Debt can be a useful source of capital for many arts and cultural organizations.
As different kinds of financing serve different purposes, it’s important to understand the reasons why nonprofits borrow money, and the types of loans that support them.
- Cash and receivables management: organizations often borrow to help smooth the gaps between when revenue is pledged or earned and bills get paid.
- Lines of credit provide access to cash to help manage seasonal or cyclical mismatches in revenue and expenses.
- Working capital bridge loans are made to finance certain expenses in anticipation of future payment via foundation or government pledges.
- Asset acquisition: Debt can help finance the construction, purchase or renovation of facilities and the acquisition of equipment.
- Term loans, mortgages, equipment loans and tax-exempt bonds support these investments.
- Bridge loans help finance asset acquisition prior to the receipt of capital campaign pledges.
- Growth: In rare instances, debt can help finance the temporary deficits (or fixed assets) that often accompany a growth opportunity.
In evaluating whether debt is appropriate for your organization, consider your particular needs for financing within the context of your current financial stability.
As a general rule, debt should not be used to help finance chronic deficits or cash shortages. Borrowing increases the need for surpluses and positive cash flows because these are the sources of funds for debt repayment.
Borrowers need to be clear about the kind and amounts of debt they need and their plan for debt repayment. Organizations that seek working capital for cash flow management purposes, for example, should develop monthly cash flow projections that show when revenue will materialize to pay down (or “clean up”) their credit line at various points throughout the year. Facility and growth financing are only appropriate for organizations that can show a clear pathway to debt reduction through recurring operating surpluses once their project or expansion is complete.
Management Tip: Before borrowing, make sure your board and staff leadership understand the benefits, limitations and risks of the loan. Be clear about your organization’s ability to repay the loan through funding commitments and/or execution against a fundraising plan. Develop contingency plans in the event that your projected repayment source doesn’t materialize.
