The community not-for-profit sector is buzzing with talk about mergers at the moment. It would be easy to spend a day just talking about why people are considering mergers, and the structural factors at work in the sector at the moment, but let’s save that for now.
Instead, I just wanted to share a few thoughts about mergers in the community sector versus mergers in the corporate sector and highlight a few fairly obvious points of comparison.
Mergers are frequently used in the corporate sector, where share price and shareholder dividends provide a clear way of measuring increases in shareholder value. There are lots of specific motives behind mergers, which can include:
- integration along the supply chain (buying your suppliers or customers)
- increasing market share (buying your competition)
- tax benefits
- acquiring new technologies
- entering new markets…
In each case the underlying driver is generally about creating a new larger entity which is greater than the sum of the parts – in other words 1 + 1 = 3.
It’s worth noting in the corporate sector the word ‘merger’ is a bit of a euphemism. In reality, it’s nearly always an acquisition, where a larger company acquires a controlling interest in a smaller company. In the corporate sector the market’s response to a proposed merger is often telegraphed very clearly through the share price of the participating companies. The share price of the smaller, target company often spikes up rapidly, and the share price of the acquiring company can spike up or down, depending on what the market thinks about the merits of the deal.
These market fluctuations create massive financial incentives for mergers to occur, as investors stand to make large gains, or losses, in the short term and over the longer term, if the merger creates lasting shareholder value for the acquiring company.
Interestingly, studies in the corporate sector (Agus 2000) have shown such acquisitions typically create large gains for shareholders of the smaller, target entity being acquired and small losses or marginal gains for the larger, acquiring entity. However, even though a bad acquisition can destroy shareholder value over the long term, the activity itself nearly always creates an opportunity for individual investors (who might buy and sell shares in both companies) to make large gains in the short term, so the market tends to incentivise merger activity.
There are also specific individual incentives for the executives of the participating companies. While the maths suggest the CEO and several executives from the target company are likely to become surplus to requirements, they usually benefit handsomely from the deal, are rewarded with a highly lucrative golden handshake and gain kudos for having steered their smaller company to a successful sale, which has generated high returns for their shareholders.
So how does all this play out in the community sector?
Instead of ‘shareholders’ not for profits have ‘stakeholders’ and instead of a share price the Boards of the participating NFPs have a duty to create social value for those stakeholders. Calculating social value is much trickier, and there’s no market mechanism to provide minute-by-minute updates. Social return tends to unfold over a much longer period.
The activity of a merger does not inherently create social value. On the contrary, while a merger must create long term social value for stakeholders to be worth doing, in most cases the activities of bringing a merger together can be seen as tedious distractions from the main business of delivering social services, which almost certainly reduces social value in the short term, while the merger is happening.
And what about the CEOs? The impact of any NFP merger is usually felt most at the top of the organisational chart. The number of front line staff is unlikely to radically change. There may well be opportunities to achieve efficiencies in the coordination and management of those staff, especially through the use of better technology and systems, so there may be some reshuffling in the middle tiers. But, at the top, at least one CEO and some upper management are highly likely to drop from the top tier to the second tier or become redundant.
So, while the incentives to consider an NFP merger are the opportunity to create long term social value for stakeholders, there are lots of short term disincentives for individuals within the participating NFPs.
This is summarised in the table, below.
When you boil it down:
- The corporate sector offers both short term and long term incentives for M&A activity. Any downside unfolds long after the merger has occurred, by which time everyone has already moved on to the next one.
- In the community sector, all the potential benefits for a merger are long term social benefits, which are hard to measure at the best of times, while there are plenty of very immediate, tangible disincentives for the executives who stand to lose their jobs.
When you look at it like this, it’s pretty clear NFP mergers are best approached with a great deal of sensitivity and caution. There needs to be a pretty compelling long term benefit to justify the short term pain. I’ve been involved in a few such mergers and I’ve found the motivation to shift from talking about it to actually doing it often arises because one or more of the participants is facing some sort of crisis and a merger becomes the ‘least bad’ option.
At the same time, it’s worth noting the courage of those NFP leaders who do forge ahead, and who are bold enough to see and commit to the opportunity to create social value for their stakeholders, ahead of their own self-interest. Perhaps we should think about ways to reward them for their foresight and fortitude, and actively encourage such leadership behaviours?