Inspired by a recent Better Business Bureau of New York City panel discussion on non-grant funding for mission-driven organizations, I am devoting this newsletter to the opportunities and challenges associated with revenue from loans (the discussion was sponsored by Seachange Capital Partners). Loans continue to be by far the largest source of non-grant revenue for nonprofits, making them a worthy topic for discussion.
Types of Loans
There are many different kinds of loans, from project finance and mortgages to working capital and lines of credit. Many different types of lenders make loans to nonprofits, from the obvious ones, like banks and community development financial institutions (CFDIs), to the less obvious, like board members and foundations. For many nonprofits, borrowing is a dirty word, and leaders do not take advantage of the funds available to them. Many nonprofits get lines of credit and then don’t use them, only to find that the lines have been canceled because they were not activated.
Loans Require Collateral
What loans have in common is that they require collateral to protect the lender in case the loan is not repaid. Collateral could be a solid asset, like a building. It could also be an unrestricted endowment or funds in reserve. Endowments and reserves presume a solid, larger nonprofit that has been in existence for some time and has a track record of good fiscal management. The purpose of the loan is not to pay this month’s rent or salaries but to finance a new project or get through a period where revenues have been earned but not paid.
To Lend or Not to Lend? That Is the Question
What makes lending tricky for smaller nonprofits is that they can be tempted, under stress, to use future revenues, like gala income or donor pledges, as collateral. Things have not been going well, and the board and executive director are desperate to keep the organization running.
This situation should be a big red flag for the organization’s stakeholders. Even if a board member agrees to make a loan, the board should think hard before accepting it. Without a thoughtful plan for fixing the issues that underlie the lack of financial stability, the loan is at best a stopgap measure.
Most traditional lenders put an organization through a series of tests before making a loan. It is the non-traditional lenders, like board members, who can follow their hearts, not their heads, and make a loan when perhaps they should not.
Think Carefully Before Going Down the Borrowing Road
Loans can be a great source of funding for nonprofits but also a dangerous trap. Think carefully before going down the borrowing road.