannot always be counted on to act in their group's collective best interest, especially as defined by someone outside the group. I "knew" that PCC was living on borrowed time, and I knew what moves were needed to preserve the services. But this knowledge did no good. Powerful internal group dynamics can keep a dying organization from seeing its own predicament.

2. Don't threaten your partner. A threat to autonomy, identity, or other critical, deeply held values will kill a merger effort. Approach the other group respectfully, in a manner which allows its leaders to save face. The merger process must provide a way for the mission, individuality, and culture of both groups to be valued and incorporated into the new entity. Fear of change, loss of autonomy, individual egos, habit and culture all cause nonprofits its to avoid mergers.

I made the mistake with PCC of assuming that once I had demonstrated in writing that PCC had no choice but to merge or dissolve, they would thank me and simply ask where to sign the document. Instead I had insulted them, questioned their deepest assumptions, and so caused them to retreat further from a consideration of the facts.

3. A minimally functioning board may not speak with one voice. While we negotiated in good faith with PCC's board, factions of this very same board were seeking the support of our mutual funders to block the merger.

4. People have assumptions about mergers that make true negotiation, worked out in good faith, difficult. Because of confusion with corporate takeovers, the "weaker" party in a merger is bound to suspect the initiator of trying to maneuver into a position of unfair advantage.