Taking on Debt for All the Right Reasons

Did your parents teach you to never buy anything on credit — or at least try? Avoiding debt is almost always good advice. But borrowing money can be a smart solution if it’s used for the right reasons. Sometimes it might even catapult an organization from a tough financial situation.

Is borrowing necessary?

Emergencies and unforeseen problems happen. Roofs leak, donors pull away, fund-raisers are canceled — and sometimes it may be weeks or months before you receive grant money. A loan can be a quick source of cash to handle such unanticipated situations.

There also are times when an organization just needs to stabilize its cash flow. Frequently, nonprofits must bridge the gap between a project’s startup and its ongoing program revenues.

Other not-for-profits need funds at different times of the calendar year than their funders’ grant schedules dictate. Still others need a line of credit to have a steady source of cash between billing and collection. Borrowing for short periods to stabilize cash flow can help keep your organization running smoothly.

When does borrowing make sense?

A capital purchase is another situation when borrowing money may be justified. Say that your copier breaks down or you’ve outgrown your office or warehouse space. Taking on a loan for “big ticket” capital purchases provides an immediate source of cash that can be repaid over time. It avoids the time and cost involved in writing and waiting for a grant, and it keeps you from depleting your carefully built cash reserves.

A not-for-profit occasionally needs to take advantage of an opportunity. A local food pantry, for example, has an opportunity to start a hot lunch program and will receive funding based upon the number of meals served.

But to meet health department requirements, the pantry must purchase a commercial stove. This could be an opportunity of a lifetime that could expand the organization’s income and diversify its services. But if there’s no time for grant proposals and your group doesn’t have the money in its savings account, financing can make it all possible.

Where can you find loan money?

Banks are still the primary source of loans for nonprofits, so it’s always a good idea to build a relationship with a banker who understands your industry. And in larger banks you’re apt to find associates who specialize in services to nonprofits.

But you may be able to find a low- or even no-interest short-term loan program somewhere other than a bank. Some community-based foundations provide funds that allow not-for-profits to continue operating until they receive contract monies. The Cash Flow Loan Program, created in 1976 by the Fund for the City of New York, is the granddaddy of them all, but there are many others.

How can you secure a loan?

Applying for a loan doesn’t require any more time or skills than writing a grant or contract proposal. In fact, it may be easier. But you must demonstrate your ability to repay.

First, apply at the right time: Your chances to negotiate are better when you’re in a position of financial strength. Consider establishing a line of credit with a local bank when you don’t need to draw on the funds.

When talking to the banker, be specific about how the loan will be used. Thoroughly describe the proposed project, your readiness to launch the project and its timing. Be prepared to specify the amount you need to borrow and the date you’ll need the loan.

What will you need to provide?

Come prepared for your meeting with the lender. Be ready to present your organization’s budget, a current and accurate statement of financial position, prior statements of activities, cash flow projections, and an annual report if you have one. And keep in mind that lenders want to know who your executives and board members are so they can judge the management strength of your not-for-profit.

To protect their interests, banks may expect you to secure the loan with collateral, which is generally based on contracts and accounts receivable. But they also may require assets such as unencumbered real estate, automobiles or equipment. You might need to produce cash collateral from board members, supporters or constituents — who place an amount of money into a special interest-bearing account, which is pledged to the bank. Another scenario: Instead of collateral, the bank may ask you to have a co-signer or guarantor of the loan.

Be careful

Borrowing money should only be considered in the right circumstances. But, if you believe it’s the correct step for your nonprofit, examine interest rates and loan terms carefully before jumping in.