The potential role of loans in Sector: Summary report

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1 The potential role of loans in the ADHC funded NGO Sector: Summary report Department of Family and Community Services: Ageing, Disability and Home Care 28 April 2014 Bold ideas Engaging people Influential, enduring solutions

2 This page is intentionally blank. Nous Group nousgroup.com.au

3 Contents 1 The project considers NGO loan finance in the context of change in disability service provision The project is considering the potential role of loans to support ADHC funded NGOs Access to loan finance can assist sector growth and productivity The diversity and changing context of the disability sector creates specific funding requirements There are a range of loan products and providers available Commercial finance providers offer a wide variety of lending products Social financial service providers offer products that are designed to meet the needs of social sector participants Philanthropy and guarantees can enhance NGO access to loan finance Loans are a viable option to supplement NGO funding needs NGOs are using loan financing to further their social goals Options to improve access to loan financing are available Actions to increase the demand for loan financing are required Attributes of the sector discourage suppliers of loan products The relevance of barriers varies by the type of financing required The barriers to demand and supply can be reduced to expand the use of loan financing Further innovation in loan financing is possible Expanding the use of loans is possible for some, but not all, NGOs Some NGOs are excluded from accessing loan finance NGOs follow a similar journey in accessing loan financing Recommendations nousgroup.com.au

4 Glossary of key terms Assets Balance sheet Broker Capital Cash flow Collateral Covenant Default Equity Financial literacy Guarantee Impact investment Interest Lease Liquidity Loan Market rate NFP NGO Opportunity cost Patient finance Philanthropy Profit and loss Reputational risk Social finance/ investment Transaction cost Working capital Economic resources owned or controlled by an organisation, such as cash and property. Financial statement with an organisation s assets, liabilities and equity at a point in time (also known as the Statement of Financial Position). An intermediary that assists in sourcing and arranging loans between a borrower and lender. Financial assets, such as cash, that are used to support operations or for investment. Revenue or expense streams that result in the movement of cash in and out of an organisation. Asset or assets that a borrower offers a lender as security for a loan. Terms in a financing contract that specifies the extent to which certain activities may or may not be carried out, such as limits on any further borrowing. A loan is said to be in default when a borrower has been unable to make loan repayments when they fall due. A claim to ownership of an asset or organisation, after all other liabilities are paid. Knowledge and understanding of financial matters and concepts. An agreement under which a third party takes responsibility for a debt should the borrower be unable to make loan repayments. Investment made with the intention of generating measurable, beneficial social, cultural and environment impact alongside some measure of financial return. The cost of borrowing funds, typically expressed as an annual percentage rate. An agreement under which one party agrees to rent an asset from another party. A measure of readily available assets, such as cash and assets that can be readily converted to cash. An agreement to provide access to finance, on condition that the loan amount and interest are repaid under specific terms and agreed timeframes. The cost of borrowing on the open market. For this report, the term not for profit organisation (NFP) is used when discussing the broader Australian non government sector. For this report, NGO refers to an ADHC funded non government organisation, which is a subset of NFPs. The cost of the best alternative forgone in order to pursue a certain action. Debt products that provide long term returns, often with below market or zero return in the short term. Charitable donation undertaken with a desire to improve human welfare. Financial statement with an organisation s revenue, expenses and net result over a period of time (also known as the Statement of Financial Performance). The risk to the lenders reputation from having to take action should an NGO be unable to make loan repayments, such as from negative publicity. An approach to lending money or investment with the intention of delivering a social benefit and some level of economic return. Costs associated with undertaking a transaction. Short term assets available to cover day to day operations. nousgroup.com.au

5 Executive summary The project is considering the potential role of loans in the ADHC funded NGO sector In November 2013, Ageing, Disability and Home Care (ADHC), commissioned Nous Group to provide advice on the potential role of loans in the ADHC funded non government organisations (NGO 1 ) sector, and recommend approaches to address barriers to NGOs gaining access to loan finance. The project is one of a series of initiatives that ADHC is undertaking to support and build the capacity of the NGO sector. This summary report outlines the project's key findings and recommendations. There is a growing recognition that social investment and access to debt financing can assist the sustainability and responsiveness of the NGO sector. In recent years the Productivity Commission, the Australian Senate Economics Reference Committee and others have highlighted opportunities for encouraging social investment and increasing access to debt financing. The ADHC funded NGO sector is highly diverse, provides a wide range of services to the community, and has a long history of supporting people with disability. The National Disability Insurance Scheme (NDIS) represents a profound reform, providing a significant increase in funding that will benefit 460,000 Australians with disability, and expand the capacity of the disability services system to meet their needs. A range of other NSW Government reforms, such as Ready Together, are also aiming to deliver improvements in the lives of vulnerable groups through a range of initiatives and changes to funding arrangements. ADHC funded NGOs require finance, and loan products and providers are available to support their needs These reforms require new thinking by NGOs of the service models they use. NGOs require access to capital to invest in assets (such as property, vehicles and equipment) and organisational capability (such as staff development and systems), and to provide working capital for day to day operations. Loan financing has potential to assist with these financing needs, and can enable NGOs to make a step change in the value they deliver to their clients. However, the interest in and use of loan finance by the sector is variable, and the majority of NGOs have not previously considered using loan finance. There are a range of loan products available. Traditional lenders, such as banks, credit unions and building societies supply loan products at standard market rates. These products include loans to purchase or construct buildings, acquire equipment and other assets, and cash flow products such as overdrafts and lines of credit. More specialised commercial lenders also provide products such as financial leases, invoice discounting and factoring, and revenue based finance. A variety of social finance providers, such as Community Development Financial Institutions (CDFIs) and some specialised banking providers, offer products that seek a blend of financial and social returns. These include submarket loan options, patient finance and equity like debt products that are designed with the needs of social organisations in mind. The expansion of the social finance sector, particularly as a result of the Commonwealth Governments Social Enterprise Development and Investment Funds (SEDIF) initiative, has increased the pool of funding available to NGOs, and is also providing greater support to NGOs to explore their financing options. There are a range of examples of NGOs who have and are successfully using loan financing as part of their funding mix. 1 For ease of reading, throughout this report, references to the NGO sector refer to the ADHC funded NGO sector. The acronym NFP is used when discussing the broader Australian not for profit and non government sectors. nousgroup.com.au i

6 There are barriers to loan financing There are a range of barriers to both the demand for and supply of loan finance. Figure 1 below outlines the key characteristics of supply and demand, and barriers that impact NGOs accessing loan finance. Figure 1: Characteristics of demand and supply of loan financing Demand for loan finance Supply of loan finance Scale Client Financials ADHC funded NGOs Differentiated by: Skills Products and services Geography Structures Demand barriers Financial strength (Cash flows, Assets) Willingness to engage in loan finance Financing of investible propositions Supply barriers Evidence of financial strength Reputational risk Traditional: Banks, credit unions, building societies Cash flow lenders Private, institutional lenders Lease providers Providers Social / specialist providers: Specialist financial intermediaries Social impact investors Capital for asset investment Financing needs Working capital Capital for organisational capability development Governance, leadership and decision making Strategic and operational planning Transactional and opportunity costs Sector knowledge and products Market return: Cash flow lending Asset lending Leasing Socially responsible investments Products Blended financial and social return: Sub market loans Equity like Revenue based Peer to peer Loan guarantees The impact of barriers is not evenly distributed, and varies depending on an NGO s specific characteristics and its external environment. In general, larger NGOs with diverse products, multiple funding sources, existing asset bases, skilled and effective boards, and capability in financial management experience are better able to access loan finance than other NGOs. There are a range of options to address these barriers The primary barrier to both demand and supply is the ability of NGOs to understand and demonstrate their future cash flows. Without evidence that future cash flows will be sufficient to enable loans to be repaid, neither NGOs nor lenders are willing or able to enter into loan finance. Improving strategic planning and business planning, as well as looking to improve internal efficiencies, can assist in improving cash flows. Planning is also critical so that NGOs can maximise the benefits from the move from block funding to individual funding arrangements. The transition to the NDIS is creating a temporary challenge to NGOs in understanding and evidencing their future cash flows. NGOs are experiencing difficulties in determining what their future pricing and client volumes will be, as well as the impact that changes in the competitive environment may have. As a result, they are less able to understand their future cash flows and are less inclined to enter into loan finance during the transition. Similarly, lenders are cautious about lending within this environment. This situation is temporary, and will reduce as the NDIS is rolled out in each area. Options to address this barrier include disseminating information about the NDIS market as it develops to better inform sector participants and lenders, establishing a SEDIF style fund to support NGOs make the transition, and introducing a temporary, carefully structured and time limited guarantee arrangement to free up the flow of finance during the transition. These options will require further exploration, and participants in the social finance sector may be well placed to support further work in this area. Other barriers to the demand for loan finance can broadly be addressed through education initiatives. These should address improving strategic and business planning as a precursor for improving financial strength. Education can also enable better understanding by NGO boards and management teams of the potential for loan financing to support their organisation s social purpose, the loan products and nousgroup.com.au ii

7 providers that are available to them, and the steps they can take to be positioned to access loan finance that is suitable to their needs. Measures to address demand side barriers during the transition to the NDIS will also address many of the barriers to the supply of loan finance. Further options available to address supply barriers include publishing information about the NGO sector so that financial service providers can make more informed investment decisions. Further innovation in loan finance is possible There are a range of innovative approaches that have been identified through the review. One NGO has identified opportunities to use the savings of its own clients as a way to secure loan financing, in the process improving both the client s experience and financial footing. There may also be potential for establishing an investment fund that leverages surplus funds held by NGOs for lending across the sector. Additional opportunities include the development of combined social and financial return products by commercial lenders, and the potential for a Canadian stock exchange based lending initiative in the Australian context. There is a pathway for NGOs to gain confidence in loan financing, though some exclusion to loan finance will continue Addressing the barriers to loans should enable more NGOs to access finance, however some NGOs may still be unable to access loans. Loan financing is not suitable to all organisations, and loans should only be entered into where there are clear benefits for doing so. Examples from NGOs who have and are using loan finance demonstrate a journey through which NGOs gain access to loan finance. This begins with building consensus and planning for the future, building reserves and exploring the investment options, followed by trialling and expanding the use of loans as confidence in their use develops. Recommendations to expand the use of loan finance The project identified three overarching recommendations to better enabling NGOs to access loan finance. The focus of these recommendations is to reduce the barriers to the supply and demand of loan financing that limit NGO access to loans, and to better enable the transition to new funding arrangements. The overarching recommendations are as follows: Recommendation 1: Develop resources and tools to assist the NGO sector to understand and better access loan products Recommendation 2: Engage with the financial services sector to promote the understanding of and opportunities for NGO sector lending Recommendation 3: Further enable NGOs to successfully transition to new funding arrangements through additional initiatives nousgroup.com.au iii

8 1 The project considers NGO loan finance in the context of change in disability service provision The NGO Loan Financing Project has built on previous reviews to identify the potential role of loans in the ADHC funded NGO sector. The project has been undertaken in the context of a diverse disability sector, and a number of major reforms that are underway across the sector. The following pages discuss the background to the project, recent work regarding finance for the not for profit sector, and the investment in disability support that is currently underway. 1.1 The project is considering the potential role of loans to support ADHC funded NGOs Ageing, Disability and Home Care (ADHC) commissioned Nous Group to undertake the NGO Loan Financing Project, provide advice on the potential role of loans in the ADHC funded non government organisations (NGO) sector, and recommend approaches to address barriers to NGOs gaining access to loan finance. The project is one of a series of initiatives that ADHC is undertaking as part of its focus on supporting and building the capacity of the NGO sector, and is funded through the DisabilityCare Australia Sector Development Grants. This summary report outlines the projects key findings in terms of: the potential role of loans in supporting the ADHC funded NGO sector; including as a potential response to cash flow issues of disability NGO s moving from block funding to individual funding under current reforms the type of debt financing institutions and products available barriers for NGO s to accessing debt finance and how these may be addressed the potential of new/innovative approaches to providing debt financing and accessing debt finance. 1.2 Access to loan finance can assist sector growth and productivity Interest in using loan finance as part of the funding mix for NGOs has received more attention in recent years. In particular, recent reviews have highlighted: the potential for loan financing to supplement NGO capital sources, better enabling capacity building and growth in services and the social value delivered that access to loan finance has been a barrier to sector growth, with smaller NGOs facing greater levels of financial exclusion as a result of a range of barriers the role that social finance providers can play in developing capability and increasing the supply of loan finance to the sector. These factors are discussed in more detail below. nousgroup.com.au 1

9 The Productivity Commission identified a need to develop a sustainable market for NFP debt The Productivity Commission (PC) released its report on the Contribution of the Not for Profit sector in The report considered ways of improving the efficiency and effectiveness of the sector in response to the changing nature of relationships between government, business and Not for Profits (NFPs). The PC identified a lack of access to finance as an inhibitor on sector growth, as well as a factor that reduced the sector s ability to innovate and compete against for profit providers. The PC noted the importance of developing a sustainable market for debt finance as a key mechanism to increase the finance available to the NFP sector. Access to finance was also identified as being inconsistent across the sector: while most larger NFPs have ready access to capital from conventional lenders, other NFPs have difficulty in meeting lending criteria and often experience difficulties in accessing capital. 2 The PC also noted the emergence of specialised financial intermediaries, such as community development finance institutions (CDFIs), and the role these organisations have in improving access to capital. The Senate highlighted the role of CDFIs in enabling a sustainable market for social finance In response to the Productivity Commission s report, the Senate Economics Reference Committee (ERC) investigated the barriers and options to developing a capital market for the social economy in Australia in its 2011 report titled Investing for Good: The Development of a Capital Market for the Not for Profit Sector in Australia. The ERC identified that loan financing is an important element of the funding mix that will be required for the ongoing growth of the sector and to enable the sector to address the demand for services. The report also noted a range of barriers that limit the flow of finance to the sector, and highlighted the role of financial intermediaries, such as CDFIs, to connect financial investors and mainstream financial institutions with social economy organisations. This includes the development and promotion of tailored financial products to social economy organisations, such as new debt instruments, equity type investments and long term patient finance. CDFIs were also seen as best placed to engage with social economy organisations to build financial capacity, provide knowledge about the finance options best suited to the organisation, and help to link them to suitable sources of capital. Other projects have identified barriers and opportunities to the use of loan financing A range of other projects 3 have been undertaken that explore, either directly or indirectly, loan financing for the NGO sector. In summary, these have reaffirmed the work of the PC and the ERC, in particular: the potential benefit to the NFP sector and their clients of loan financing as a mechanism to increase the finance available. exclusion from access to finance is still a major factor, with larger, more sophisticated NGOs better able to access commercial finance than smaller NGOs. This is a concern both in Australia and internationally. the development of CDFIs is seen as a key element in enabling the growth of social finance and addressing exclusion, both in terms of lending to traditional NGOs, as well as supporting the development of social enterprises. 2 Productivity Commission 2010, Contribution of the Not for Profit Sector p Such as Ingrid Burkett (Commissioned by NAB), Finance and the Australian Not For Profit Sector (Foresters Community Finance, March 2011), Rosemary Addis, John McLeod and Alan Raine, Impact Australia: Investment for Social and Economic Benefit (DEEWR and JBWere, March 2013) and Coro Strandberg, Scaling the Social Finance Pipeline: Challenges and Opportunities (Strandberg Consulting Report, November 2013) nousgroup.com.au 2

10 philanthropic lending is another area that is seen as having potential for expansion, however this is as yet relatively underdeveloped in the Australian context, with a preference for philanthropic giving rather than lending predominating. there are barriers to the supply of and demand for loan financing that need to be overcome to enable the expansion of finance. Matching demand with supply requires the development of both suitable financial products and providers, and the development of investible propositions by the NGO sector. Increased access to finance is dependent on an expanded social finance sector A key finding of previous reviews has been the need to grow the Australian social finance sector to better enable NFP access to finance. This recognises that social finance in Australia is generally seen as an emerging area. There are a number of providers that offer lending services tailored to NFPs. These include impact investors such as Foresters Community Finance (Foresters), Social Ventures Australia (SVA) and Social Enterprise Finance Australia (SEFA). There are also a number of banking services that seek a mix of social and financial benefits, such as Bendigo Bank s Community Sector Finance and bankmecu. The Social Enterprise Development and Investment Funds (SEDIF) launched by the Australian Government in 2010 have resulted in the three new funds in the Australian market managed by Foresters, SVA and SEFA. The funds were established through a $20 million grant by the Australian Government, with an additional $20.6 million provided through private capital arranged by fund managers 4. In its most recent progress report, the Australian government identified that there had been strong interest in the funds, with almost 600 enquiries from social enterprises, which led to over 125 engagements with fund managers and 50 progressing more fully through the loan application phase. Overall, CDFIs in Australia have close to $150 million under management. 5 This represents a substantial pool of capital that is accessible by NFPs. Comparisons with markets in the US and UK highlight the potential for further growth in this area. For example: In the US, targeted development in the CDFI sector since 1994 has resulted in long term growth, with 808 certified CDFIs as of December In the UK, CDFIs have developed since the late 1990s. In 2012, 53 CDFIs were in operation, and provided 225m in new loans to 33,300 individuals and organisations The diversity and changing context of the disability sector creates specific funding requirements The NGO sector in NSW is large and rapidly growing. NGOs provide vital disability, home and carer services to support vulnerable people in NSW to live independently and lead fulfilling lives. The NGOs who support people with disability are diverse in terms of the services they provide, the groups they serve and their funding bases. 4 DEEWR 2013, The Social Enterprise Development and Investment Funds: Progress Report June 2013, p. 1 5 Social Ventures Australia Scoping Study, Community Development Financial Institutions (CDFIs), A new option for addressing financial exclusion in Australia, Social Ventures Australia, US Department of Treasury, CDFI certification data % %20v6.xls accessed 2 January Community Development Finance Association 2012, Inside Community Finance: CDFIs in the UK 2012 nousgroup.com.au 3

11 The disability support sector is undergoing significant reforms. In particular, the NDIS and Ready Together represent historically unprecedented growth in disability funding which will reach $3.3 billion by The reforms will dramatically change the way people access support. New arrangements include commitments to individualised packaging and person centred service approaches which empower recipients to have greater control over what services they require and how the services will be provided. These factors are discussed in more detail below. The NGO sector is a large and diverse group ADHC supports vulnerable people in NSW including older people, people with disability, their families and carers. In funding organisations, ADHC s aim is to provide better and more integrated services to these groups. In , ADHC provided a total of $1.3 billion in funding to 579 NGOs, with an additional $41 million provided to 117 councils. 9 Funded NGOs can operate across multiple sectors, be specialist disability service providers, home care or carers support service providers. The services provided to people with disability, their families and carers enable them to pursue meaningful lives. Funded services provide essential support to allow increased community participation, maximised wellbeing and independent living. A diverse range of services are provided by NGOs to people with disability, their families and carers. NGOs range from small, niche organisations that are wholly reliant on ADHC funding to provide a service to a handful of clients at a single location, through to state wide and national organisations offering an array of different service offerings to clients across a range of communities, drawing on multiple different revenue sources. Characteristics of NGOs indicate larger organisations are better placed to secure loans Analysis conducted through the project indicates that a number of characteristics of NGOs are significant when considering their capability to secure and sustain loan arrangements. In particular: medium and large NGOs generally have assets that can be used to secure loans, while smaller NGOs are less able to provide assets as loan security NGOs are heavily reliant on government funding. Analysis of the 2011 NSW Disability Services Quality Systems Survey identified that ADHC grants accounted for 50% or more of income for nearly 70% organisations, and 75% or more for over 40% of the NGOs. 10 NGOs hold varying cash reserves. Some NGOs hold sizeable reserves as a buffer against future events, while others prefer to invest all available resources into immediate services delivery. smaller NGOs are more likely to lack financial skills, as they have less access to staff and board members with specialist financial knowledge. The sector does not make substantial use of loan financing NGO interest in loan financing is variable, and loan finance is not widely used across the sector. Consultations throughout the project indicated that many NGOs have yet to engage with the idea of using loan finance. A survey conducted through the project identified that 56% of NGOs had not considered using loans over the past three years, and 19% of NGOs had made applications during this 8 Department of Family and Community Services 2013, Ready Together: a better future for people with disability in NSW p. 7 9 Department of Family and Community Services Annual Report PwC 2011, Potential contribution of the NGO sector to deliver more and better services to people with a disability, p. 15 nousgroup.com.au 4

12 time. Analysis by ARDT of a concurrent project identified similar results, with 58% of NGOs surveyed not having considered loans previously 11. Significant reforms are growing disability and aged care services Significant reforms to disability and aged care services in Australia are currently being implemented, reshaping both funding and service delivery arrangements at state and federal levels. Key reforms are outlined below: The NDIS represents a profound reform to supporting people with disability, their families and carers, and will dramatically change the way people with disability are empowered to control how and what services they require, enabling a better quality of life and increased social and economic participation. The NDIS will deliver a significant increase in funding, with the Australian Government providing $19.3 billion over seven years from Once implemented, the NDIS will benefit 460,000 Australians with disability who are aged 64 years or younger. Stronger Together is NSW s ten year plan for major disability sector reform and service expansion. Building on the previous five year, $1.3 billion investment, Stronger Together Two includes a commitment for a further 47,000 new places and introduced an additional focus on person centred approaches which enables people with disability to be the determinants of how their support resources are used. Living Longer Living Better details the Commonwealth s commitment to aged care reforms, which includes $3.7 billion in funding over five years. These reforms aim to significantly expand home care to assist people to remain living at home for as long as possible, and to introduce more choice and flexibility for people receiving care at home through Consumer Directed Care (CDC). Sector reforms are likely to impact the demand for loan funding The reforms will result in significant growth in the disability sector, which will require greater capacity to service the additional demand. The introduction of reforms will have implications on service providers, the markets they operate in and the way services are provided. Some of the key implications are as follows: Growth of sector(s) and the new market opportunity the sectors will experience unprecedented levels of investment and growth, which will require adequate capacity to meet the demand created. For NGOs this growth represents an opportunity to provide services to a larger market and increase their scale of operations. The increased investment is also likely to result in an increasingly competitive market which attracts new entrants, merging and partnerships. Increased competition may result in some providers losing market share. Introduction of individualised funding arrangements sector reforms are empowering individuals with greater choice and control to determine what and how they apply their resources. This change in funding approach will require service providers to design appropriate services that attract consumers to achieve funding security instead of relying on block funding arrangements. Person centred service models providers will be required to develop new service delivery methods and support systems. The sector reforms either directly empower consumers to choose the services they require or mandate the use of new service delivery methods that are delivered in more person centred ways (e.g. Consumer Directed Care). Providers may require funding to acquire new systems or develop new service models to retain or attract new market share. 11 ARTD, 2014, Evaluation of the Community Asset Building Project (Draft Report), p.34 nousgroup.com.au 5

13 2 There are a range of loan products and providers available Loan financing can be useful as part of an NGOs overall funding mix. There are a variety of loan products and providers available, and in some instances this variety provides a broader range of options than is the case for many for profit organisations. Loan products include generic products that are available at market interest rates, to more specialised products that can be at sub market rates. There are also a variety of lending providers available, from mainstream banks, credit unions and building societies, through to more specialised social finance providers that seek to achieve a mix of financial and social returns. Table 1 below provides an overview of the various financing options available, both within Australia and examples of emerging specialist providers internationally. For ease of understanding, financing options are classified as commercial finance (i.e. lending that is available to any business or organisation, generally at market rates) and impact investment and patient finance, which aim to achieve a mix of both financial and social benefits. Table 1 : Overview of financial products and providers Products Traditional providers Social / specialist providers Australia Commercial finance Cash flow lending and short term loan products (secured and unsecured loans, credit cards, lines of credit, overdrafts) Asset lending (against inventory, property, plant and equipment, construction etc.) Financial leases Invoice discounting and factoring Revenue based financing Impact investment and patient finance Similar products as those in commercial finance, as well as: Sub market return loans (zero interest, structured lower return) Equity like investments and patient debt Supplier finance Peer to peer loans Authorised deposit taking institutions (banks, credit unions, building societies etc.) Private, corporate and institutional investors Cash flow lenders Lease providers Brokers Private, corporate and institutional investors Banks (through foundations) Superannuation funds (particularly ethical super funds) Each of these is discussed in more detail in the following pages. Specialist financial intermediaries e.g. Social Enterprise Finance Australia (SEFA), Foresters, Social Ventures Australia (SVA), Community Development Financial Institutions (CDFIs) Social investment funds Impact banks, e.g. Community Sector Banking (CSB) Impact investors, e.g. Small Giants, Impact Investment Group Social / specialist providers International Specialist financial intermediaries, e.g. New Hampshire Community Loan Fund USA Impact banks, e.g. Triodos Bank Netherlands, Charity Bank UK Impact investors, e.g. NESTA, Bridges UK Impact first stock exchange platforms, e.g. SVX Canada Peer to peer lending platforms, e.g. societyone.com.au, zopa.com, kiva.org nousgroup.com.au 6

14 2.1 Commercial finance providers offer a wide variety of lending products Commercial finance is lending available to businesses and organisations, usually at market rates. Lenders enter into loans to generate a financial return from the investment, with interest rates varying based on the investment s risk profile. Accessing commercial finance requires that an organisation can evidence that both the loan principal and interest can be repaid when they fall due. The main products available in this category are outlined in Table 2 below. Table 2: Types of commercial lending products available Product type Cash flow lending Business investment term loan Asset lending Financial lease Invoice discounting Factoring Commentary Cash flow lending helps organisations to smooth their cash flows and can also provide temporary relief against unforeseen financial events. These can take the form of: Credit cards: credit cards enable organisations to make purchases, and in some instances receive cash advances. Minimum repayments are usually required each month. Credit cards may have higher interest rates than other types of loans, as they can be more risky for lenders. Lines of credit: lines of credit provide a facility that the borrower can draw from up to a maximum agreed amount. This is advantageous to the borrower as no interest is paid on the unused credit. Overdrafts: an agreement under which the borrower can withdraw money from their bank account beyond the balance of the account (i.e. below zero). The borrower pays interest on this negative balance. Business investment loans enable organisations to borrow a fixed amount for investment in different aspects of their organisation s operations, such as investing in new IT systems, purchasing minor equipment, or developing a new enterprise offering. Loans of this type generally take the form of: Secured loans, where the lender takes a charge over an asset in order to protect themselves in the event of a default. Unsecured loans, here the lender does not have a charge over an asset. This type of loan poses a higher level of risk to the lender and therefore the interest rate payable is generally higher. Lending that uses an asset as collateral for the loan. If the loan is not repaid, the asset is taken by the lender, and can be sold to recover the balance of the loan (known as foreclosure). Loans for which the collateral is inventory or accounts receivable are more commonly used for working capital. Larger loans against more significant assets, such as property, plant and equipment, are often used for development or investment. In some cases, the development itself may be used as collateral for the loan, such as the construction of a new property. A financial lease is a commercial arrangement where the borrower (lessee) obtains the use of an asset which is purchased and owned by a finance company or third party (lessor). The lessee makes a series of payments to the lessor for use of the asset, which covers the purchase cost of the asset plus any additional interest. The lessee may have the option to acquire ownership of the asset at the end of the lease. This is most commonly used for the purchase of motor vehicles or major machinery items. Invoice discounting can be used to improve an organisation s cash flow by reducing the lag between invoicing a client and receiving payment. Under an invoice discounting arrangement, finance is provided by a lender against the value of the goods and services provided by the borrower to a third party. The lender provides a proportion of an invoiced amount to the borrower when the borrower issues an invoice to a customer. The remaining percentage (less interest and fees) is available to the borrower to draw against once the customer has paid the invoice in full. Factoring operates similarly to invoice discounting. However under a factoring arrangement the lender takes responsibility for maintaining the sales ledger, credit control collections and, in some instances, the management of bad debt. nousgroup.com.au 7

15 Product type Revenue based financing Commentary Finance is provided in return for a percentage of ongoing gross revenues until the initial principal amount, plus any additional amounts, is repaid to the lender. Borrowers generally enter into revenue based financing when they do not have the asset base to support a commercial loan, and interest rates are generally higher than for lending secured against assets. Commercial finance is available through a broad range of traditional, generally for profit providers of varying sizes and sophistication. An overview of major provider types is as follows: Banks, credit unions and building societies represent the main providers of commercial finance. Major Australian banks have specialist teams that focus on the NGO sector, though they may refer smaller NGOs to their local commercial bank managers. Credit unions and building societies also provide loans on more or less favourable terms than major banks, depending on a range of factors, including their own costs of capital and their priorities in terms of purely financial or mixed financial and social benefits. Cash flow lenders are specialist financial service providers that provide cash flow finance and solutions to small and medium sized enterprises. Clients are typically in the $250,000 to $10m turnover range and borrow amounts ranging from $50,000 to $1m. Financial leases can be obtained through the financing or leasing arm of a commercial bank, or directly from the provider of the product or service (e.g. heavy machinery can be leased from the manufacturer). Alternatively, a broad range of independent lease providers also exist, who generally specialise in providing lease agreements for a particular type of asset, such as motor vehicles. Finance brokers are an intermediary that can assist organisations source appropriate lenders, and educate and assist organisations through the loan application process. Brokers tend to be more relevant for smaller and medium sized organisations that do not have regular access to expert financial advice, and have limited knowledge of the finance sector. Private, corporate and institutional philanthropic funds are a significant source of capital for the social sector. The level of lending through these arrangements is generally lower than in comparable markets, such as the United States, due to the preference for philanthropic giving rather than lending. 2.2 Social financial service providers offer products that are designed to meet the needs of social sector participants Social financial service providers have developed a range of products that are aimed at the funding needs of social sector participants, and can be better aligned with the financing needs of NGOs. These products can broadly be seen as impact investment and patient finance products. Impact investment is a form of socially responsible investment that is made in companies, organisations and funds with the intention to generate a measurable, beneficial social, cultural and environment impact alongside some measure of financial return. Impact investment targets a range of financial returns from below market to above market rates, depending on the circumstances and the relative weighting of social impact versus financial return desired by the investor IMPACT Australia, Investment for social and economic benefit, March 2013, p.2. nousgroup.com.au 8

16 Patient finance refers to debt products that provide long term returns, often with below market or zero return in the short term. The borrower may not be required to make any repayments on these loans for the initial years, but make higher or equivalent payments in the later years. Impact investment and patient finance loan products can be similar to commercial finance products, however impact investment aims to address social, cultural and environmental challenges with the funds. For patient finance, the difference is the structure of the repayments, with the delayed returns representing an investment in capacity building. The additional products available in this category are outlined in Table 3 below. Table 3: Impact investment and patient finance products Product type Sub market return loans Commentary Sub market return loans are products provided at below market interest rates. These may take the form of: Zero interest loans: loans on which the lender does not charge any interest. Structured lower return loans: loans, typically negotiated on a case by case basis between social investors and borrowers, designed to provide a blend of social and financial return that reflect the priorities of the investor. Equity like investments Supplier finance Peer to peer (P2P) loans These are products that are structured like equity investments, but do not necessarily reflect an ownership stake in the borrower. These may take a variety of forms, such as: Subordinated loans, whereby repayments are only made after higher priority debts have been serviced. Patient debt is a long term investment and capacity building product in which the return to the investor may be nil or low for an initial period and then increases over time. Supplier finance is an arrangement whereby funds are provided by a large organisation to one of its suppliers in order to support the operations of the supplier. In such cases, the lender is generally reliant on one supplier (the borrower) for input into their product development or service delivery, and supporting the supplier is mutually beneficial to both parties. These loans can be at nil, low or market rates. P2P lending involves private donors providing loans directly to individuals and ventures rather than through a financial institution or investment fund. The structure and financial returns for these loans are determined on a case by case basis. It is important to note that some commercial providers also offer sub market return products. For example, banks may provide lending at sub market returns through foundations, while some credit unions and building societies may seek a mix in social and financial returns and are therefore willing to undertake loans at sub market rates of return. In addition, there are a range of other organisations that provide finance for NGO lending, either directly or indirectly. In particular: A small number of specialist financial intermediaries exist in Australia that are not for profits themselves and focus on lending to social enterprises and not for profit organisations. These organisations provide commercial financial products (such as loans) comparable to those offered by traditional providers, and may also provide education and assistance with the loan process. Community Development Financial Institutions (CDFIs) are emerging in Australia, providing credit and financial services to underserved markets and populations. CDFIs can take various forms, including community development banks and credit unions, and community development loan funds. nousgroup.com.au 9

17 Social investment funds are a particular type of financial intermediary that manage funds to invest in social finance organisations and target social investment opportunities. Impact banks are public banking institutions that make selective investment and lending decisions based on their founding principles to achieve positive social, environmental or cultural impact. In Australia, Community Sector Banking is one example of this approach. Impact investors are individuals or organisations that engage in impact investment. However, in the context of this report, impact investors are individuals or organisations that specifically invest, as opposed to lend, for social impact. As such, this refers to equity investors and venture capitalists that provide financing to organisations that create positive social, environmental and cultural impact in exchange for an ownership stake. Impact first or social stock exchanges are exchange platforms that enable debt or equity investments for social good. They operate similarly to regular stock exchanges. There are currently no exchanges of this type in Australia, and this represents a potential area for innovation and development. Peer to peer (P2P) lending platforms have emerged as an innovative means of credit provision to small social enterprises and new ventures in developed and developing countries. It is usually managed through a commercial online platform such as societyone.com.au (Australia) or zopa.com (UK), though P2P lending can occur offline as well. While not a direct lender to NGOs, superannuation funds do provide funding to the sector via social finance intermediaries. Some superannuation funds have a mandate to make social investments at either market or sub market rates of return. For example, Christian Super partnered with the Australian Government and Foresters Community Finance in 2011 to establish the Community Finance Fund, which aimed to enable community organisations to transition from rented accommodation to their own premises. 2.3 Philanthropy and guarantees can enhance NGO access to loan finance Philanthropy can play an important role in lending to NGOs Philanthropy can take the form of donations or sponsorships, both on a one off or ongoing basis, and can involve individual giving or through organisations. Philanthropy is not a form of loan financing. However, philanthropic giving can be an important source of pre lending finance, as: it can provide the basis for a deposit for a loan developing a cash reserve through regular saving can in itself provide comfort to lenders of an ability for financial discipline, which reduces the risks to the lender, increasing their willingness to lend it can be a practical addition to loan financing, and evidence of the backing of a lender can be leveraged to encourage charitable giving. Some forms of philanthropic funding are: Philanthropic foundations: Funding from these organisations can take the form of grants or donations, as well as venture philanthropy to support the establishment of new social ventures. Local community foundations and cooperatives: These are geographically concentrated funds that channel funds from institutional and retail investors seeking to make values driven investments that benefit local communities. nousgroup.com.au 10

18 Ancillary funds: Public and private ancillary funds make distributions to deductible gift recipients, such as registered not for profit organisations. Primarily philanthropic in nature, ancillary funds may provide money, property or benefits and are required by law to disburse 5% of their funds under management annually 13. Crowd funding: Crowd funding online platforms enable a large number of individuals to contribute small sums towards organisations, projects or product development. A range of platforms focus on fundraising for NGOs, including crowdrise.com, indiegogo.com, razoo.com, justgiving.com, weeve.it and firstgiving.com. Loan guarantees are a further option that can enable access to loan finance Loan guarantee arrangements are a form of additional security, and can be used to enable lending to organisations that are otherwise precluded from entering into loan finance. Guarantees can take a variety of forms: Government guarantee schemes: Governments may undertake different types of guarantee arrangements to enable lending, particularly where a market failure exists in the supply of loan financing. Such schemes are a common tool internationally used to increase access to credit for small yet viable organisations 14, and have previously been used in the Australian NFP context. Guarantees by other organisations: Other organisations may be willing to provide a guarantee for a loan to an NGO, generally arranged through the personal relationships of management or board members. The other organisation would agree to take over the repayments of an NGO that was unable to meet its loan obligations. By providing this security and reducing the risk involved, a lender may be more willing to lend, and may also be able to lend at a lower interest rate. Personal guarantees: The requirement for personal guarantees by board members is common practice for lending to NGOs and small businesses by commercial banks. Social finance providers have recognised that this can be a barrier for NGOs to undertake finance, and offer loan products that do not require director guarantees. 2.4 Loans are a viable option to supplement NGO funding needs While many different types of loan products exist, the purpose of all loans is similar; to provide additional or supplementary cash to an organisation in order to fund operations or expand activities. In a simple loan, a borrower receives funds from a lender, with the repayment of the original capital and interest made at agreed points of time in the future. In taking out a loan, an NGO s expenditure increases over the period that the loan is being repaid, but the loan ultimately benefits the organisation through an increase in revenues over the longer term. In turn, this enables the organisation to increase the investment it can make in the products and services it provides. A prerequisite to taking out a loan is having the ability to repay the capital and interest when they fall due. As such, NGOs need to demonstrate to lenders that they can generate sufficient future cash flows to make repayments. 13 Australian Charities and Not for profits Commission, Factsheet: Private and public ancillary funds and the ACNC, NSW Business Chamber, Small Business Access to Finance, P 96 nousgroup.com.au 11

19 Different types of lending represent different levels of risk to lenders. As risks increase, the interest rate at which lenders are able to provide finance also increases. Additionally, increasing risk levels also affect the size of loan that a lender is willing to enter into, and whether they are able to provide finance at all. Reducing the risks faced by lenders is a major factor in accessing affordable loan finance. Providing loan collateral (such as a property under a mortgage or different types of loan guarantee), evidencing a history of savings or previous successful repayment of loans, and clear plans about how loan finance will be used are common approaches to reducing lender risk. 3 NGOs are using loan financing to further their social goals A wide range of NFPs are using loan finance as part of their funding mix and to further their social goals. Loan financing represents an opportunity to create a step change in the social impact that NGOs can achieve. Figure 2 below illustrates the theoretical impact of loan financing on an NGO s ability to deliver social impact, moving from incremental growth using available revenue streams, through a step change as additional loan finance enables service expansion and enhancement. Figure 2: Illustrative example of impact of loan financing on NGO social impact Social impact Long term trajectory of growth in social impact Social impact growth through leveraging additional finance Step change in social impact from additional finance Time While Figure 2 is illustrative only, it is broadly consistent with the experiences of NGOs that have explored finance in the past, and the experiences of social finance providers working with the not for profit sector nationally. Some examples of the way in which organisations have used loan financing are outlined in the case studies on the following pages. nousgroup.com.au 12

20 Case study 1 Childhood disability NGO expands into new building When a neighbouring property came up for auction, a childhood disability service provider decided to explore whether it could purchase the building to expand its operations. The board had previously agreed to purchase a property as part of its long term strategy to expand services, and after more than a decade of saving a deposit of almost $300,000 was available. The CEO approached a range of lenders. While some lenders were not able to provide a loan, a commercial lender agreed to enter into a mortgage following from lobbying by board members and management. The service provider successfully purchased the property, and is now helping more families and children through its new building. The loan is progressively being paid off, and the board and management have a new confidence in using loan finance. The loan is also being used as a working capital facility. All revenues are being paid directly into the mortgage account, reducing the interest costs. Day to day cash needs are then transferred to the service provider s transactional account each month, which is helping to smooth out cash flows. Case study 2 Day program provider uses line of credit for new vehicles This organisation provides a range of supported day programs to people with disability. It has a small fleet of vehicles that it uses to transport its staff and clients to day program venues. The vehicles were getting old, and it was decided that finance was needed to renew the fleet. The service provider used a loan broker to help find a suitable loan. After looking at multiple loan options, the broker identified and supported the service provider to apply for a $100,000 line of credit facility. The service provider successfully applied for the line of credit, and purchased some new vehicles. The line of credit is still in use, and is now used to smooth cash flows. Any income received is used to pay off the line of credit to reduce interest costs. Case study 3 Supported day program NGO overcomes short term funding need This NGO provides early intervention and day care programs for children with disability and learning difficulties. In the lead up to the Christmas period, the organisation identified a need for additional funding due to some unexpected expenses and an inability to withdraw cash from a trust account. Based on the upcoming payment of grant funding and the collateral in the trust account, the NGO was able to access an overdraft facility that was sufficient for their immediate needs. The overdraft was then repaid once the next grant funding was provided early in the new year. Case study 4 NGO uses mortgages and client savings to deliver social benefits This not for profit community organisation provides a range of support services for people with disability, and has been using loan finance for over a decade. This provider has built up a sizeable property portfolio to support its operations and provide housing for its residential clients, and has used mortgage finance to purchase ten properties. Key aspects to this organisation s approach have been: Taking the view that property should be viewed on a why not buy rather than why buy basis Engaging with the board to develop trust in management recommendations about property purchases, which enables rapid decisions to be made when good purchase opportunities are identified Developing a strong, trusting relationship with their bank manager, making sure that they are well aware of the financial position of the organisation Undertaking valuations of the property portfolio every 3 years, so that the true value is understood and can be used as the basis for further property purchases Being prepared to sell properties if they no longer meet the needs of the organisation nousgroup.com.au 13

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