Trustee essentials: The pros and cons of loan finance

Peter Kelly is Charity Bank’s business development director. His previous roles include corporate lending at Barclays where he also led its work in tackling financial exclusion across the UK. Peter has also worked with the Association of British Credit Unions and at Unity Trust Bank.

In the right circumstances and with the right kind of loan, debt 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 pros and cons of loan finance?

Pros: Good debt

A loan can help organisations become more sustainable

For instance, it can allow you to buy a property rather than continuing to pay rent.

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 realise your plans this year rather than in five

Lenders can’t give you instant finance, but in the right circumstances, a loan can be arranged within weeks. Grants can take longer to organise, and are sometimes paid at the end of a project – rather than at the beginning, when you frequently 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 social impact study revealed that 41% of the organisations to which it has lent were able to leverage additional funds from sources such as local trusts.
One example is Towcester Museum, which received a £50,000 grant from Heritage Lottery Fund (HLF) alongside other smaller grants as a direct result of its loan.
Sometimes securing a loan provides credibility to an organisation and grant funders may feel more comfortable funding it in the light of the due diligence the bank undertakes.

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.

Cons: 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 how you will repay the 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?’

Loans cost money

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.

Loans can also come with legal expenses (for example security valuation fees or costs associated with taking charges over property).

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. See 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. 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, then loans can be a highly useful tool.

You can read more about Charity Bank on our blog, or talk to our team directly. NCVO members can claim a discount on Charity Bank loans.

Social investment

Read more on social investment and what it means for you on NCVO, Know-How and on our blog on the topic.