How to Prepare Your Nonprofit for a Bank Loan or Line of Credit
Nonprofit organizations often come up empty-handed and frustrated when their attempts to borrow funds or establish a line of credit from a bank hit multiple roadblocks. This can lead to delays and, at worst, being denied or outright blocked from starting the application process. Using a business-like approach to planning and having regular meetings with your bank representative is the best way to avoid these outcomes.
Nonprofit finance executives need to assume upfront that the borrowing process will be more difficult and time-consuming than expected. They may have to work harder than other types of businesses to be approved for a bank loan or line of credit because borrowing is not necessarily an expected part of a nonprofit organization’s business model. As frustrating as this could be, nonprofit executives should step back and take the time to assess their approach to bank financing now in anticipation of meeting possible future needs when they may arise.
Like many efforts in the financial world, when it comes to borrowing funds from a bank it is best to:
Consider safety early in your planning process;
Set conservative expectations; and
Communicate thoughtfully.
All meetings with your bank representative should be approached through the lens of these three factors.
Considering safety
Most will not think of safety as a key financial risk factor for successfully borrowing funds, but it is extremely important. Building a financial safety net is an ongoing process that includes strategic planning, scanning the business horizon, and building strong and ongoing relationships with financial partners, especially banks. The risk comes from starting the process too late based on current needs vs. planning as part of long-term risk assessment and future financial management planning processes. Risks tend to be highest when a critical outcome is taken for granted and not evaluated as part of regular risk management planning practices.
A direct parallel can be drawn from the decision-making process for purchasing additional insurance coverage. The best time to consider increasing insurance coverage is before you need and must have the coverage. For example, planning for adding insurance for a new program well before the program starts (community center adding a swimming pool to its facilities). Front-end planning discussions with your insurance broker will go a long way towards partnering to find the best solutions to balance risk management and cost.
Nonprofits often have a more regular business relationship with their insurance broker than with their banker. But, as banking professional Maria Georges says, “it is never too early to start the process to qualify for a bank loan.” It is important to establish a strong business relationship with your bank that includes regular sharing of financial information and discussions of your plans for future operations.
This effort will be invaluable. You will be surprised by the amount of useful information received and, at the same time, you will be raising the bank’s trust and confidence in your organization. When the time comes (and it will) for adding additional banking services (loan, letter of credit, line of credit, etc.), the bank will be more inclined to provide these services than if you unexpectedly approach your bank with a last-minute surprise request out of desperation.
Setting conservative expectations
The chances of future success are better when expectations are conservative, and surprises are minimized. Conservatism is intended to temper expectations in budgets, forecasts, and operational planning while presenting a balancing act between overestimating risk vs. overstating optimism. For nonprofit organizations, setting conservative expectations means staying alert to changing circumstances and having plans in place for when conditions change. This approach helps to mitigate risks as well as to take advantage of opportunities that may arise in the future.
As mentioned above, the time to start having regular meetings with your bank and discussing additional banking services like bank loans is well before the need arises. What is the best approach for these meetings? Maria Georges suggests treating meetings with your bank representative as an opportunity to “explain how you run your nonprofit like a business.” At these meetings provide regular updates on current as well as expected “business” outcomes, leaning more on your “business” model and less on the mission of the organization. Make sure to highlight:
The business climate for your industry, constituents, funders, and causes you represent.
How funding streams are changing and your expectations for future budgets.
Any operational and business management changes.
Your business strategic plan and expectations for the future.
Banking services you may need down the road, emphasizing why you may need those services, the anticipated timing for acquiring those services, and (for bank loans and lines of credit) how you would manage the loan proceeds, use, payment of interest, and repayment of principal.
Being realistic and conservative with your expectations and using a business-like approach will give the bank a convincing sense of the organization’s business model and financial position without overstating outcomes.
Communicating thoughtfully
Careful planning and the regular sharing of those plans are the most important priorities. This is especially true for plans that may require future bank loans (not only for expansion and new programs but also for bridging temporary funding disruptions or seasonal funding gaps). How you document these plans and share that information with your banker will be a key factor in successfully navigating the loan application process.
Consider developing a written business plan for a loan just like a for-profit business would prepare. As with a strategic plan, a business loan plan includes a broader vision than a single fiscal year and should be adaptable to incorporate changing conditions and align with regular financial reporting updates. The plan should be well-written and include financial details sufficient to demonstrate to the bank that the loan is a good option for both the bank and the nonprofit.
The meetings with your bank representative are a good opportunity to make sure you understand the bank’s compliance requirements, minimum qualifications (both at the beginning of the process and throughout the loan term), types of financing options, and the financial reporting the bank will need.
Be prepared to discuss the nonprofit’s operational business model, funding and revenue cycles, strategic vision, and risk tolerance. Explain the type of financing the organization may need, for example whether you need asset or project specific funding such as acquiring a program from another nonprofit or expanding the headquarters facility vs. a revolving line of credit to bridge seasonal cash flow gaps in funding.
Make sure to communicate internally all bank loan compliance requirements and how these may impact future budgets (interest expense, cash flow budgets, indirect costs, surpluses, deficits, etc.) and the balance sheet (liabilities, operating reserves and net assets, liquidity, quick asset ratio, etc.). This should include discussions with the senior management and appropriate staff, and governance discussions (Board, finance committee, and audit committee) related to approval and oversight requirements over the life of the loan.
Planning Tip – Internal accounting control systems (IACS) need to be updated before starting the process to procure a bank loan or other form of financing. Procedures should be divided into two groups. The first group is a set of procedures for acquiring a new loan, including documentation showing the purpose of the funds and any limitations on use, management and Board approval requirements, maximum loan amount, and disclosure of key loan fulfillment requirements. The second group is a set of procedures for managing the loan internally, meeting the loan’s fulfillment and purpose requirements, and providing the Board with reporting information to enable Board members to fulfill their fiduciary oversight responsibilities.
Borrowing funds is never an easy process. Without early planning and tempering expectations, mistakes are more likely to be made. This can hinder an organization’s ability to borrow and potentially damage its good reputation. Thinking about how bank financing maybe be needed in the future, developing a business plan for bank borrowing, and communicating those plans through regular meetings with your banker will greatly improve planning, enhance confidence and trust, and raise your organization’s chances for success.
