Welcome to the March 2009 edition of The Director’s Dilemma newsletter. I hope you find it interesting, informative and inspiring.
I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each way has different pros and cons for the individuals and companies concerned. Every month this newsletter considers three responses to a real issue. Which response would you choose?
Erica is a director on the board of a medium sized not-for-profit company. Donations have been deteriorating over each of the last three years whilst demand for service has gone up. The executive team have responded to the challenge in a tremendously successful manner, working smarter and harder, to achieve the planned activities and end each year with a small surplus. The CEO knows that this performance can’t last forever and has put forward a strategy to purchase a profitable event and conference management business. The business is well run and has values that are compatible with those of the organization. There may well be some synergies but the main rationale for the acquisition is to buy a dividend stream that can replace the falling donations.
The chairman is excited about the possibility and has exhorted the board to support the venture. He has also offered to make a sizable donation (giving now what he had planned to leave as a bequest in his will). The numbers have been thoroughly analysed and the venture certainly makes commercial sense but Erica is concerned that the board may be missing something. Is the opportunity really too good to be true?
Mark’s Answer
On the surface, I don't see any enormous red flags for Erica to be concerned about. According to the information we have the organization is performing a meaningful service and there continues to be demand for those services; but there is a funding issue in regards to the NPO being able to generate adequate funding to support their mission and operations.
The CEO has suggested the acquisition of a commercial or for-profit entity to support a funding stream and has located an organization that looks to be compatible from a "mission" and values standpoint. The Chair is so enthused about the project that he/she has expressed a willingness to accelerate a bequest to assist in the acquisition.
Here are some questions Erica should resolve before finalizing the arrangement:
- How will the costs of the acquisition effect the operations of the NPO in the short and long term? Is the "payback" immediate or will there be a period to "breakeven" or profitability?
- Does the organization possess the appropriate acumen and expertise to run this new enterprise successfully? My concern would be the diversion of energies from the core mission to the new enterprise while "learning" or operating the new entity.
- The Chair is obviously quite enamoured with this concept. Does he have a financial or other interest in the business being acquired? Why is this prospect so enticing that the Chair would accelerate contributions that he has previously been unwilling to consider?
- Are the organizational cultures compatible? I mean not just the values, but the systems and the human resource cultures. In many cases the business models used in NPOs and for profits are quite different. Could the new enterprise be run as an autonomous subsidiary and still deliver the revenue stream?
- What is the long term market outlook for the business? The revenue stream could be good short term, but.....
These are key questions that I would want to thoroughly examine prior to moving forward.
Mark Herbert is a Principal at New Paradigms LLC, Oregon, USA
Julie’s answer
This board presided over decreasing revenue for three years without developing an approved strategic response. It is no wonder they are now caught napping by the CEO’s proposed specific course of action. They should have set a strategic direction in advance of the proposal. However, they are where they are and must deal with that situation now.
The board needs a good cash flow projection to show how long they can survive under the current ‘decreasing donations’ scenario. This will establish how quickly they must move. The board should also investigate staff morale. Is rapid action required to retain key staff? NFP staff are typically loyal and motivated but if they have worked harder each year to deliver the desired performance without any sign that things will get better they may be thinking of leaving.
Next the board should evaluate their options. They need capital inflow. What are the pros and cons of getting it from a donation or bequest campaign as opposed to income from investments, government grants, fee for service within their own organisation, or a dividend stream from an acquired business?
There is nothing intrinsically wrong with a NFP company owning a for-profit enterprise but the board need legal advice to understand the implications for tax, staffing and other issues.
If an acquisition is made the management of the two entities must be carefully structured. The culture of the organisations is probably very different. The board must preserve the essential elements of each culture. Risks must be identified and managed.
It is normal for a Chairman and CEO to communicate more than a CEO and board. But an information disparity of this size and importance is not healthy. Erica should ascertain from the chairman when he knew of this opportunity and what else he knows that the rest of the board may not. The board needs to be brought up to speed and given some assurances that they will not in future be left out of a strategic discussion until such a late stage.
Whether or not they accept the CEO’s proposal the board need to wake up and do some work.
David’s Answer
There is nothing inherently wrong with a not-for-profit organisation investing any surplus cash in the shares of for-profit corporations. In substance, it is the same as any deposit of funds in an interest-bearing account to generate an income stream from otherwise idle funds, save that there is a risk of capital loss. Thus, the not-for-profit must be able to identify specific powers in their Memorandum & Articles or constitutive by-laws allowing them to make such investments risking capital loss. There may also be conditions attached to donations made to the not-for-profit organisation that might inhibit use of the donated funds in this way.
However, the nature of the investment changes if the not-for-profit proposes to buy a controlling interest in a for-profit company. Acquiring ownership is not the same as investing in shares. With ownership comes responsibility for management. Prima facie this will be incompatible with the status of a non-profit organisation. Even if there was an explicit power in the M&A permitting the acquisition and management of a for-profit business entity, there would have to be clear acceptance in the law of incorporation for this management function.
Vague synergies between the two organisations might not be enough. If the not-for-profit also had a charitable registration, there could be further problems if a part of the charity's function could be classified as for-profit. I make no comment on the CEO’s enthusiasm for a for-profit investment. Mindsets and motivations among those who run companies can be difficult to interpret.
David Marshall is Managing Director of Sirleafe Pte, a Singaporean registered company specialising in medico-legal issues.
DISCLAIMER:
The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances have been changed to ensure anonymity.
What’s new
Video tips – I occasionally present courses for IIR Executive Development. Together we have recorded a video of key tips for presenting to boards. Here is Part 1. Part 2 will be in the April newsletter.
Book review – Directors do a lot of reading. I keep a note of my thoughts on each book I read. Recently I have been reading books about entrepreneurs to help me understand the issues and characteristics of founding directors. Here is my review of The Boardroom Entrepreneur by Mike Southon and Chris West.
Where’s Julie? – A few readers managed to catch up with me on my travels and it was such a pleasure to meet them that I have decided to divulge my non-confidential travel plans each month. In March I shall be in Sydney on the 10th, in Sydney again from the 26th to the 30th and in Melbourne on the 31st. In April I’ll be in Canberra on the 2nd.
This newsletter – If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription. It is (still) free.
Suggestions for dilemmas – Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.
Be an expert – I will post the next dilemma on LinkedIn. If you would like to feature in April just log on to my Q&A and type in your advice. I will pick the best answers to be published in the next newsletter.
Farewell until next issue (due 1 April 2009). Enjoy governing your corporations; we are privileged to do what we do!
Best wishes
Julie
