Should your nonprofit take out a loan?

Debt is an integral part of many for-profit companies’ strategic plans, yet it has traditionally carried a stigma in the nonprofit world. That view is changing, as more organizations borrow money for major capital purchases, new program funding and other reasons. But before your nonprofit borrows, it’s important to understand that it takes prudent financial management and reliable donor support to pay back a loan.

Exhaust other options

You may think your organization has a good rationale for borrowing, but that doesn’t mean lenders — or even your supporters — will agree. One of the primary criteria watchdog groups such as Charity Navigator and CharityWatch use to evaluate nonprofits is the percentage of available funds spent on programs. If a large portion of your budget is tied up in debt repayment, that’s likely to affect how the public, including prospective donors, perceives your organization.

What’s more, lender covenants may prevent you from borrowing for other purposes — and thus limit strategic flexibility — until your existing debt is paid off. And debt makes periods of economic uncertainty that much more challenging. So it’s best to exhaust other funding sources before applying for a loan.

Are you prepared?

Even if you determine your nonprofit can handle the risks of borrowing, you need to make your case to lenders. Before approaching a lender, make sure you have:

• A realistic repayment plan
• Current financial statements and up-to-date cash-flow projections
• Collateral to secure the loan
• A proven history of prudent financial management
• The support of your board of directors

The odds of qualifying for a loan are better if you’ve already established relationships with lenders. Your reason for applying also plays a big part in the decision. Seeking money to make a major purchase or to stabilize cash flow (with a line of credit) is more likely to be successful than applying for a loan to start a new program.
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