Understanding Loans and How to Get Them
The following article outlines the process for community and voluntary organisations to understand the various loan finance options available for their organisation.
Social Finance Loans:
Social finance or ‘community development finance institutions' are independent organisations that provide access to financial services for people, voluntary and community organisations and enterprises. They have social as well as financial objectives. They also set out to be sustainable organisations and will only support viable organisations that can repay their debts so that the funds can be used to support other organisations in the future. The leading social finance provide in the Republic of Ireland is Clann Credo. In 2007, the Government set of the Social Finance Foundation which provides finance to social finance providers.
Commercial finance can take the form of debt or equity. The advantages and disadvantages of debt or loans from the banks are similar to those from social finance organisations. However, the banks are less likely to lend to new or more risky organisations or to spend the time to work with organisations that need help to develop their business plan.
For completeness sake, equity finance is permanently invested in the organisation in exchange for part-ownership and a share in the profits. However, registered charities and many other not-for-profit organisations cannot share ownership or distribute profits. It is usually very difficult to sell on any ownership stakes, which deters investors of this nature.
Uses of Loan Finance:
Loan Finance can be used for capital investment such as the purchase, renovation and repair of premises and the purchase of large items of machinery or equipment. It can be used to provide working capital, which ensures that enough money is available to pay bills as they fall due. It can fund growth in operations, such as increasing staff or production levels. It can be used for bridging finance - bridging the gap until grant or other payments are received. It can be used to purchase an existing business, perhaps to convert it into a social enterprise. It can be used to start new income-generating activities, either as a charity developing a trading arm or as a social enterprise starting from scratch.
Advantages and Disadvantages of Loans
Loans can give greater independence than grants, as the borrower is not tied to outputs or outcomes
Lenders will often look for security over assets, such as land, buildings or equipment. If a lender takes security over the organisation's assets, these could be lost in the event that things go wrong and the loan cannot be repaid.
Loans are usually quicker to obtain than grants
Loans have to be repaid with interest, unlike grants.
The funds received from a loan can be used for more flexible purposes
Lenders will look at your operating history and track record of income generation. It is more difficult for start-ups to obtain finance.
Loan applications are assessed on their own merits, rather than in competition with other applications, as for grants
Taking a loan can have positive side effects, such as improved financial management and a greater focus on commercial objectives
"Success" and "failure" in relation to a loan are much clearer and more straightforward, as is the relationship with the lender.
How to get a loan
A basic step for any organisation is to speak to your bank on a regular basis. Build a relationship with your bank - invite them to your AGM, send them your annual report and accounts. Ask for their advice.
Make an application
The finance provider will probably require the list of items below as a minimum:
- Memorandum and Articles of Association
- Three years audited and management accounts
- Five years of financial projections, with three scenarios: (1) A realistic scenario or base case (2) A worst case e.g. with income down 10% (3) A best case e.g. with income up 10%
- Organisational structure
- CVs of key employees and board members
- Project description
- Business plan
Desk Review (by the lender)
The desk review will be carried out by a loan officer who may come back to you for more information, for example market research, grant and other funding details, contracts and invoices, accounts receivable and accounts payable.
On-Site Visit and Due Diligence (by the lender)
The (potential) lender will look carefully at your:
- Debt service
If they believe the proposal is worth pursuing, they will conduct a more thorough investigation on-site.
The sort of factors that will be assessed in what is called the "due diligence" stage are:
- Historical accounts
- Anticipated cashflow
- Assumptions underlying the projections
- Finance need relative to cash flow
- Liquidity and working capital
- Relationship with finance providers
- Management skills
- Operating environment
- Mission and strategy
Structuring and Negotiations (both parties)
The lender will recommend a finance package covering:
- The amount of funds
- The term
- The product type
- The interest rate and whether it is fixed or variable
- Conditions for drawing down the funds, such as agreement by the Board, evidence that the enterprise is appropriately registered, licensed and insured, valuation of property, planning permission, etc.
- Covenants - these are items that must be maintained throughout the life of the agreement. They might include the provision of quarterly management and annual audited accounts, agreement not to sell or transfer assets and agreement not to borrow more money without prior approval.
It is very important that the proposal be reviewed thoroughly and that you and your Board or Management Committee understand the commitments that you are making.
Final Approval, Contract and Meeting Requirements for Disbursal of Funds (both parties)
Once you have agreed the terms, a contract will be signed with the finance provider setting out terms and conditions. It is advisable to have a lawyer review the contract. Funds can be disbursed once the conditions are met, and the enterprise will then have to fulfil any covenants that have been agreed.
Visit the website of Clann Credo, the social investment fund: http://www.clanncredo.ie/