Like businesses, nonprofit organizations sometimes need money in the form of loans for working capital, payment of bills, or to make strategic investments. Loans or lines of credit help a nonprofit to remain afloat when the organization’s cash flow is temporarily down or when reimbursement or donations are delayed. However, lending money to a nonprofit is not as straightforward as advancing credit to for-profit entities because of variations in their objectives.
Unlike for-profit organizations with the ultimate goal of maximizing profits for the benefit of the owners, nonprofits operate with the primary objective of achieving their mission. This stark difference between both organizations in terms of the purpose of operation provides a different landscape for lenders, and lending institutions must be aware of some potential pitfalls when extending credit to nonprofits to reduce the risk of default on payment.
Below are the three pitfalls you must know when lending money to a nonprofit.
Summary
Financial Constraint
Financial struggles are a reality numerous nonprofits face today. Many nonprofits depend largely on grants and donations from the government and people to raise money for their cause. And this makes it difficult for not-for-profit entities to have the same financial flexibility as for-profit businesses, as revenue from these funding options doesn’t always come when needed.
This means that nonprofit revenue sources are highly limited and can be determined by individual whims and decisions. For example, there is no guarantee that donors who are sympathetic to a nonprofit’s cause will keep donating year after year. Plus, their levels of support might reduce over time, leaving the nonprofit to struggle to make up for the lost income they bank on.
Similarly, most funds realized by nonprofit organizations are being plowed into delivering services rather than investing them to ensure more sustainable financing options. The reason is that since nonprofit funding mainly comes from grants and donations, grantmakers and donors prefer their money to be used for the direct delivery of services or programs instead of enterprise investment.
Lack of financial flexibility makes nonprofits to be more vulnerable to uncertainties. For example, the Covid-19 pandemic made many nonprofits become insolvent and could not meet their loan obligations.
Eligibility For Bankrankruptcy
Nonprofit lenders should ascertain whether borrowers are eligible for bankruptcy protection before lending money. Bankruptcy is a legal proceeding initiated by a person, business, or organization when they cannot repay outstanding debt due to financial difficulty.
Many for-profit businesses are eligible for bankruptcy protection either voluntarily or involuntarily. On the hand, nonprofits might not be. Bankruptcy protection offers a lot of benefits and financial security to lenders. For example, the Bankruptcy Code provides an efficient mechanism for restructuring or winding down a business by allowing for the provision of debtor-in-possession financing, making capital available to meet the obligations of creditors in an orderly manner.
In addition, bankruptcy allows for court oversight and, in some cases, the transition of management of the organization to a third-party trustee. When bankruptcy is unavailable, a nonprofit may close operations without restriction, and you will lose your money.
Collateral Options
Every lender wants the assurance that they will recover their money. And many of them want some form of security before advancing loans to borrowers. This security is called collateral which minimizes the risk of the lender. Collateral may take the form of real estate or other kinds of assets that the borrower provides as security when applying for a secured loan. If the borrower defaults on their loan payments, the financing institution can sell the collateral to recover its losses.
There’s an additional risk for nonprofit lenders as some of the nonprofits’ assets might be restricted and not available as collateral or cover lenders’ losses. In addition, nonprofit financing institutions may not be able to access restricted or designated funds, endowments, and other trust assets of nonprofits that failed to meet their loan obligations. Sometimes, the nonprofit’s assets are not private corporate property but charitable trusts designed to benefit the stated nonprofit mission. 
Hence, lenders must exercise due diligence and extensive review to determine available unencumbered and unrestricted assets for distribution. Further, loan facilities should allow nonprofit lenders to conduct a periodic review of their borrower’s assets and regular reporting of restricted and unrestricted assets.
Are You In Need Of a Loan for Your Nonprofit?
There’s no doubt that many nonprofits struggle to maintain regular cash flow to carry out their numerous undertaking. Unlike for-profit businesses that deal in products and services to generate money and ensure steady cash on hand, nonprofits often have to wait for reimbursement or donations from people before taking on their many projects.
However, there are times that nonprofits will need to make an urgent financial decision even as cash flow is temporary down and many financial institutions are not comfortable lending money to nonprofits. Not having a cash backup plan such as a nonprofit line of credit means you will not be able to meet your financial obligations, which can negatively affect your nonprofit.
At Financing Solutions, a leading provider of business loans for nonprofits in the form of a 501c3/not for profit line of credit, we ensure that nonprofits have enough money to finance their operations. We offer an easy 2-minute application that requires no documents to receive an offer letter. Financing Solution’s unsecured line of credit also requires no collateral or personal guarantees.
An excellent alternative to a traditional bank loan, our line credit costs nothing to set up, nothing until used, and requires no collateral.
Find out today why we have five-star ratings from the Better Business Bureau by filling out the no-obligation, 2-minute line of credit application here.