Much has been written about mergers and acquisitions within the nonprofit and charitable sectors. Many have explored these mergers’ pros and cons, and there are toolkits to guide leaders who are considering whether to merge their organization with another nonprofit. However, with few exceptions, much less has been written about acquisitions of for-profits by nonprofits and charities. Given recent trends in demography, business turnover, and the movement for more social enterprise, the time is ripe to consider this option. This sort of acquisition can open up much-needed opportunities for small businesses across North America to become enduring assets for our communities, while strengthening the charitable sector.
It’s often difficult for smaller family business to find potential buyers when younger generations are not willing to take over, especially if the business is located outside a major urban center. Private equity firms may not be interested, and merging with a competitor may not be a viable option. In response, some specialty private equity firms, such as Lynx Private Equity, target smaller firms because of their lower valuations. Nonetheless, many business owners ultimately have to wind down their operations, destroying years of hard-built value in customer relationships, existing processes, and employment in their communities. These kinds of losses are set to grow. For example, a 2016 survey of 600 business owners found that 29 percent plan to leave their business in the next 5 years, rising to 54 percent over the next 10 years.
Meanwhile, more charities and nonprofits are becoming interested in exploring the creation of social enterprises. Often, these organizations are motivated by a desire to diversify their revenues and reduce dependency on grants, especially as philanthropic resources become more competitive. Other organizations see engaging in social enterprise as a means to support vulnerable populations by providing a much-needed, innovative product or service, or by providing targeted employment.
Creating a social enterprise most often means launching a new business. Making that business profitable can be a long and challenging process—if it succeeds at all. In Canada, where both authors are based, around 85 percent of businesses survive their first year, but fully one in two will have failed within five years. Importantly, failure rates decline as businesses mature. So rather than go through the process of building a new business with the intent to generate profits to support a social mission, why not consider a pathway that leapfrogs the startup stages? By acquiring established, operating businesses from owners looking for succession, nonprofits across North America can acquire cash-flow-positive businesses with established processes and pre-existing customers.
Big Brothers and Sisters of the Okanagan (BBBSO) provides an example. In 2012, as BBBSO leaders looked at their budget, they knew that they needed more revenue to support growing demand for the social and emotional learning programs the organization delivers to children through the interior of British Columbia, Canada.
BBBSO’s revenue model was already atypical; most of its revenue was already being generated from a social enterprise partnership, in which BBBSO collects used clothes and household items from the community and sells them to Value Village, a chain of used-clothing shops operating in the United States and Canada. So its leaders, looking for opportunities to leverage the organization’s existing strengths, were naturally drawn to a for-profit clothing-recycling business in Alberta (a neighboring province) that had nearly the same business model as the one BBBSO was already using. The board of directors made the courageous decision to buy the for-profit business and roll it into BBBSO’s nonprofit social enterprise.
The terms of the agreement were intended to reduce risk for BBBSO. The business’s former owner agreed to stay in a leadership role for a period of time to help reduce transition costs. What’s more, BBBSO made only a relatively small payment up front; the rest of the cost of the business would be paid out of revenue earned in subsequent years of operation. And finally, one of the terms of the sale was that the payments would be reduced if the business did not perform similarly to how it had been running under the previous owner.
The new business has continually contributed revenues to BBBSO. This, among other changes, enabled the organization to increase the number of children it serves from fewer than 1,000 at the time of the purchase to more than 3,000 per year.
The BBBSO has gone up a steep learning curve, dealing with increased organizational risks stemming from the purchase. Integrating a for-profit company into a nonprofit has compelled the organization to evolve its culture and develop new skills. In the months leading up to the decision and in the years after the purchase, BBBSO dealt with a number of challenges, including:
- Purpose: Why would this step be good for the organization (profit vs. impact)?
- Commitment: Is our staff and board ready to run a business? Are we missing any skills on the team?
- Demand: What will the market bear? Who are the customers? What is the business’s growth potential?
- Risk: What impact will this business have on the organization’s existing activities?
- Control: What type of governance structure will be needed to support the business?
- Capital: How will we finance the deal, and what will our ongoing capital needs be?
- Partner: What type of partner will be able to help us add revenue, reduce cost, reduce risk, and add impact?
First steps for nonprofits, governments, and philanthropy
This opportunity is real, and the benefits can be significant, but the challenges are also considerable for interested organizations. In many cases, for example, a nonprofit will need to take on debt to buy out existing owners, even if they are community-minded and set the price accordingly. Banks and credit unions may be unwilling to take on the lending risk on their own. And many nonprofits will need targeted technical assistance to help connect with willing business owners.
Organizations interested in exploring this strategy should consider connecting with their local Business Improvement Areas and Chambers of Commerce, to increase their understanding of the local business environment. They should also consult with their local small business center (if one exists) to begin planning and networking with the leaders of small businesses who may be thinking of selling and retiring. Finally, they should start connecting with organizations such as their local credit unions and other community development financial institutions, to build relationships and support for potential financing in the future.
Progressive governments can help by offering targeted credit enhancement programs to mitigate the risk of lending to nonprofits seeking to acquire existing businesses. They can also fund existing innovation and business support centers that have the capacity to champion, market, and support these opportunities to interested nonprofits and business owners. Impact investors, especially mission-based institutions such as community foundations, can also step up; here is a way to make their dollars go further by creatively deploying guarantees or more catalytic capital to enable these transactions to move forward. These are opportunities to strengthen existing grantees, while encouraging a more entrepreneurial and diversified social sector.
By supporting a vision of small businesses throughout our communities owned by and strengthening the non-profit sector, we can ensure that these businesses, often the heartbeat of main street, continue to strengthen their communities for decades to come.