Dear Nonprofiteer, Can I borrow working capital from a Board member?

Dear Nonprofiteer,

One of our current issues is lack of short-term working capital. As with many organizations, our expenses always precede our revenue by weeks, sometimes months. We were carrying some debt into the recession, which worsened as the economy imploded. We’ve grown fairly organically through the recession and thankfully we have paid the debt down; however, that has left us without much in the way of cash reserves. Which leads us to a short-term crunch on working capital to bridge the gap between the time frames for our expenses and for our revenue.

With the current banking climate credit can be tough to come by so one of our Board members has offered to lend our organization some money to help smooth out our short-term working capital issues. We want to make sure, though, that we are not skirting any legal issues before we proceed. Should an organization accept a short-term loan from a Board member?

Also s/he had a secondary question about interest if we were to accept the loan:

One question I did have is regarding the IRS interpretation of not profiting from board activities.  I should be able to do that as a no interest loan; though, would I still be able to do it as a below market rate loan?  (Not that there is much of a distinction at the moment with interest rates pretty close to 0.5%)  My thinking is that I could lend something around $3-5000 for no more than one year, and I would certainly want fund raising to continue in the meantime, but what would the IRS’s rules direct for this?

What would you advise?

Signed, Board-rich but Cash-poor

Dear Cash-poor:

It would be hard to provide a better summary of the pluses and minuses of borrowing from Board members than the one on Blue Avocado last year; it lays out all possible iterations of such borrowings, along with pros and cons of each type.

As you’ll see, there’s no legal obstacle to your accepting a loan from a Board member (see also this legal guidance, which makes explicit that what’s prohibited is Board members borrowing from nonprofits, not the other way around).  But doing so may alter the dynamics of your Board in a way you don’t particularly want.  S/he who has the gold makes the rules, of course, and a lender is apt to feel that s/he has a greater stake in the financial success of the organization than other Board members.  This may lead to conflicts about whether, e.g., to do something artistically daring or commercially safe, with the creditor putting a heavy thumb on the “safe” side of the scales.  The borrowing doesn’t create a conflict of interest, exactly, but it creates the potential for one.

Given the relatively small sum involved, it might actually be better to have a Board member, or members, co-sign a line of credit at a bank or credit union.  Many reluctant lenders are willing to lend with personal co-signers, and this keeps the day-to-day financial decisions where they belong—with the staff—while keeping Board members in their proper fiduciary role.

As to the interest-rate issue, Nonprofits for Dummies notes that loans from Board members are only legitimate if they are at or below market rates.  The goal is to prevent Board members from looting their agencies by charging exorbitant interest.  To be sure that there’s no question about the validity of the interest rate, the full Board should approve the loan by a vote from which the lending Board member recuses him/herself.  Under those circumstances, the IRS will not question the transaction—though it must be reported on the agency’s 990 form, and of course any interest income must be reported on the lender’s own tax returns.

Again, your difficulties are not legal, but managerial: if there’s truly no other way, you may borrow from a Board member.  But the less you let Board members serve as your creditors, the better governors they will be.

Also—though there’s nothing wrong with borrowing for a defined short-term need like the one you’ve described—if there’s a chronic delay between expenses and revenues, you probably want a longer-term solution (like the credit line) instead of a Board member’s temporary willingness to tide you over.

And please make sure the lending Board member knows that, in the unlikely possibility that you go bankrupt, his/her loan will be the last paid.  As an “insider,” his/her loan will be subordinated to everyone else’s, almost as though s/he were a stockholder.  In short, make sure everyone on both sides of this transaction understands the risk.

None of these gymnastics would be necessary if there were a Nonprofit Business Administration which would lend to nonprofits the way the Small Business Administration lends to small businesses.  But this hobby-horse of the Nonprofiteer’s doesn’t seem to be making any more headway in the Obama Administration than in any previous White House.  Maybe there’s a reason—but she can’t imagine what it is.


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