The ins and outs of obtaining financing
If your nonprofit needs to finance a project or program, you may be discouraged by reports that credit is still tight. But if you understand the choices available to you, your chances of securing financing will grow.
Lines of credit and term loans differ
Bank financing generally comes in two basic forms: line of credit or term loan. Your nonprofit’s underlying cash needs will determine which one you should pursue.
A line of credit is a negotiated amount of financing you can draw against as needed. When the goal is to smooth out cash flows over the year, it’s usually the best option. The maximum amount is available to you, but you use only what you need.
If you obtain a $200,000 credit line, for example, you may use up to the $200,000 limit. Once the line has been paid down to $180,000, you again have $20,000 available to borrow. You can continue this draw-down and repayment cycle until the credit line’s term expires. (But check with your lending officer, because some banks are terminating unused lines of credit.)
Required monthly payments may be limited to interest expense, while principal payments can be made any time cash flow permits. So you have flexibility in how much you repay each month.
When you obtain a term loan, you receive a lump sum, usually for a specific purchase. The term loan application process is usually more complicated, and approval typically takes more time. Repayment is in installments, which means you’ll make equal monthly payments consisting of interest and principal throughout the entire loan term.
Bond rates are often attractive
An alternative to a traditional bank line of credit or loan is a tax-exempt bond issued by a municipal, county or state government. The interest payments to investors aren’t subject to federal income tax and may be exempt from state and local income tax.
Tax-exempt bond financing may benefit your nonprofit because tax-exempt interest rates are generally two to three percentage points lower than on money raised from other sources. The Internal Revenue Code allows a nonprofit to use the proceeds, which are borrowed from the issuer, to further the organization’s stated charitable purpose.
The first step in planning a bond issue is to identify which local government unit has the ability to issue bonds on a nonprofit’s behalf. This unit (the issuer) then lends the bond proceeds to you.
The next step is selecting a team of specialists to work out the mechanics of the bond issue, including a bond counsel who’ll draft the documents and deliver an opinion. An underwriter advises on the bond issue’s structure and then buys the bonds from the issuer and offers them to investors.
Tax-exempt bonds make the most sense for larger capital investments. Although interest payments over the bond’s term can be significantly lower than on a term loan, the up-front legal and other fees can be substantial.
Also consider that the process may take longer due to more stringent financial disclosure requirements and tighter scrutiny overall. While a line of credit or term loan can be approved in a matter of weeks, bond financing can take six months to a year before the funds are received.
Do the advance work
In any economy — whether credit is tight or plentiful — a smart nonprofit will research and weigh its options carefully before seeking financing. Your CPA can assist you in preparing the financial documentation, such as a multiyear cash flow projection and a project budget, which you likely will need to secure financing.