Advice: When and How Your Charity Should Borrow Money

The_Guardian.svgDo you represent a charity which is considering borrowing money to help reduce costs or perhaps as a means of securing effective streams? If so, this advice, which was originally published in The Guardian, might of use to you.

Ian Mansfield, Charities Aid Foundation

Borrowing is not a last resort: Lending should not be considered a last resort. Indeed, many occasions when this situation occurs result in the finance provider not looking favourably as the underlying performance has deteriorated and would struggle to support a funding request.

Trustees can be skeptical: In our experience, many financial directors have come from a financial background and recognise the importance of having alternative growth strategies and ways of achieveing these, including the use of finance. However, at trustee level, a significant number still hold the belief that being a charity means “we don’t borrow”. This can (and has) led to interesting discussions at board level that have resulted in changes of opinion within the charity and the belief that borrowing is bad. I think maybe executives are closer to market trends, while some trustees are a little further removed.

Things to consider before approaching a lender: A common pitfall is a charity requesting finance without a form of plan ie they have a need and have decided to borrow without thinking about the term of the loan, the type of loan (fixed/variable rate) or the impact of interest rate changes. Market research and forward planning for the service to be offered needs to have been quantified and evidenced for the lender to be comfortable and, more importantly, for the board to be comfortable that investment in this area is the correct path to follow.

David Hopkins, Charities Aid Foundation

Don’t view loans as an income stream: We as charities should never fall into the trap of seeing a loan as an income stream. Borrowing will work best ā€“ as suggested ā€“ where there is a clear and coherent strategy in place to use the loan to reduce costs or secure effective income streams rather than a bail-out mechanism.

The sector needs to talk about borrowing more: I suspect examples and case studies will be the way to shift the mood music here and the increasing coverage given to traditional lending and social investment in the sector will be important. I know, for example, our colleagues in CAF Venturesome have developed a good collection of case studies that have been useful in helping CEOs considering taking on a loan to make the case internally.

What you should include in your business plan: We look for a business plan. This will vary in complexity depending upon the size of the charity, but will fundamentally provide the background information on the borrower, what they want, what for, how it will be repaid, and alternative sources of repayment plus a sensitivity analysis to show “what if”. The plan should also include income and expenditure, balance sheet and cashflow actuals and forecasts. This can then be used to frame a discussion with the bank about the type of facility (for example, short or long, secured or unsecured) and the terms that are most appropriate.

Talk to other charities: Don’t fall into the trap of seeing a loan as a replacement for a grant. Test your financial assumptions as much as possible and, if possible, spend some time researching and talking to other charities that have walked the path you intend to as part of your process.

Helena Wilkinson, Price Bailey

Borrowing must be affordable and achieve your aims: There can be a significant downside if the borrowing proves to be too much and the charity is not delivering on its business plan and is struggling to meet any repayments. The pressure on the remaining charity’s resources, its management and reputational issues spring to mind. Therefore any borrowing needs to be affordable, based on sound principles and almost guaranteed to achieve.

Social investment is on the rise: More boards are starting to mention social investment, which is one form of borrowing, and how this can be apllied to them. The recent government consultation on the introduction of a new tax relief to encourage investment in social enterprises, with a view to introducing legislation in the finance bill 2014, may open up the level of future borrowing in charities as a result.

Make sure your constitution allows for borrowing: The charity and trustees need to look at their constitutions to see if they have the appropriate authority in their governing document regarding loans, mortgages or borrowings and whether they are any restrictions imposed. They may not be allowed to borrow even if they wish to without first updating their constitution.

David McHattie, Barclays

The climate is changing: With the increasing move to commercial contracts with payments in arrears, away from upfront payment of grants, there is an increasing working capital requirement in the charity sector. Some of these needs can be met from charity reserves, but these are increasing in size and scale, leading to a number of charities seeking working capital facilities similar to corporates.

Reema Mathur, Stone King

Put your decisions on record: Look at bank borrowing as one of the financing options available, and discuss and record the reasons why trustees decide that borrowing is the best option for the charity.

Nigel Morrison, Grant Thornton

Smaller charities can still seek internal financial advice: If the charity does not have a financial expert on its board or at its disposal, then the auditors or solicitors would be an obvious starting point where objective professional advice will be available to the charity.

Charities will be treated like for-profit organisations: In my experience banks will approach a request from a charity in the same way they would if it were a for-profit organisation. I think this fact may sometimes come as a surprise to trustees. It is also clear that banks have increased the scrutiny they apply to lending requests and this again applies as much to charities as any other sector ā€“ the bar has been raised and charities need to react accordingly.

Article originally published in The Guardian, 1 October 2013.

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