The paucity of forced consolidation mechanisms in the nonprofit sector

As a longtime nonprofits lawyer, I have long been struck by the asymmetry between the not for profit sector and the for profit sector in the matter of takeover mechanisms. Essentially, the not for profit sector lacks any true mechanism for a hostile takeover - because it has no share ownership structure that is legally separate from the board and management of the enterprise, such that an outside acquirer could obtain control from the share owners against the wishes of the organization’s board and management.

I say ‘paucity’ rather than absolute lack of consolidation mechanisms for two reasons. One is that in the case of non profits that are about selling services for fees and income, albeit with a charitable purpose, such as a nonprofit hospital, there are indeed mechanisms at work that can force a board and management to have to merge, consolidate or otherwise be acquired. Moreover - and this is one of those mechanisms - it is possible that an organization can default and go into insolvency, which can also force a takeover of sorts. However, there are important issues in that case as to the disposition of charitable assets - one reason why lenders to nonprofits are typically careful to insist on precisely described secured assets, the seizure of which will not create issues of public policy or diversion of charitable assets. And in any case, if the reason a charitable organization has to seek consolidation or some other exit is on account of default or insolvency, the interests that are at stake are not the disposition of charitable assets as such, but the interests of creditors as such.

What I mean here, rather, is a mechanism by which a nonprofit organization can undertake a takeover, and in particular a hostile or unsought takeover, of another nonprofit. Not as a matter of insolvency acting as creditors, but for the specific social efficiency of having a mechanism (equivalent to the ability of outsiders to purchase stock ownership and hence control, without the permission of management and the board) by which nonprofit assets can flow into the most efficient hands and efficient uses. There is a nonprofit capital market of sorts; there is, however, no market for nonprofit corporate control.

Is this an inefficiency? An inefficiency in the sense that we would say would be the case if there were no market for corporate control in the for profit sector? A good question, in both a conceptual and empirical sense. I’ll leave that for now.

In a sense, true, there is a market for control in the nonprofit world in the sense that the upstream funders of nonprofits - the private foundations, the philanthropists, perhaps even the public - can refuse to fund and so put pressure on a nonprofit to merge or otherwise join with some other organization, or to reorganize to get rid of existing management and even the board. But I do not think this is the same thing as a market in control.

However, one effect of the asymmetry between the nonprofit and for profit world with respect to take over mechanisms is that there is a further asymmetry between mechanisms of consolidation and mechanisms of devolution in the nonprofit world: it is far easier, especially in world that consists almost entirely of human capital, for any player to set up a new organization. You can’t (very easily, anyway) force organizations to consolidate, but it is easy for them to splinter and create a raft of smaller, independent organizations. To the extent that there is a check on it, the check comes from the willingness or unwillingness of the upstream funding organizations to fund or not fund.

It might be that this asymmetry is efficient in the nonprofit world, in which human capital is everything and it is often hard to imagine that a fundamentally forced consolidation could work very well - maybe the good people leave and the bad people stay. But I’m doubtful this is any different from the for profit world.