Expert Advice: When and How Your Charity Should Borrow Money | Voluntary Sector Network
Borrowing is not a last resort: The loan should not be seen as a last resort. Indeed, on many occasions when this situation occurs, the financing provider does not look favorably on because the underlying performance has deteriorated and would find it difficult to support a request for financing.
Trustees can be skeptical: In our experience, many CFOs come from a financial background and recognize the importance of having alternative growth strategies and ways to achieve them, including the use of finance. However, at the trustee level, a significant number continue to believe that being a charity means “we don’t borrow”. This can (and has) led to some interesting discussions at board level that have resulted in changes of opinion within the charity and the belief that borrowing is wrong. I think executives are perhaps closer to market trends, while some directors are a bit further away.
Things to consider before approaching a lender: A common pitfall is that a charity asks for funding without a plan, i.e. it has a need and has decided to borrow without thinking about the length of the loan, the type of loan ( fixed/variable rate) or the impact of interest rate changes. Market research and forward planning of the service to be offered must have been quantified and documented for the lender to be comfortable and, more importantly, for the board of directors to be convinced that the investment in this area is the right way to go.
David Hopkins, Charities Aid Foundation
Do not consider loans as a source of income: As charities, we should never fall into the trap of viewing a loan as a source of income. Borrowing will work best – as suggested – when there is a clear and consistent strategy in place to use the loan to reduce costs or secure efficient revenue streams rather than a bailout mechanism.
The sector needs to talk about borrowing more: I suspect examples and case studies will be the way to change the mood music here and the growing coverage of traditional lending and social investment in the sector will be important. I know, for example, our colleagues from CAF Venturesome have developed a good collection of case studies that have been helpful in helping CEOs considering taking out a loan to make their case internally.
What you need to include in your business plan: We are looking for a business plan. This will vary in complexity depending on the size of the charity, but will basically provide general information about the borrower, what they want, why, how they will be repaid and other sources of repayment, as well as an analysis of sensitivity to show “what if”. The plan should also include income and expenses, balance sheet and actuals, and cash flow forecast. This can then be used to frame a discussion with the bank about the type of facility (eg short or long, secured or unsecured) and the most appropriate terms.
Talk to other charities: Don’t fall into the trap of seeing a loan as a substitute for a grant. Test your financial assumptions as much as possible and, if possible, spend time researching and talking to other charities who have walked the path you intend to take in your process.
Borrowing should be affordable and achieve your goals: There can be a significant downside if the loan turns out to be too high and the charity fails to stick to its business plan and struggles to meet repayments. Pressure on the charity’s remaining resources, its management and reputational issues come to mind. Therefore, any borrowing must be affordable, based on sound principles and almost guaranteed.
Social investment is on the rise: More and more councils are starting to mention social investing, which is a form of borrowing, and how it can be applied to them. The government’s recent consultation on the introduction of a new tax relief to encourage investment in social enterprises, with a view to introducing legislation in the 2014 finance bill, could accordingly open up the level of future borrowing to charities.
Make sure your constitution allows you to borrow: The charity and trustees should review their constitutions to see if they have the appropriate authority in their governing document with respect to loans, mortgages or borrowings and if any restrictions are imposed. They may not be allowed to borrow even if they want to without first updating their constitution.
The climate is changing: With the increasingly frequent shift to commercial contracts with payment arrears, away from the initial payment of grants, the need for working capital is increasing in the charitable sector. Some of these needs can be met from charitable reserves, but they are growing in size and scale, leading a number of charities to seek working capital similar to that of businesses.
Record your decisions: Consider bank borrowing as one of the funding options available, and discuss and record the reasons directors decide that borrowing is the best option for the charity.
Small charities can always seek internal financial advice: If the charity does not have a financial expert on its board or at its disposal, auditors or lawyers would be an obvious starting point where objective professional advice will be available to the charity. charity.
Charities will be treated as for-profit organizations: In my experience, banks will approach a request from a charity the same way they would if it was a for-profit organization. I think this fact can sometimes surprise trustees. It is also clear that banks have tightened the scrutiny they apply to loan applications and this again applies to charities as much as any other sector – the bar has been raised and charities need to respond accordingly .
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