Have you ever heard of funding nonprofits which have cash flow problems by setting up a line of credit guaranteed by deposits made by the group’s supporters? The supporters put their money into a pool, the equivalent of a CD, and can state the terms (i.e.., 1 year, 3 years, etc.). They get a below-market return on their money, but it remains their money and they can take it out at the end of the term. Meanwhile, the nonprofit has a line of credit to get through the fiscal crunch periods.
It’s a system written about by a husband and wife (Linzer by name). I’m skeptical about the plan. I lose on the interest since it’s below what I get in other similar investments, and I don’t get to write off any charitable donation since it isn’t really a donation. Of course, there’s the possibility of losing the money if the nonprofit goes belly up, but that’s unlikely. I just went on a board and made a donation to the group and now am being encouraged by one board member to do this too. It’s not a plan used by any of the groups I’ve ever worked with. Your thoughts?
Signed, Not Clear Where Credit Is Due
Dear Not Clear:
The Nonprofiteer has just become acquainted with the Linzers’ work, which features skepticism about asset acquisition by nonprofits and a corresponding enthusiasm for their use of credit. Though she agrees with the Linzers that many large nonprofits become overly preoccupied with building endowment–wouldn’t it be better to use those funds to accomplish mission?–she doesn’t share their view that nonprofits should operate without any reserve whatsoever, instead using credit to respond to unexpected demands for cash.
Why? Because credit isn’t free, but it is easy. Even with the below-market-rate interest you describe, it costs money to borrow money. Wouldn’t it be better to use those funds to accomplish mission? At the same time, the availability of credit encourages nonprofits to put off the hard work of matching resources with needs–that is, either reducing costs or increasing revenue. Show the Nonprofiteer a Board able to borrow freely and routinely, and she’ll show you a Board that evades necessary fundraising until the debts are nearly overwhelming.
If the agency absolutely positively knows that the money it’s borrowing will reappear in its account three months from now–say, it has a signed grant award letter, but disbursement won’t occur til September–then it makes sense to use a line of credit to cover expenses, repaying as soon as the grant comes in. But it makes even more sense for the agency to redouble its fundraising efforts so it has sufficient income to operate between grants. Asking people to guarantee a line of credit is NOT a substitute for asking them to donate to your cause. If they care about the institution enough to give it money, they should receive the tax advantage that accrues to such generosity; and if they don’t, there’s no reason for them to make a below-market-rate investment.
Again, borrowing money isn’t free. It has a cash cost and an opportunity cost, namely, the opportunity to ask a prospective donor for a gift–because once you’ve asked him for a low-interest loan he’s not going to give you a gift, too. So while judicious use of credit (to take advantage of opportunities that will lapse if not seized immediately) is something every nonprofit should consider, the Nonprofiteer strongly cautions charities to remember that credit is not a substitute for income. Cash flow is all very well; but unless the cash actually belongs to the nonprofit, in fairly short order it’s going to flow in precisely the wrong direction.
In addition, in the Nonprofiteer’s view members of the Board of Directors should donate money and raise money in support of the agency they govern. They should not become its creditors, because that creates a conflict of interest: what’s good for them as creditors (having the agency devote all its energy to repaying the debt) is not what’s good for the agency, which is all they as governors should be concerned about.
So no, don’t make this investment, and don’t encourage the agency to keep borrowing money. Instead of treating the symptom (temporary cash-flow shortage), work with your colleagues on the Board to treat the cause (insufficient income or excessive expenses)–otherwise the agency will never return to financial health.
Tags: Board of Directors, Boards of Directors, borrowing, cash flow, charity, Conflict of Interest, credit, debt, donors, Endowment, Fundraising, Management Advice Day tip, Mission, nonprofit, Nonprofit management, not for profit, philanthropy, Private Philanthropy