How will borrowing benefit us in the long term?
It’s important to have a strong business case for why you want to borrow. Faced with shortfalls in funding and persisting social needs, it may be tempting to look at borrowing as a way of plugging the gaps. But treating debt as income will inevitably lead to trouble. The purpose of borrowing is to create a pathway to income – whether that’s bridging the gap until receipt of a grant, or for investing to grow revenue or develop new income streams.
Are our expectations realistic?
Wouldn’t it be nice if you could borrow as much money as you wanted, for as long as you wanted and for next to no interest? But lenders have needs too. They need to achieve appropriate returns, cover losses across their portfolio and meet their own costs of capital.
You might be able to get a personal mortgage for less than 3% but that doesn’t mean your charity could borrow on the same terms. Before you go too far with numbers in your business model, make sure your expectations are realistic.
How will we meet our interest payments?
Will you be able to meet the costs of borrowing within your current budget, or are you banking on your new activities generating enough income to pay the interest? The answer will be a key factor in determining the right debt solution, the kinds of lenders you should be speaking to and the sorts of terms and covenants that will be appropriate.
What if things don’t quite go as we expect?
Because, of course, they won’t. Reality doesn’t respect your business plan. If you’ve planned conservatively you may do better than expected, but as a general rule things take longer, end up costing more and don’t succeed quite as spectacularly as we hope. When factoring borrowing into your business model ask yourself, would we manage if costs were 10% higher or revenues 10% lower, or if delays in income affected our cashflow?
What if rates rise?
If you take out a loan on a variable rate, your cost of borrowing will go up as the benchmark rate rises. You’d think that was obvious, but it’s remarkable how often borrowers reject a fixed rate simply because the variable rate starts lower. It may be that an initially lower cost is better for you, but you need to understand the risks and make sure you compare costs on a like-for-like basis across the full term of the loan.
What covenants will we be signing up to?
When evaluating a loan offer, look deeper than just the headline terms. What restrictions does the lender want to put on your future business activity or future borrowing? What promises are you making about your financial performance? A potential breach of covenants down the line may simply give the lender an opportunity to reconsider the price of the loan in return for a waiver, but if it results in a default it could have serious consequences for the charity.
What will we do at the end of the term?
Your business plan may envisage being able to generate enough cash to pay off the debt in full at the end of the term. But refinancing, in part or in full, through new borrowing is a perfectly valid strategy. Bear in mind though that you might not be able to borrow in future at the same rate or on the same terms that you can now.
Have we compared our options?
Talking to your bank may be the obvious course of action but it’s not the only option, particularly if you have a significant funding requirement. Syndicated loans, bonds or private placements may be alternatives to consider and, depending on your circumstances, may offer better terms. While bank borrowing can feel more familiar and comfortable, it’s good governance to review all the options open to you, comparing them on a like-for-like basis as far as possible.
What is the risk to the charity of borrowing?
What’s the worst-case scenario? It probably won’t happen - but it might, so you need to understand the risks and be prepared for them.
What is the risk if we don’t borrow?
You need to be clear on the risks of borrowing – and on the risks if you don’t. Without the investment you’re considering, what’s the risk to your financial sustainability? Will you still be able to achieve the change you could have made?
Allia Impact Finance, provides advice and arranges debt finance solutions for charities and impact business. Daniel Carrico from Allia Impact Finance will be speaking more on loans at CFG's Alternative Finance Conference 24 January 2019.
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