Running a nonprofit often means managing a mismatch between when expenses must be paid and when revenue actually arrives.
Payroll is due Friday. A government reimbursement may arrive three weeks later. A grant that was expected this month gets delayed. Donations fluctuate throughout the year. Yet employees, rent, programs, insurance, and other expenses still need to be paid.
That is where a nonprofit line of credit can be valuable.
My name is Stephen Halasnik, and I am one of the managing partners of Financing Solutions. Over the past 15 years, we have worked with thousands of nonprofit executive directors seeking lines of credit. During that time, we have heard many of the same questions repeatedly.
Below are answers to 15 of the most common questions nonprofit executive directors have about lines of credit.
Summary
1. What Is a Nonprofit Line of Credit and How Does It Work?
A nonprofit line of credit is a predetermined amount of money that an organization can access when needed.
Unlike a term loan, the nonprofit doesn’t receive the entire amount upfront. Instead, the organization draws money from the credit line when it experiences a cash-flow need and repays the balance as cash comes in.
For example, a nonprofit might have a $50,000 line of credit but only need $20,000 to cover a temporary shortfall. It would draw $20,000 rather than borrowing the entire $50,000.
At Financing Solutions, there is no cost to establish or maintain the line when it isn’t being used. The nonprofit is charged only when it draws funds, and the outstanding balance can be repaid early.
This makes a line of credit particularly useful as a cash backup plan.
2. When Should a Nonprofit Get a Line of Credit?
Ideally, before it needs one.
One of the most difficult situations we encounter is an executive director calling on Tuesday because payroll is due Friday.
At that point, the organization isn’t simply applying for financing. It is dealing with a financial emergency.
Underwriters also evaluate the organization’s financial condition. If the nonprofit is already experiencing a severe cash-flow crisis, obtaining approval can become more difficult.
A better strategy is to establish the line when the nonprofit’s finances are healthy. The organization can then have access to capital if an unexpected cash-flow problem develops later.
3. How Can a Nonprofit Qualify for a Line of Credit?
Qualification requirements depend on the lender.
At Financing Solutions, a nonprofit generally needs at least $400,000 in annual revenue to be considered.
Underwriting can include factors such as:
- Annual revenue
- How long the nonprofit has been operating
- Existing debt
- Bank account activity
- Sources of funding
- Overall financial condition
- Diversification of revenue
Funding sources can be especially important. A nonprofit receiving money from several sources—such as private donations, grants, fundraising and government reimbursements—may present a different risk profile than an organization heavily dependent on a single funding source.
4. How Much of a Line of Credit Can a Nonprofit Qualify For?
One common misconception is that a nonprofit can obtain a credit line representing a very large percentage of its annual revenue.
That generally isn’t realistic.
At Financing Solutions, line sizes are typically around 3% to 5% of the nonprofit’s previous 12 months of revenue, although every organization is evaluated individually.
For example, a nonprofit with $700,000 in annual revenue should not expect to receive a $300,000 line of credit simply because that is what it requests.
Responsible lending means providing an amount the organization can realistically manage and repay.
5. What Interest Rates and Fees Do Nonprofits Pay on a Line of Credit?
The cost depends heavily on the lender and the structure of the financing.
Some lenders charge origination, maintenance or annual fees. There may also be interest on outstanding balances.
Financing Solutions structures its product differently. There is no charge to establish or maintain the line when it isn’t being used. When funds are drawn, Financing Solutions charges a fee based on the amount borrowed and how long the funds remain outstanding.
Because pricing structures differ substantially, executive directors should look beyond an advertised interest rate and ask:
What will this actually cost our organization based on how we expect to use it?
6. Can a Nonprofit Get a Line of Credit Without Collateral?
Yes.
An unsecured nonprofit line of credit does not require the organization to pledge specific assets as collateral.
Financing Solutions provides unsecured lines of credit.
Traditional commercial banks may be more likely to require collateral, particularly when lending to smaller organizations. This is one reason obtaining a traditional bank line of credit can be challenging for smaller nonprofits that don’t own substantial assets.
Nonprofits should also understand exactly what product they are being offered. A short-term cash advance, for example, is not necessarily the same thing as a revolving line of credit and can have a very different cost structure.
7. Does a Nonprofit Line of Credit Require a Personal Guarantee?
This is understandably one of the biggest concerns for executive directors and board members.
Requirements vary by lender.
Financing Solutions generally does not require board members to personally guarantee the nonprofit’s line of credit. Its agreements do, however, contain provisions dealing with fraud and the organization’s obligations while money is outstanding.
Executive directors should always understand exactly what they are signing and specifically ask whether they or board members could become personally liable under any circumstances.
8. How Long Does It Take to Get Approved for a Nonprofit Line of Credit?
At Financing Solutions, we have seen nonprofit credit lines established in as little as approximately seven days, although the process can also take several weeks.
Interestingly, one of the biggest variables isn’t always the lender.
It’s the nonprofit.
Organizations that quickly provide requested documents and obtain board approval can move through underwriting much faster.
This is another reason not to wait until a financial emergency to begin the process.
9. What Documents Are Needed for a Nonprofit Line of Credit?
Documentation varies depending on the lender.
Financing Solutions typically requests documents including:
- Bank statements
- IRS Form 990s
- A voided check
- Identification for the individual signing the agreement
A commercial bank may require considerably more documentation, potentially including detailed financial statements and information regarding collateral.
Ask prospective lenders for a document checklist early in the process so your organization can prepare everything at once.
10. Can a Nonprofit Use a Line of Credit to Cover Payroll?
Yes. In fact, payroll is one of the most common reasons nonprofits seek access to a line of credit.
Imagine that a nonprofit knows a $100,000 reimbursement is coming but won’t arrive for another three weeks. Employees still need to be paid in the meantime.
A line of credit can bridge that temporary timing gap.
The important distinction is that a line of credit should generally address short-term cash-flow timing problems, rather than continuously financing an organization whose expenses permanently exceed its revenue.
11. Can a Nonprofit Use a Line of Credit While Waiting for Grants or Government Reimbursements?
Yes, and this is another common use.
Many financially healthy nonprofits experience cash-flow shortages simply because their funding arrives after expenses have already been incurred.
A line of credit can help bridge that gap.
However, lenders will want to understand where the nonprofit’s money comes from and the reliability of those funding sources. An organization with diversified revenue sources may be viewed differently from one that has recently lost a significant portion of its funding.
12. Should a Nonprofit Establish a Line of Credit Before It Needs the Money?
Yes. This may be the most important point in this article.
The best time to obtain access to capital is generally when your organization is financially healthy—not when you’re desperately trying to find money.
There are two reasons.
First, underwriting may be easier when the organization’s financial statements and bank activity aren’t showing signs of severe financial stress.
Second, management has time to evaluate its options, understand the agreement, obtain board approval and make a thoughtful decision.
At Financing Solutions, 90% of the nonprofit clients that establish a line of credit ultimately use it.
A line that isn’t being used can simply remain available as a financial backup.
13. Does the Board of Directors Need to Approve a Nonprofit Line of Credit?
Board involvement is commonly required and is an important governance step when a nonprofit takes on debt.
At Financing Solutions, board approval is required before the line is finalized. The process involves documentation showing that the board is aware of and approves the credit facility.
Executive directors considering a line of credit should therefore bring the board into the conversation before an urgent cash need develops.
14. What’s the Difference Between a Nonprofit Line of Credit and a Nonprofit Loan?
The biggest difference is how the money is intended to be used.
A line of credit is generally better suited to short-term working-capital needs and fluctuations in cash flow.
A term loan is generally more appropriate when the organization needs a larger amount of money for a longer-term investment and wants a predictable repayment schedule.
Think of it this way:
Line of credit: temporary cash-flow gap.
Term loan: longer-term financing need.
If you’re waiting three weeks for a reimbursement, a line of credit may make sense. If you’re financing a major long-term capital project, a term loan may be more appropriate.
15. Should a Nonprofit Use Cash Reserves or a Line of Credit First?
In many circumstances, using available unrestricted cash reserves will be less expensive than borrowing.
But the decision isn’t always simply about minimizing borrowing costs.
Executive directors and boards must also determine how much liquidity the organization needs to maintain. Completely draining reserves to address a temporary cash-flow shortage could leave the nonprofit vulnerable to the next unexpected event.
The right question is therefore not simply:
“Do we have cash?”
It is:
“How much cash does our organization need to keep available to operate safely?”
The answer will be different for every nonprofit.
The Best Time to Think About a Nonprofit Line of Credit
A nonprofit line of credit shouldn’t be viewed as a substitute for good financial management or as a solution to ongoing operating losses.
Its primary purpose is much simpler: managing temporary differences between when money goes out and when money comes in.
Nonprofits frequently know that revenue is coming. The problem is that payroll, rent and program expenses don’t wait for a grant payment, donation or government reimbursement to arrive.
That’s why executive directors should consider access to credit as part of their broader financial contingency planning.
The worst time to discover that your organization needs a line of credit is when payroll is several days away and the bank account is running low.
The better time to investigate your options is when the organization is financially healthy, cash flow is stable and you have the time to make a thoughtful decision.
A nonprofit may never need to use its line of credit immediately.
But having access to one can provide something almost as valuable as the money itself:
Options
Stephen Halasnik is a Managing Partner of Financing Solutions, a direct lender to nonprofits and small businesses. Over the last 25 years, Stephen has built 7 companies and he passionately believes that every nonprofit and business should have a line of credit to turn to as a cash back up plan. That belief, learned over years of working with banks for his own business needs, drove him to start Financing Solutions so credit lines could be easier to set up and less expensive.
