Paul’s comments were originally featured in an article in the April/May 2022 digital edition of Charity Times, published on 27 April 2022.
One of the striking bits of data contained in the recent Good Mergers Index is the increase in numbers of mergers involving smaller charities. In my experience, the reasons for mergers are not always primarily financial ones, but it seems reasonable to speculate that these smaller charities have responded to the financial pressures of the pandemic by looking for a “safe haven” for their services, probably in most cases with a larger charity that has the scale and resilience to weather the storm. The larger charity will be able to extend the range of services it provides without having to add significantly to its operating costs.
Charity lawyers have from time to time tried to predict increases in merger activity, but the timing of any increase is made harder to predict by the fact that many charities have multi-year contracts and funding in place, so the real squeeze may not come until a few years after the initial shock to the economy. In the case of this recent increase in merger activity, there may have been an additional delay as a result of the Government’s various measures to protect businesses from the immediate impact of the pandemic, such as the furlough scheme.
Many charity mergers are prompted by financial problems, but there is a risk that any charity looking for a merger to get them out of a financial crisis is acting too late. Any potential merger partner will have to look carefully at the charity’s financial position and the trustees must carry out a reasonable level of due diligence to make sure that they are not taking on a service that will have an adverse effect on their existing range of services. Mergers can take up a huge amount of management time, and can also involve significant costs, so they will rarely offer a quick fix. Having said that, if a merger is the only way of rescuing a service that would otherwise be lost to the community, the risk may be worth taking.
The financial benefits of a merger can be slow to appear. Clearly there can be savings on staffing and premises, particularly if back-office functions can be combined, but this will vary tremendously from one merger to another. For example, redundancy costs can be substantial, so that it can take a long time for payroll cost savings to be realised. Likewise, it is not always possible to simply dispose of or sublet surplus premises, so they can continue to be a drain on resources. Sometimes the immediate benefits are non-financial, such as a clearer combined mission, or an increase in the geographical area covered.
The impact of the pandemic on the charity sector is only now beginning to become evident. It seems likely that many charities that have spent the last two years struggling to keep their heads above the water will soon have to make tough decisions about their future, and I would be surprised if we did not see a continued rise in merger activity now that charities have less protection against the financial fall-out of the pandemic. The increase in employers’ NI contributions and the threat of further sharp increases in energy costs will also have an effect on the ability of charities to continue in their current forms.
In the longer term, mergers can provide economies of scale and can give the merged charity an ability to bid for contracts that the pre-merger charities could not have taken on. They can also enable the merged charity to have a bigger presence in the sector and in the eyes of donors. All of these can put the merged charity in a stronger financial position. However, the transaction costs of a merger can be substantial: over and above the management time that it will absorb, a merger can incur redundancy costs and require the charity to go through a complete rebranding exercise, and these, combined with the cost of professional advice, can mean that the financial benefits can be slow to emerge. However, in a successful merger those costs are anticipated and budgeted for, and the parties can enter into the merger with an eye to creating a stronger and more efficient charity in the longer term.