Debt can be a powerful tool to achieve your nonprofit’s goals. As a lender and nonprofit ourselves, we’ve seen firsthand how nonprofits use debt strategically to advance their missions and contribute to the well-being of their communities.
The series below distills NFF’s 40+ years of lending experience into brief, easy-to-follow videos to help you decide if debt is right for you, how to successfully apply for loans, and how to manage debt to achieve positive impact for your community.
Don’t have time for these videos? Then just remember these key best practices:
- Know why you are choosing to pursue debt financing, how it supports your mission, and how it fits into your larger financial strategy.
- Remember that taking on debt requires consistent and accurate financial monitoring, reporting, and communication.
- Be prepared to meet the terms of a loan before deciding to enter into any agreement.
- Talk to your lender and ask questions throughout the process.
Want to learn more about our lending process? Check out the Important Steps in NFF’s Lending Process video series.
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The Basics of Taking On Debt
What Is Debt?
In this video, we define debt as a financial tool for nonprofits – both what it is and what it is not. We also name some reasons why nonprofits borrow money, as well as different types of debt products available to organizations, including the needs each can help fill.
Transcript
Welcome to the first video in Nonprofit Finance Fund’s series: A Beginner’s Guide to Debt for Nonprofits. In this series, we will share information about debt relevant to first-time, nonprofit borrowers, including how debt can be used as a powerful tool to achieve your organization’s goals and deliver on your mission. As a lender and nonprofit ourselves, NFF sees firsthand how nonprofits use debt strategically to deepen their impact.
This series pulls from our 45 years of experience lending to nonprofits, including ways to know if debt is the right for your organization, how to successfully apply for loans, and how manage debt well so that it helps achieve your objectives. In this first video, we will define debt as a financial tool for nonprofits – both what it is and what it is not. We will name some reasons why nonprofits borrow money, and talk about different types of debt products available to organizations, including the needs each can help fill.
So, what is debt? At its most basic level, debt is money that is borrowed which needs to be paid back to a lender at a predetermined and agreed upon time. But, thinking more conceptually, debt is just a financial tool – that takes the form of a loan – which many nonprofits will utilize to deliver on their missions and deepen their impact.
It is crucial to remember that debt – or a loan – can never replace critical pieces of an organization’s business model – like revenue! Debt must always be paid back, so it can never be used to replace revenue.
Rather, debt can support issues related to the timing of revenue coming in. For example, debt is a good financial tool for nonprofits when they do not have the money needed for something today, but they know that money will come in in the future. For example, a human services nonprofit might use a loan to bridge delays in payments from a reimbursement-based government contract. Or a nonprofit theater might use a line of credit to cover payroll through seasonal lulls. In both cases, the nonprofit knows this revenue is secured and will come in – they just know it’s not available today. Debt is a useful tool to bridge gaps and avoid interruptions in program service delivery.
With that said, we also note that good uses of debt should always be attached to the mission – if it’s not helping you achieve your mission, even indirectly, it’s probably not the right tool.
That’s why we also want to be clear about what debt is not. Debt is not a grant, and it’s not revenue! We recognize that many nonprofits’ first loan was through the Paycheck Protection Program (PPP) during the COVID-19 pandemic. Many organizations had PPP loans forgiven, but this is atypical and uncommon for most loans. So, we want to state early the ways that loans and grants are different – because in some ways the PPP blurred the lines.
First, let’s look at how debt is similar to a grant.
- Both grants and loans require building and maintaining a strong relationship with the funder or lender. It’s really a partnership between both parties.
- And that is done by establishing a good flow of information with open communication – both from you as the borrower to the lender, and from the lender to you. This can help build trust, which strengthens the relationship.
- Though it’s worth noting that, for most loans and grants, more information tends to flow from borrower to lender. This is to say, it’s critical to always ask questions to lenders around all components and requirements of debt so that you’re clear about its terms and are confident that you can pay the full loan back on time.
So then, let’s see how a loan is different than a grant.
- This might seem obvious, but … A grant is a gift from a funder and doesn’t need to be paid back, but a loan DOES need to be paid back! While a grant is considered income and appears on the income statement, debt from a loan is a liability that appears on the balance sheet, which is a financial statement that shows everything your organization owns and owes.
- Another key difference is that loans also have costs associated with them, like interest and other related fees – while grants usually do not. So it really does cost money to borrow money! This doesn’t mean it’s not worthwhile to take out a loan, it’s just something to be aware of and plan your financial management around through the duration of the loan repayment period.
- Reporting will also look different between grants and loans. While grant reports tend to be primarily narrative, loan reports due back to lenders are usually more oriented to your finances, like monthly or quarterly income statements, balance sheets, or other financial documents.
- So while a grant officer may focus their reporting due diligence questions on the impact of your program or programs, a loan officer is typically more interested in understanding your numbers as a means to assess the org’s ability to pay the loan back in full, and on time.
- Lastly, we all know that simply qualifying for a grant based on its criteria never guarantees that you will get awarded that grant. Conversely, if you meet the lender’s criteria, then, generally speaking, you’ll get the loan. This means a lender determined that your loan is likely to be repaid, so there’s usually little reason they’d deny the loan application (We will talk more about lending criteria later in the series). CDFIs – like NFF – also assess loan applications based on their ability to benefit your org and your mission – not just your ability to repay it. More traditional lenders may be solely focused on your ability to repay.
You might be wondering why an organization would borrow money if it has to be paid back. Essentially, borrowing money can fulfill a specific need that can’t be met from other funding sources.
- One reason nonprofits borrow money is that it can provide orgs with working capital they need to operate, grow, and manage risk. Working capital is money that every organization needs in order to cover its regular, day-to-day expenses.
- Working capital loans provide organizations with faster and more reliable access to cash, as compared to grant or contract revenue – which may not show up in your bank account as cash until weeks or months after you have incurred the related expenses.
- Working capital loans can help organizations manage swings in revenue. For example, debt can help bridge the gap in covering regular expenses – like payroll – during points in the year when cash tends to be low – perhaps due to a busy schedule of summer events, with higher related expenses and lower available cash in those summer months.
- A nonprofit might also borrow money for equipment purchases or large projects that cannot be covered with grants and revenue alone. This might be related to the purchase or renovation of a building, or the construction of a new one. Some organizations may have a capital campaign to raise funds for a big facility project, but even that may not bring in enough revenue to cover the project costs, and the grants it brings in might come after they need to pay project costs. And – even if it could – the donors may not make their payment to the organization in time for when the cash is needed to keep the project moving on schedule. In this case, taking on debt could help bridge the timing gap and ensure the organization has enough money, when it needs it, to keep all of its work moving forward.
Different types of debt – or loan products – are used by nonprofits to address different challenges and opportunities. Some loans are used to address the timing of day-to-day cash needs – or working capital.
- This includes revolving Lines of Credit. These loans are somewhat like a credit card. Essentially, a lender makes cash available to a borrower to use when needed, up to an agreed upon limit. The borrower has to pay interest on the amount that is used. As soon as an amount on the line is repaid (with interest), it becomes available to be borrowed again. This is why a line of credit is commonly referred to as “revolving.” Lines of credit help nonprofits have the cash they need based on the timing of revenue coming in from things like donations and grants.
- Bridge Loans can also help organizations access working capital. Bridge Loans are short-term loans used to bridge timing gaps between an organization’s need to pay expenses and when it receives the actual cash payment, typically in a lump sum. They can be a good solution when funding for a project has been awarded, but there’s a lengthy wait for those funds to come in. An organization may be engaged in a capital campaign for a new project – and a bridge loan can provide the organization with working capital to proceed with its project while it works on converting campaign pledges from donors into cash.
Other types of debt can be used to cover one-off projects, including the purchase or maintenance of Fixed Assets – such as property, or equipment. This could include the purchase, redevelopment, or construction of a building or a piece of land. Or, equipment like a generator for said building. Or perhaps even the purchase of a shuttle bus for clients you serve. And then lastly, we’ll note this distinction at the bottom. Whether debt is for working capital or fixed assets, it is almost always “secured.” This means the loan is backed by some type of collateral owned by the borrower that the lender can look to if the loan is not repaid as expected. A secured loan designates specific assets owned by the borrower that can be used by the lender as a backup form of repayment, if necessary. Some loans can sometimes be unsecured – without collateral – but these are less common.
That’s it for this video on defining debt. If you have other questions about debt and the lending process, please take a look at the other videos in our series.
When Is Debt Right for My Nonprofit?
This video will cover ways to determine if debt is the right financial tool for your nonprofit’s particular challenge or opportunity.
Transcript
Welcome the second video in Nonprofit Finance Fund’s series, A Beginners Guide to Debt for Nonprofits. This video will cover how to determine if debt is the right financial tool for your nonprofit’s particular challenge or opportunity.
Organizations considering taking on debt for the first time will be confronted with a lot of decision points. Since applying for and managing a loan requires a significant investment of time and energy, it’s important to evaluate whether taking on debt is the right move at the present moment. So let’s review some key criteria that should be met before moving forward with taking on debt:
- First, debt should be used to address a mission-critical need. Debt can be a valuable tool if it’s being used to help your organization fulfill its mission. For instance, a loan might provide the working capital – or cash – needed to grow a program in response to increased demand for your organization’s services. By clearly identifying how the loan supports and is critical to your mission, you can ensure that the effort, time, and money used for debt will have maximum positive impact on the communities you serve.
- Second, debt should address a need for cash related to timing. Debt can help to solve short-term cash flow challenges when revenue is secured, but not yet available. For example, a line of credit can help cover payroll or other day-to-day expenses during points in the year where an organization anticipates its cash balances will be low. Having access to a working capital loan like a line of credit can help an organization avoid a “cash crunch”, and act as a bridge to revenue that will come in at a later date – like a big end-of year fundraiser, when you can recoup the revenue borrowed against the line. Similarly, debt can help with larger planned expenses, like the cash needed to purchase a building. In this case, loans can provide the upfront cash needed to move forward with the purchase while allowing for repayment over time.
- Finally, organizations must ensure they can cover all payments associated with their debt. Before taking on debt, it’s critical to confirm that your future revenue will be able to cover your regular operating expenses, in addition to all new costs that will be associated with paying for the cost of your debt, or “debt service payments”. This includes payments that need to be made toward the loan principal, as well as interest owed, and any associated loan fees incurred. Remember: borrowing costs money! Ensuring your revenue can support both your regular expenses and loan payments and related fees is paramount.
So here is an example of an organization that determined it was a good idea to take on debt: ABC is a workforce development nonprofit that connects young people with living-wage jobs. They recently received a new reimbursement-based contract with NYC’s Department of Small Business Services to expand its programming. To implement the new program, ABC must be able to cover upfront expenses before receiving reimbursements. So, ABC is exploring a $1,000,000 bridge loan to bridge that timing delay. They used cashflow projections to determine how much they need to borrow, as well as, and important, that they can afford the debt service payments on top of all their regular expenses.
So, ABC checked all of the boxes.
- They defined how the debt is central to their mission.
- They ensured the financial need is tied to the timing of already secured revenue.
- And they projected having sufficient future revenue to cover both their regular expenses AND their new debt service payments.
Having checked all the boxes, ABC gave itself the green light to seek out debt as a financial tool to grow its programs.
But debt does not solve all issues, for all organizations, at all times. When not used well, debt can cause just as much harm as good. That’s why it’s important to name some reasons to pause when considering taking on debt, as any of these scenarios can indicate that debt may be harmful to your organization.
- First, debt will not be able to help fill a significant gap in your budget – for instance if you’ve lost major sources of consistent revenue. Again, debt is not a substitute for revenue, so in this instance, your time will be better spent trying to secure new, consistent revenue sources to fill that gap. Debt could offer short-term relief, but it is not a sustainable long-term approach for organizations.
- Second, and more generally, it’s a good idea to pause if you do not have a clear path and plan for how the debt will be repaid. If you can’t demonstrate that your organization has a clear path to repay a loan, then it likely won’t be worth your time to pursue one.
Deciding whether to take on debt is often more nuanced than a simple red light/green light approach. We recommend pausing if any of these scenarios are true, as taking on debt might weaken your organization, over the short and long term.
While debt can be a helpful tool for building and adapting to financial realities, lending and borrowing throughout history have reinforced harmful power dynamics, particularly for low-income communities and communities of color. These communities, their individuals and businesses, have been denied debt by practices like redlining, and subject to predatory lending that creates cycles of perpetual debt and inhibits wealth building.
As a Community Development Financial Institution, NFF is dedicated to serving communities that have been historically excluded from our financial system. But as a part of that system, any lender – NFF included – could unintentionally perpetuate injustice through debt. All borrowers, especially those considering debt for the first time, should approach the lending process with an awareness of these challenges.
That’s it for this video, which covered how to know if debt is right for your nonprofit. If you have other questions about debt and the lending process, please check out the other videos in this series.
What Lenders Look For
Knowing that debt is the right tool and being able to access that tool are two different things. This video covers what a potential lender will likely consider before they extend a loan to your nonprofit.
Transcript
Welcome to the third video in Nonprofit Finance Fund’s series: A Beginner’s Guide to Debt for Nonprofits. In our last video, we covered how to know if debt might be the right tool for your needs. In this video, we’ll cover how to know whether a lender will lend to you. Knowing that debt is the right tool and being able to access that tool are two different things. So here I’ll cover what a potential lender will likely consider before they extend a loan to your nonprofit.
The first thing a lender will do is hold a magnifying glass up to your financials to look for specific indicators of your financial health. So, let’s review some of the most common and most important indicators and what they mean.
The first is consistent yearly surpluses. Lenders want to see a positive bottom line year after year because consistent surpluses mean you reliably have enough money to pay back the loan, and pay the cost of the loan, which is the interest. Interest is an added expense, so those consistent surpluses assure the lender that your nonprofit typically has that extra money to pay this extra expense. Now, most lenders do know that everyone can have a bad year, that extraordinary things can happen, and that’s why they look for multiple years. They’re not going to make a lending decision on just one year of financial information.
Next, we look at your revenue sources. Here again we are looking for consistency – how reliable is it? At NFF we define operating revenue as being reliable, regular, repeatable or replaceable, which means if one funder says no this year you’ve got others in the pipeline. Lenders also look at revenue diversity, which means if something happens with one source of revenue, you have other revenue streams that can come in and cover the gap. For example, if your Development Director steps down, you have other sources that can fill in.
Then we look at repayment. Repayment might seem similar to revenue sources, but these are two different indicators. Repayment is specifically how you plan to repay the loan. Lenders want to see that your plan is solid, meaning you have revenue already identified and confirmed to repay – not just a list of funders or customers you plan to apply to. Part of what we’re looking for here is to make sure that repaying the loan won’t disrupt normal revenue and destabilize operations.
Next, we look at cash flow. This is also different than revenue or repayment because most organizations are operating on an accrual-based accounting, so cash is not the same as revenue. Almost all lenders will ask you for a cash flow projection, and we do that because they want to see that you have enough cash coming in to cover all of your regular operating costs AND regular debt payments AND the interest – keeping in mind that if you’re taking on debt for the first time these are cash outlays you haven’t had to cover before.
Then we look at available net assets – on the balance sheet. This is a little bit less tangible, but very important. First, we’ll look to see that you have positive net assets, which means more assets than liabilities, or more financial resources than financial obligations. Then we’ll look at available net assets, which is the portion of net assets that are not tied up with restricted grants or invested in fixed assets like equipment and real estate. If you have a lot of existing debt and little, no, or negative net assets, that means you already have a lot of financial obligations and it’s unlikely taking on more debt will be good for the organization. At NFF, we don’t want to provide debt if it will be harmful – and you shouldn’t want to take any on, either!
Finally, lenders will look at cash. If you don’t have money in the bank or access to cash, this is a red flag. This is why applying for a loan when you are in financial stress is rarely successful.
There is nuance to this and there are exceptions to each but in general, these are the financial indicators. While finances are obviously front and center when applying for a loan, they are not the only thing a lender will want to see about your nonprofit. Lenders also look for indicators that your organization is well-managed and stable.
So we’ll ask about the leadership team and their tenure. We want to know that the nonprofit’s leaders have the financial expertise and experience to manage a loan, because there’s a lot that goes into loan management. We also want leaders who are clearly very familiar with the organization and understand its needs.
We’ll ask about the board, because the board holds ultimate financial responsibility for the organization. Lenders need to know that the board knows what they’re getting into, that they understand the implications of the loan. At NFF we’ve seen organizations get into trouble or struggle when not everyone in board & leadership knows and understands about the loan.
Finally, lenders will also ask about the infrastructure, because we want to know if the nonprofit has the systems to manage the loan, or if loan management will place too great a burden on the organization. This means we’re looking to see that you have the systems, policies, and procedures in place to help manage the loan AND everything else you have to do. A loan is an additional burden on your time, and lenders need to know you can absorb that burden without placing undue stress on staff. Even more importantly, robust systems & infrastructure helps you avoid any financial entanglements and mismanagement.
This is why it is often harder for small nonprofits to get loans, because for small orgs especially, the ED or the Board treasurer often does the financial management, and loan management is a big additional burden for just one person to do.
The focus of both the financial indicators and the management and governance indicators is on your nonprofit’s financial situation. This is because a lender has to trust that a loan is what you need and that you can repay it. They will do all they can to verify that this trust is well placed before approving a loan. They need solid evidence that your finance team can accurately assess your financial situation & needs and predict your ability to repay the loan. If you can see trends and deviations from trends, you can anticipate problems and take preventative action. Lenders need to see that you can make real-time, data-informed decisions.
Because this is so important to a lender for getting that money back, they will look for evidence – things like:
- Timely, accurate financial reports.
- If your yearly audit is two years late a lender will want to know why. If you haven’t closed the quarter six months later they’ll want to know why.
- Consistent accounting practices – meaning the lender – and you – can follow what’s happening with your internal financials from year to year.
- A strategic plan that includes a financial plan and that includes analyses of program and financial strategies, multi-year projections, and adjustments as needed. This isn’t always necessarily a requirement, but it is evidence of that ability to plan ahead.
Now that you have a sense of what funders want to see and why, I’ll share where they find that information. When you apply for a loan, lenders will require that you submit a bunch of documents.
Starting with the financial documents. Lenders will ask for:
- Audited financial statements. Audited is best, compiled/reviews may be ok as an alternative in some cases; lenders rarely accept internal statements and tax returns alone.
- Budget, typically board-approved.
- Year-to-date financial statements (with budget-to-actuals).
- Budget to actuals to show how the organization is performing against their budget. Since a budget is a plan for what will happen, lenders also want to see what has actually happened. This is another opportunity to show how well the organization does at predicting their financial future.
- If you have any existing debt or borrowing history, lenders will want to see those current & past loan agreements. Past loans that you’ve fully paid off can be especially helpful for showing that the organization has successfully managed debt in the past.
- Fundraising plan, to understand your revenue & repayment sources.
- Financial projections covering the expected loan term, if repayment relies on operating surpluses.
And then on the organizational side, lenders will require:
- Description of mission, programs, and community served.
- Strategic and/or business plan.
- Bios of board members and key staff, including those who will be managing the loan and running the organization more generally as it relates to bringing in revenue and managing expenses.
- List of major funders or customers.
- Organizational documents: by-laws, articles of incorporation, certificates of good standing, 501(c)3 status, etc.
A lender will ask for all this information, and this means that you should analyze this information for yourself first, before you even reach out to lenders. You should know ahead of time where you fall with these metrics and indicators and be ready to explain any potential weak points. Most lenders look at your organization holistically, which means one or two weak points can be bolstered by strengths in other areas – but you still have to be able to explain the weak points.
One final point here. There are additional documents that are specific to the type of loan you are interested in taking out.
For example, a loan that is for operating support or to bolster your working capital, like a loan you take out to bridge the gaps created by reimbursement-based contracts, will require copies of those contracts, confirmation that that money will be coming in eventually, as well as monthly cash flow projections and accounts receivable schedules.
For a loan that supports a facilities project or capital asset, lenders will require more information about the project, including the scope of work, timeline, and budget. The budget needs to include all sources of funding for the project as well as all expenses.
If the project is big enough to significantly change the organization’s operations, they’ll also require multi-year projections showing those changed operations.
Finally, they’ll want to see any additional financial documents related to the project, such as lease agreements, if your organization is buying a building and will be renting out part of it, and signed agreements with your contractors.
As with the indicators and financial documents, you’ll want to have these prepared before you go to a lender, to make sure you are ready.
Thank you for watching. We hope this was helpful. If you have more questions or are interested in other parts of the lending process, please take a look at the other videos in our series.
Types of Lenders
This video covers the different types of lenders who offer debt to nonprofits.
Transcript
Welcome to the fourth video in Nonprofit Finance Fund’s series: A Beginner’s Guide to Debt for Nonprofits. This video covers the different types of lenders who offer debt to nonprofits.
We are going to go over five types of lenders. The most common are banks & credit unions. Also fairly common are Community Development Financial Institutions – or CDFIs (that’s where NFF falls, we are a CDFI). You might also be able to get a loan from a government entity, a foundation, or an individual.
I’ll share some details about each type of lender but first want to note that there is a lot of variety within each category. You can find good & bad actors of every type. Predatory lending is real, and you want to avoid it no matter who is doing the lending. Systemic racism is also real and shows up in predatory loans and otherwise inexplicable loan denials. The sector is improving but it is still far from perfect, so you do want to be really careful about selecting a lender.
One question we get asked a lot is whether or not you can be in conversation with multiple lenders at the same time. The answer to that is ABSOLUTELY! Yes! When you’re exploring debt we absolutely encourage you to have conversations with multiple lenders. Shop around, compare rates and terms, spend the time to find a lender that you like, who will work with you – debt is often a medium to a long-term financial relationship, so you want to find the right partner! Who that is will depend on your needs and financial circumstances.
So let’s talk about the options.
Let’s start with banks & credit unions:
- Traditional banks are for-profit businesses (which mean profits are divided up among shareholders), while credit unions are nonprofits (which means there are no shareholders and profits are reinvested back into the business). Both are driven by a profit model, meaning they charge interest and fees that let them cover their costs and make a profit.
- In terms of process: They might be more rigid than other lenders, in the sense that the more nuance or ambiguity you have in your business model (revenue coming in and expenses going out) the less likely you are to qualify. Flexibility, customization, and approval for exceptions may be harder to get with more traditional lenders.
- When it comes to working with nonprofits, not all banks understand the nonprofit business model and the nuances of the nonprofit world. Some banks may have nonprofit lending experience, but it’s important to confirm that before choosing that lender.
- Bank interest rates will be market rate.
In general, first-time nonprofit borrowers may find that banks don’t always offer the flexibility they need, but if your nonprofit already has a strong relationship with your bank, they should definitely be on your list of options to explore.
Another common type of lender to explore is CDFIs. CDFIs are great options for nonprofits. Not all CDFIs lend to nonprofits, some focus on microbusinesses, consumer finance, housing, or other sectors, but many do and they may be a good option.
- CDFIs have a mission to use capital for social good which creates alignment between lender and borrower. CDFIs have to cover their costs, so they charge interest, but achieving their mission also depends on the success of your organization, so they have to care about that success.
- Since nonprofit CDFI loan funds are mission-driven and accountable to their volunteer boards and communities rather than shareholders, the incentive structures are more oriented to nonprofit borrowers.
Regarding interest rates, CDFIs have access to different sources of capital, so depending on the type of loan product and financing need, they may offer loans with lower interest rates. In other cases their rates will mirror the broader market, so you can’t count on a CDFI having a lower rate. But because you are mission-aligned, you can count on a CDFI to be more of a patient lending partner, especially in times of uncertainty.
Remember that I’m speaking generally here. You can find banks that are values aligned and CDFIs that don’t fit your need. The point is to look into both and find one that fits your needs and financial circumstances.
Governments:
- Government bodies and quasi-government agencies like the Small Business Administration or like state loan programs often offer loans and upfront payments for contracts.
- There are often federal, state, and local government funds set up specifically for nonprofits both large and small, so those are worth exploring where available.
Foundations:
- Some foundations have programs offering nonprofit loans through program-related or mission-related investments. You might hear these referred to as PRIs or MRIs. These programs will depend entirely on the foundation setting them up and are very rare, so it’s likely not a realistic option for most nonprofits. They are great when you can find them, but they are rare.
Individuals:
- Finally, you might be able to get a loan from an individual. We usually see individual loans from board members, but it could be any individual, so there is not a lot we can say here. We do recommend being careful with these loans, as we’ve seen both organizations and the individuals doing the lending get into difficult situations with these types of loans.
Remember as I said in the beginning, there is a lot of variety within these lender categories. Whatever type of lender you pick, you want one that you feel comfortable building a relationship with. It is a medium-to-long-term relationship, because you’ll be working with them for the time it takes to get loan approval and for the life of the loan, so you want to build a good relationship.
Thank you for watching. We hope this was helpful. If you have more questions or are interested in other parts of the lending process, please take a look at the other videos in our series.
The Lending Process
In this video, we provide a brief overview of the full life cycle for taking on debt, from first having the idea to fully paying off the loan.
Transcript
Welcome to the fifth video in Nonprofit Finance Fund’s video series: A Beginner’s Guide to Debt for Nonprofits. In this video I will give a high-level overview of the steps for taking on debt, from first having the idea to fully paying off the loan.
Nearly all lending follows an 8-step process, though there can be differences in how a borrower or lender approaches each step.
Let’s start with Step 1. This is making sure you need a loan! This is something you do on your own, without a lender. You want to make sure a loan fits your needs best, and not some other form of capital. If you can get a grant instead, go with the grant! But sometimes you can’t, sometimes debt is the best option, but you need to make sure of that before taking on debt.
If you know you need a loan, you must also determine exactly how much you need and ensure you have everything in place to manage the loan. Taking out a loan requires a lot of work and time, and you don’t want to go through the process unless you are reasonably certain of a positive outcome, so you want to make sure that you’re ready.
Step 2 is choosing a lender. We encourage you to talk to several lenders to find the one that best fits your needs and who you can build a partnership with for the life of the loan. Usually one or two conversations is enough to know whether it’s possible or you want to move forward. If you and the lender agree there’s the possibility of a relationship, then you move into Step 3.
Step 3 is what lenders call “Underwriting.” This is a technical term that your lender will use for their work of analyzing the loan. Unlike individuals, nonprofits don’t have “credit scores”, so the lender will request a lot of documents from you and have multiple conversations with you to make their own assessment of your ability to manage and pay back the loan. If you’ve done your own due diligence carefully in Step 1, that makes this process much smoother. If they think it’s a good fit, then they’ll send you for approval.
In step 4, you get approved and will finalize the terms of your loan with your lender via a commitment letter. This step also often involves making a deposit, which is sometimes called good faith money. It might seem odd to send your lender money when they’re about to send you a whole bunch of money, but remember that in most cases you are not borrowing the money for free, and this deposit goes towards paying any fees that are part of your loan.
Step 5: Once you finalize terms you go through what lenders call the “Closing” process, which is when you complete a series of required legal documents, including a board resolution and a signed loan agreement. The loan agreement is a much longer document than the commitment letter, and will lay out both the terms of the loan (like the amount, interest rate, and repayment schedule), and all the loan covenants, which are all additional things you are agreeing to, usually around reporting.
Step 6 is the fun one! This is where you receive the funds. It’s the shortest step!
Step 7: For the course of the loan, you make your payments on the loan principal, you pay interest, and you submit whatever other financial reports & documents might be required by your loan agreement.
Step 8: Finally, you pay off the loan and get a pay-off letter.
Each of these steps takes a different amount of time and effort. There are additional sub-steps within most of them, sometimes a lot of sub-steps, depending on your situation. The first step, for example, is entirely dependent on you, and can take your organization years to get ready. Then, from identifying lenders to receiving the funds, all these steps here, usually take 3 to 6 months. If you already know your lender and it’s a simple loan it might go faster, and if you have a complicated, large loan or you’re not ready for underwriting then it can take longer.
Here’s a bit more detail about NFF’s process, if one of the lenders you want to explore is NFF.
We have an intake form on our website that is the best way to see whether you qualify for a loan from us. After you fill out the form, if you meet our initial baseline criteria then you’ll have an intro call with someone on our team. If in that intro call we think you’re a good fit we will move you forward into underwriting, where you’ll work closely with another member of our lending team as we conduct our initial analysis. You’ll have multiple calls with our underwriter and send us lots of documents. If our analysis is positive, then we’ll write up a term sheet with you, which is a nonbinding agreement that shows the basic terms and conditions of the loan NFF is willing to offer you, such as the loan amount, the lengths, interest rate, collateral, covenants, and other conditions. If all that is agreeable to you then we’ll continue our analysis, asking more questions and requesting more documentation to ensure we can appropriately meet your financing needs. If we decide we can, then your loan gets approved. Then during our closing process, you submit all your final legal documents, and once we review those, we send the loan agreement out for your review and signature. The rest of our process includes regular reports and payments over the life of the loan until it is paid off in full. If you are interested in learning more about NFF’s specific process you can see a link to our full process in the description of this video.
If you want to learn more generally about other steps, like getting ready or choosing a lender, you can check out the other videos in this series.
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