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Due Diligence Vital Before Joining New Nonprofit

Gelman, Rosenberg & Freedman CPAs is a member of CPAmerica International, an association of CPA and consulting firms that provides industry knowledge including insightful articles, to help member firms serve clients and other individuals and organizations.

There are more than 1.5 million nonprofit organizations in the United States, many of which have overlapping causes. Each year, more organizations compete for a finite pool of funding, resources and talent.

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This competitive pressure has been worsened by the economic downturn. There are fewer funding sources, and the funders may not want to give to multiple organizations with like causes.

For the past several years, mergers between nonprofit organizations – the process by which at least two nonprofit corporations join to form one legal entity – have been on the upswing.

There are many solid reasons for organizations to merge, including increasing funding opportunities, cutting costs and better achieving their mission.

Merging is a multi-step process. Due diligence is a critical step. If your organization merges with another nonprofit, it becomes owner of the other’s funds, logo, name, assets, programs, licenses and other property. Your organization also takes on their debts, liabilities, contractual obligations and claims against them.

Due diligence may be costly and time consuming, but the risks of becoming a legal successor justify the intensive effort. Mergers should be a combination of strengths. Don’t overlook the long-term impact of the merger in favor of immediate relief.

Distressed mergers often don’t work, and many things can cause a merger to fail. Directors may be held personally liable if negative results occur because the organization didn’t carefully examine the merger partner.

A robust diligence process can help protect directors from such challenges. Good due diligence reports will not only support the board’s approval and recommendation for the merger, but will also serve as a type of “insurance policy” against personal liability of directors of both governing boards involved.

Due diligence consists of legal due diligence conducted by attorneys and financial due diligence conducted by accountants.

In addition to reviewing the items in the box at right, you should interview the other organization’s executive director, major donors, program directors and CFO. Be sure that no key stakeholders or funders are strongly opposed to the merger and staff members are not resistant to change. Conduct background checks of key people.

Comparing financial information of the two organizations will help you identify items that can be eliminated or combined. The ones that can be combined should be split into those that can reduce costs and those that can increase revenue.

Compare the organizations’ statements of financial position, budgets, donors, human resources and financial ratios. Prepare projections for a combined budget and a cost/savings analysis. Due diligence is more forward-looking than audits of historical financial statements.

Consider engaging an outside consultant or facilitator. The benefit of using external advisers is that the review is based on an independent viewpoint from a party with no direct interest in the outcome of the proposed transaction.

Seek advice from a tax attorney or tax accountant to assess whether the post-merger entity continues to be organized and operated for tax-exempt purposes. You should notify the IRS of the merger, and submit copies of any amendments to your articles of organization or by-laws as part of the merger transaction. A new organization will need to receive determination that it is tax-exempt.

Tax-exempt organizations that end their operations must inform the IRS about the details of the action.

You may also wish to consider whether the merger will result in any adverse tax consequences, such as recognition of gains on assets transferred. If there is any concern about the tax consequences of a proposed merger, the parties may wish to first request a private letter ruling from the IRS.

Mergers are sophisticated transactions that are difficult to bring about on a do-it-yourself basis. As early in the process as practical, raise funds to cover the cost of the merger, including the cost of due diligence. Make sure there are people on your board who have experience with mergers.

Items to examine when conducting due diligence

  • Audits, tax returns and budgets for the last three to five years
  • Current internal financial statements and budget
  • Bank and investment statements, including a list of investments and investment policy and valuation method
  • List of receivables and pledges receivable, including calculation of allowance for doubtful accounts
  • Property and equipment – listing of assets and useful lives, title reports, inspections, capital needs assessment and reserves
  • Liabilities – list of current recorded payables and accrued expenses (A search should also be made for unrecorded and contingent liabilities. Review payments made subsequent to the cutoff date, evaluating the adequacy of recorded accruals and inquiring with senior management.)
  • List of any regulatory audits and their outcome in the past three years, including any outstanding issues
  • List of limitations on the use of any funds, including temporary or permanent restrictions (Understand these limitations because the restrictions survive the merger.)
  • Listing of leases, grants to pay others and any other commitments
  • Listing of insurance coverage in place
  • List of loans outstanding
  • List of past legal judgments
  • Articles of incorporation, bylaws and IRS determination letter
  • Development – list of donors, noting donors that are new or those that overlap
  • Information systems, including development software (You should plan on merging the donor databases.)
  • Board and executive committee meeting minutes for the past 12 months
  • Copies of licenses and permits
  • Personnel:
    1. List of active employees and pay
    2. Performance evaluation criteria and bonus plans
    3. Copy of any collective bargaining agreements
    4. Copy of pension plans, including retirement and health plans
    5. Vacation/PTO policies
    6. Employee handbook
    7. Employee contracts
    8. History of workers’ compensation claims, and verification of misclassified workers
    9. Employee vs. independent contractor issues
    10. Employee discipline records
    11. Deferred compensation agreements


For the past 12 years, the accounting firm of Gelman, Rosenberg & Freedman has consistently provided the Chesapeake Bay Foundation (CBF) with superior services.  The Gelman, Rosenberg and Freedman team, led by partner Terri McKnight, is knowledgeable about the nuances of the nonprofit industry, as well as attentive and thorough in their responses to any questions and concerns.

Fay Nance |  Chief Financial Officer
Chesapeake Bay Foundation