People working in mergers, like many others working in specialised areas, have developed jargon: shorthand for common processes and concepts that is helpful to those ‘in the know’ but intimidating for those unfamiliar with the activity. Much of it also applies mainly to the private sector and is not always easy to translate to a non profit context. What follows is a quick demystification of some common merger jargon.
Economies of scale and of scope
When people talk about reasons for merging organisations to create a single larger organisation the rationale usually includes cost savings, often described as resulting from economies of scale.
Economies of scale are factors that allow for a reduction in the average cost of delivering a service or making a product as the level of activity increases. This is possible because the same investment in fixed costs (salaries and other overheads) can support the creation of an range of outputs.
In the following simple example the fixed costs for supporting the production of one, two or three new theatre shows are the same (£9,000) but as the number of shows increases the deficit becomes break even and then a surplus.
| One show | Two shows | Three shows | |
| Box office income | 7,500 | 15,000 | 22,500 |
| Costs of production | (3,000) | (6,000) | (9,000) |
| Contribution to overheads | 4,500 | 9,000 | 13,500 |
| Overheads | |||
| Salaries etc | (6,500) | (6,500) | (6,500) |
| Other | (2,500) | (2,500) | (2,500) |
| Total | (9,000) | (9,000) | (9,000) |
| Surplus/(deficit) | (4,500) | 0 | 4,500 |
Economies of scope are less often discussed but are also important. They arise when it is cheaper to produce a range of products together rather than producing each one on its own. Factors leading to economies of scale could include.
- Sharing back office functions such as finance or marketing
- Opportunities for cross selling – a merger of a theatre and a museum in the same town might create opportunities for the sale of exhibition tickets to theatre goers and/or the creation of a combine cultural offer for out of town visitors
- Using the outputs from one business as inputs in another such as the merger of an FE/HE provider of vocational training with a gallery or theatre
Note of caution: when we have been involved in supporting the assessment of the possible gains of a merger we have often been unconvinced by the hoped for cost savings but have also seen the benefits of being able to build capability through the employment of more skilled staff and the use of better systems.
Due diligence
It has been our experience that the need for due diligence is one of the questions that crops up early in merger conversations.
Due diligence is the mutual, legal and financial exercise which uncovers information an organisation would need to:
- Assess the feasibility of the other party to merge
- Provide detail about the other organisation’s assets and liabilities
- Identify any obstacles which might stop or delay merger.
This exercise helps to assure trustees that a merger is in the best interests of their organisation. (NCVO, 2020)
Due diligence is an essential part of any merger but it can become quite a headache for two reasons.
- It requires the exchange of substantial quantities of confidential information; issues of trust and logistics often arise. These can be dealt with by good planning and phasing – you don’t have to exchange everything at once – and the creation upfront of a good confidentiality or non-disclosure agreement (there are good templates online that you can adapt).
- Uncertainty about when and how to involve external advisers such as lawyers and accountants and concerns about the resulting costs. You are likely to need external advice on some matters but, if you have access to some expertise (staff and/or trustees) it is usually good to identify the issues that you want external advisers to look at rather than just ask them to take over your due diligence process wholesale.
NCVO has a good summary of the issues around due diligence and they are currently making their resources free to all.
Post-merger integration (PMI)
Post-merger integration is a catch-all title for all the work that you will need to do after a legal merger has been effected to bring the predecessor organisations together to create one new organisation. It is the work that will determine whether your merger succeeds in achieving the goals set for it and delivering value or not. It includes a wide range of activities from across the organisation including bringing staff teams together, creating common systems, launching and embedding a new brand and identity, promoting the new entity and building a new governance team.
Boston Consulting Group suggest the following framework.
Transfer of Undertakings (Protection of Employment) Regulations 2006 (usually referred to as TUPE)
When employees are transferred from one company to another, as will happen to at least one group of employees in a merger, the law requires that their employment terms and conditions transfer and that their continuity of employment is maintained. If the new merged entity wants its staff to have different terms and conditions, possibly as part of a harmonisation scheme (see below) they will need to negotiate with the affected employees.
This is most likely to be a significant issue in the following situations.
- The terms and conditions of the merger partners are substantially different either wholly or in specific functional areas.
- Employees are being transferred from a public sector organisation (local authority, education, university etc) or have been transferred from such an organisation in the past, for example into an arts and culture trust spun out from a local authority. The rights of such employees are usually significantly more generous than those routinely granted to employees of stand-alone charities.
Harmonisation of terms and conditions
In a TUPE situation, legal experts often remind employers that normal rules about varying contracts don’t apply. It’s not enough that employees protected by TUPE agree to proposed variations, even favourable ones. Any variation brought about because of a transfer could be ‘void’, without legal force – which could lead to difficulties further down the line if an employee raises a later objection about what’s been agreed. (ACAS)
Harmonisation refers to the process of reaching a common set of terms and conditions for all staff of the new entity. In normal times, harmonisation is more likely to lead to an improvement in terms and conditions for most staff than a reduction. It is often a long and complex process as all terms and conditions will need to be considered and dealt with. Unless the merged organisation is small and/or the inherited terms and conditions are very similar, it is usually wise to seek external HR support.
Harmonisation can lead to staff members having different terms and conditions for a long period, for example if the new organisation grows and employs people over time on different terms and conditions to those staff covered under TUPE. Harmonisation after a transfer is unlawful. If you want to change the terms and conditions of transferred employees, you would have to have an economic, technical or organisational (ETO) reason for the change. This means that there has to be changes in the actual numbers of staff employed or in the work performed by the people concerned. Suffice to say this is complex area and you should seek appropriate legal advice.
A merger map
Next week we will share a map of a ‘typical’ merger journey and do get in touch if you there are specific merger related areas it would be helpful for us to cover.
Susan and Dawn