​Trustee essentials: The pros & cons of loan finance

By Dec 16, 2015

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Good information enables good decisions, which is vital when it comes to financing charitable activities. Here are the key factors to take into account when considering loan finance.

In the right circumstances and with the right kind of structure, loan finance can help a charity to thrive and to have greater control over its future.

Trustees and management need to understand the opportunities and what is involved to determine whether it is a suitable option for their organisation.

So what are the key factors to take into account when considering loan finance?

The benefits

A loan can help organisations become more sustainable. For instance, it can allow you to buy a property rather than continuing to pay rent. This is one of the most common purposes for Charity Bank’s loans.

Loan finance can empower you to take advantage of new opportunities. It can help you to grow and expand your services, diversify your income streams, or make the most of a newly available opportunity.

Loan finance could help you accelerate your plans. Lenders can’t give you instant finance, but if the circumstances are right, a loan can be arranged within weeks. Grants can take much longer to organise, and are sometimes paid at the end of a project – rather than at the beginning, when you often need it.

Loans can help you to grow and increase your income. Borrowing to invest in a new activity that increases income can be a fast track to growth, with the additional income repaying the loan. In this way, loans can reduce reliance on grants and donations, while allowing you to broaden your range of services.

Loans can help bring in grants. Charity Bank’s recent social impact study revealed that 41 per cent of the organisations to which it has lent were able to leverage additional funds from sources such as local trusts.

One of Charity Bank’s borrowers, Towcester Museum, received a £50,000 grant from Heritage Lottery Fund (HLF) alongside other smaller grants as a direct result of its loan. A local group of people from Towcester spent 15 years campaigning to establish a museum and heritage centre for the town, which is one of the oldest continuously occupied settlements in Britain. Charity Bank provided the loan which helped the community’s hard-fought campaign achieve its goal. Towcester now has a thriving museum and visitor centre, providing somewhere for people to learn about their local heritage and get involved in educational projects.

Loans are non-restrictive. Grants are usually restricted to a specific activity or project. This tailors your charity’s work to the preferences of grant-making bodies – but a loan can give you more freedom. As long as your idea and your organisation are financially sustainable and deliver impact, you can choose the purpose for which you require a loan.

Loans can help smooth cashflow deficits. This can make it easier to plan and manage your finances. They can also be used to bridge receipt of retrospective grants or payments under service delivery contracts.

Loans don’t need you to compete. Unlike when you apply for a grant, you do not have to compete with other organisations when applying for a loan.

Talking to lenders can open doors. Simply talking to social lending experts can open doors: lenders know others in their field, and can often team up with partner organisations to offer blended funding packages. For example, a sports organisation was able to secure a £100,000 grant from a local trust which was identified by its social lender.

Things to consider

Whilst loans have many potential benefits it’s important to bear in mind the reputation of the lender as well as the cost, flexibility and affordability of a loan to make sure you make the right decision.

Loans aren’t suitable for all organisations. All responsible lenders will need to see that a loan is suited to your organisation, by looking at whether you can afford a loan.

A good social lender would require answers to the below:

The loan: ‘What will you use the loan for?’

Your impact: ‘Can you show you’re delivering social good?’

Your governance: ‘Who is running the charity, how long have they been there and does the team have the right skills?’

Your income: ‘Do you have diverse income streams and are they generating a surplus?’

Your plans: ‘How do you aim to sustain and/or grow your organisation over the coming years?

You’ll need to consider the cost of a loan. The price of a loan will usually include an interest rate and arrangement fee. Always check with a lender what fees are involved over the course of the loan so that you don’t get any surprises.

You’ll need to consider legal expenses. Borrowers are also required to pay for any legal and related expenses incurred (for example security valuation fees or costs associated with taking charges over property).

You’ll need to be sure you can meet the financial requirements of a loan. You can get a rough idea of whether you would be able to repay a loan by considering your ‘debt service cover ratio’, which is a measure of the cash-flow you may have available with which to make loan repayments.

This involves looking at the surplus income you have available, from any trading activities, rents and other unrestricted funding, to repay your loan. Once you’ve taken into account overheads, expenses and any plans to generate future revenue, do you or will you have enough surplus available to create a realistic plan for paying back a loan, that allows you to clear the debt as quickly as possible, or in a series of regular and affordable payments?

You’ll need to consider and mitigate risks. With any kind of loan finance there will always be an element of uncertainty. Good debt relies on a good business plan with mitigating actions to reduce risks and access to funds in case things don’t go to plan.

You can reduce risk by stress testing your plans against unexpected events and devising actions for best, difficult and worst-case scenarios? Read a guide to stress-testing your plans.

Not all lenders are the same. Taking out a loan is a serious commitment, so you want to make sure you trust that the bank lending to you will work with you side-by-side. It pays to do some research. Alongside the price of a loan, find out what people say about the lender. How flexible are their loans in adverse circumstances? Are they prepared to come and visit your project? Are they thorough in their assessments and responsible in their lending?

What next?

If you have considered your finances carefully and you’re confident your lender is taking a responsible approach to lending, loans can be a highly useful tool.