Nonprofits have needs for various types of credit facilities from financial institutions. Credit needs vary from operating lines of credit to long-term financing for buildings and equipment.
As in any sector there are those organizations that are debt adverse and others that use substantial debt to leverage growth. Regardless of where your organization is on that debt continuum, there is a common thread when it comes to requesting a loan from any financial institution and that is the underwriting process from the lender.
To help you and your organization increase the success of obtaining a loan and shorten the time for a decision, there are two significant things that you as the borrower can do — tell your story and make sure the financial reporting package is both complete and tailored to the request.
Your organization acquires a new business partner when it obtains a loan — the bank. As with any new partner, bankers want to better understand needs and activities exist before they “invest.” To help in creating this understanding, you should first prepare a document that contains the following:
- A short history of your organization, no more than one page;
- A short and easy to follow description of the core programs, again, no more than one page in total;
- A copy of the Articles of Incorporation and By-laws;
- An organizational chart(s) of both management and the board of directors;
- Bios or resumés of the key management and officers of the board of directors;
- A description of the competitive landscape the organization operates in for all revenue and funding sources, including a list of organizations that provide similar programs; and,
- A description of the purpose for the loan and what the potential economic outcomes would be if you obtain the loan.
For some of the above, the inclusion of charts, graphs and pictures are encouraged to assist the underwriter to more easily understand your organization.
To prepare a complete and easy to follow financial information reporting package, this presentation needs to be well organized and complete. The financial reporting package should contain:
- The three most current years of audited financial statements or the highest level of financial statements prepared by an independent certified public accountant (CPA);
- The most current interim/internal financial statement;
- The three most current years of federal Form 990;
- A current, detailed listing and ageing report for pledges and receivables of any kind;
- A current, detailed listing and ageing of accounts payable and other outstanding debt;
- A description of the major revenue sources, including a discussion of any unusual timing of the revenue streams; and,
- A description of the major expense items.
While preparing these two information packages it might be helpful for you to understand the key elements that go into the underwriting process at any financial institution. The cornerstone of underwriting is characterized by the five C’s of credit. These five C’s assist the underwriter in determining two things — the credit worthiness of the organization — and “most importantly to the lender” your ability to repay the debt.
Character equals integrity. This is the general impression you and the organization make on the potential lender. The lender will form a subjective opinion as to whether or not the organization is sufficiently trustworthy to repay the loan. The educational background and experience of the management team in the industry will be reviewed.
The quality of your references, if any are requested, and the background, tenure and experience levels of your board of directors will also will be taken into consideration.
Capacity equals sufficient cash flow to service the obligation. The ability to repay is often viewed as the most critical of the five factors. The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash flow from the organization, the timing of the repayment, and the probability of successful repayment of the loan.
Payment history on existing credit relationships is considered an indicator of future payment performance. Lenders also will want to know about additional sources of repayment, also known as a secondary source of repayment.
Capital equals net worth. This is the net cash and other assets in the organization and is often an indication of how well it has been managed from a fiscal perspective. Capital is often referred to as “skin in the game,” meaning the organization has assets at risk along with the lender, thus ensuring a motivation and desire to have successful operations.
Collateral equals assets to secure debt. Providing collateral means that an owned asset or assets are pledged to the lender with the agreement that it will be the repayment source in case you can’t repay the loan. A guarantee, on the other hand, is just that, some other person or entity signs a guarantee document promising to repay the loan if you can’t. These personal guarantees are more often used in general commercial lending to privately owned businesses.
Most often loans to nonprofits do not contain these guarantees. However, in some circumstances a lender might require such a guarantee in addition to collateral as security for a loan. This might be a requirement for an organization that has had some difficult financial history.
Conditions equals the general economy in the borrowers industry. This focuses on the intended purpose of the loan. Will the loan proceeds be used for working capital, additional equipment, or property? The lender also will consider the local economic climate and conditions both within the industry and in other industries that could affect your organization, such as funding or contracting sources.
By contemplating and considering the five C’s of credit the preparation of your loan “package” will provide the lender and its underwriting group with sufficient information to have a clear picture of your organization.
The preparation of these two documents should be completed before any meetings with a potential lender. A complete, well-organized package will demonstrate to the lender the understanding you have of your organization and that you are approaching the loan request in a thoughtful and professional manner.
While the preparation and delivery of this package does not guarantee a loan will be approved, it does make it easier for the lender to provide an answer more quickly. By always viewing the lender as a “partner” in your organization the process will be less painful and generally more successful.
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Robert Leslie is director of nonprofit services for Mutual of Omaha Bank and is based in Phoenix, Ariz. His email is [email protected]
