Loan financing for service providers

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1 Loan financing for service providers May 2014

2 Disclaimer The materials presented in this document are for general information only and should not be taken as constituting professional advice. Users should seek independent advice to better understand how the information presented relates to their unique circumstances. Loan financing for service providers

3 Table of contents Loans are an emerging source of finance for the social sector... 3 Loans can be a practical source of additional finance... 5 Traditional lenders provide a wide range of loan product... 6 Social finance lenders can provide advice and tailored loans... 7 Loans can help service providers expand social value... 8 There are a variety of loan products available... 9 There are some common steps to take out a loan Assessing your organisation s readiness to use loans Service providers overcome common challenges to access loans Frequently asked questions Further information and resources Loan financing for service providers

4 Loans are an emerging source of finance for the social sector Background Loans have been around for a long time, and are a common approach that organisations use to help them invest in the future. They can be used in diverse ways, ranging from everyday transactions (like using a credit card to purchase supplies) through to major investments (like a mortgage to buy a property). A wide variety of organisations use loans as part of their financing mix. When used well, loans can help smooth out an organisation s cash flows, support its operations, and enable major investments, such as developing new products and expanding services. Historically, social sector organisations have used loan finance less often than organisations in other sectors. In part this has been due to challenges in accessing loans from lenders, as well as hesitancy by an organisation s decision makers about using loans. However, loan products are becoming more and more accessible as lenders look at how they can better support the social sector. Traditional lenders, like banks, building societies and credit unions, are learning how to work more effectively with the sector and some have developed specialist teams that focus on not-for-profit organisations. The social finance sector is also emerging in Australia. A range of specialist lenders provide loan products that are designed specifically with the social sector in mind, and work with organisations to help them explore their financing needs. Social sector organisations are also finding new and innovative ways to use loan finance to help them and to help their clients. An increasing range of social sector organisations have and are using loan finance to support and build their services. Purpose of this document This toolkit has been developed to help organisations like disability service providers understand loan financing, and assist them as they explore their loan financing options. It builds on a more detailed report developed by Nous Group for Ageing, Disability and Home Care (part of the NSW Department of Family and Community Services) in early 2014 regarding the potential role of loan financing for service providers 1. The material on the following pages provides some high level information about the loan products and providers that are available, and some practical guidance to help service providers explore their loan financing options. A range of case studies are also included that demonstrate how service providers and other social sector organisations are using loans. 1 This report, titled The potential role of loans in the ADHC funded NGO sector, is available at Loan financing for service providers 3

5 Who should use this toolkit This toolkit is intended to be used by not-for-profit disability service providers that may be interested in loan financing and how it can support the work that they do. Other not-for-profit service providers may also find the content useful in considering their loan finance options. It s been designed to be used by a service provider s key decision makers. In particular: Board members can use this toolkit to help assess whether loan financing is appropriate for their organisation and to determine what strategic discussions and decisions may be needed. CEOs and senior management staff can use this toolkit to help them understand the financial information needed to make loan decisions and to apply for a loan. Finance Managers can use this toolkit to identify potential gaps in current financial management practices, and where the Board and management team may need extra decision making support or information. Loan financing for service providers 4

6 Loans can be a practical source of additional finance Many types of loans exist, and the purpose of most loans is broadly similar to help an organisation fund its operations or expand its activities. An organisation enters into a loan with a lender and receives (or is given access to) an agreed amount of money. In return, the organisation repays the original loan amount plus any interest at agreed times in the future. Loans for service providers generally fall into one of three categories: loans to invest in major assets, such as to purchase property, vehicles or equipment loans to invest in organisational capability, such improving systems and processes, or to develop staff working capital loans to help with day to day cash flows. The type of loan that a service provider uses varies depending on its needs and its ability to make repayments. Some loans, such as mortgages, are designed for making major, long term investments, while other products are better suited to address smaller, short term funding needs. Loans should only be used when there is an identified use for the funds, and when it is clear that the loan can be repaid. Using a loan can help service providers in a variety of ways, however it s important to be clear about why a loan is being used to make sure it is appropriate to the organisation s needs. Additionally, it is important to understand how the loan will be repaid, and to be able to demonstrate that future cash flows will be enough to make repayments when they fall due. Purchasing new vehicles using a line of credit 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 assisted 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. Loan financing for service providers 5

7 Traditional lenders provide a wide range of loan product In addition to their transaction and savings products, traditional lenders such as banks, building societies and credit unions are a potential source of loan finance. Service providers often have existing relationships with traditional lenders through their everyday banking arrangements, and speaking to your local branch manager is a great place to start exploring loan options. Local branch managers are very knowledgeable about the loan products available. They are also well placed to provide advice, as most lending is handled at a local level. As branch managers typically focus on lending to small and medium-sized businesses it s important to build a relationship with them so that they can get a good understanding of your organisation, how it works, and what its funding needs might be. Loan brokers can also help to source loan products from traditional lenders. Brokers have information on a wide range of loan products from many different providers, and can advise on the appropriate loan for different situations Childhood disability service provider expands into a 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 $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 approaches 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. Loan financing for service providers 6

8 Social finance lenders can provide advice and tailored loans Social finance is an emerging area in Australia. Social finance providers specialise in working with organisations to achieve both social and financial returns for their investors. They can also work with service providers to help them explore their financing options, tailoring loan products that are suited to their specific needs. This can mean that loans can have terms and conditions that are better suited to a service provider s situation, such as longer repayment periods and interest arrangements structured in different ways. Many social finance providers have also removed the need for director guarantees in recognition of the different governance arrangements in the sector. Foresters Community Finance, Social Enterprise Finance Australia and Social Ventures Australia are active in this space, and have received government funding to support the growth of social finance. Organisations like Community Sector Banking and bankmecu have also developed loan products with the social sector in mind, blending traditional and social finance approaches. Disability services provider moves from renting to owning 2 This provider supports people with an acquired brain injury through training, education, accommodation and community programs. When the lease on a small rental house was due to expire, the organisation saw an opportunity to act on their plan to enhance quality and grow their services by purchasing a property. The provider sought and was approved for a loan from a social finance provider to purchase, renovate and customise a property. This enabled the organisation to build tailored consulting and training rooms to meet their needs, provide hot-desking facilities to help travelling carers remain connected, deliver higher quality case management and counselling services, and provide a healthier environment to support better client and staff wellbeing. 2 Based on Community Sector Banking case study, real stories: supporting people affected by brain injury, available at Loan financing for service providers 7

9 Loans can help service providers expand social value When used appropriately, loan finance can help make a step change in the social impact a service provider can achieve. Figure 1 below illustrates how this can happen, with the additional finance available from a loan helping the organisation increase the social value it generates, going beyond what it could deliver without a loan. While Figure 1 is illustrative only, it does reflect the experiences of the wide range of social sector organisations that have and are using loans. Social impact Figure 1: Illustrative example of impact of loans on a service provider s 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 Loan financing for service providers 8

10 There are a variety of loan products available There are a variety of loan products available that can be useful for service providers in different situations. Some of the most common products are outlined below. Credit cards for service providers can be a practical way of making purchases like petrol for a work vehicle and everyday supplies. Monthly credit card statements and online reporting facilities are also useful for tracking where money is being spent. Many credit cards come with an interest free period, and when used appropriately this can help smooth out a service provider s payments so that they align better with income. In choosing a credit card it s important to understand the interest rate and any fees and charges, as these can vary widely between different providers. Overdrafts and lines of credit effectively allow an organisation to draw extra funds when needed, up to a set limit. They can provide a buffer against the chance an organisation will run short of cash. They can also help smooth out cash flows and assist in making minor purchases without taking out another loan. Interest rates for overdrafts and lines of credit vary, but are only payable when the facility is in use and are generally lower than for credit cards. Depending on the lender s terms and conditions, overdrafts and lines of credit may involve monthly fees, and it s important to understand what these are and limit the size of the facility to what is needed in order to reduce these costs. Business investment loans are a common way for organisations to borrow money for a specific investment, such as new equipment, vehicles and computer systems. Interest rates are generally lower than for credit cards, overdrafts and lines of credit, and vary depending on whether the loan is secured or unsecured. Interest rates for a secured loan are lower, as a major asset (such as a property) is used as collateral. Unsecured loans have interest rates that are higher, as they are more risky for lenders. Some aspects of the loan, such as the loan duration and the timing of payments, can be negotiated to some degree with the lender. Mortgages are a form of lending used to buy property. As the mortgage is secured by the property, interest rates tend to be lower than other types of loans. Interest rates are generally either variable (i.e. can increase or decrease as economic conditions change) or fixed for a period of time. Financial leases are one way to purchase assets like motor vehicles and major equipment. Under a financial lease, the borrower enters into a contract to use an asset, and makes regular payments to cover the asset s cost plus interest. There are a range of other, more specialised loan products that can be useful in different circumstances. These include invoice discounting and factoring, which provide finance against invoices issued to clients, and revenue based Loan financing for service providers 9

11 financing, which bases loan repayments on a proportion of an organisation s revenue rather than a set amount. New products are also emerging that are tailored to the needs of social sector organisations. These social finance products are focussed on delivering both financial and social returns, and can be structured with longer repayment periods, different interest rates and more favourable terms and conditions to make them more accessible to social sector organisations. New types of Equity-like loans are also available that mimic how for-profit organisations raise money from their shareholders, using delayed repayments and allowing interest to be capitalised to help new social enterprises become established. Disability service provider builds a property portfolio 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 Using any surplus funds to reduce the amount of interest paid, by parking any additional funds in loan accounts. The management team and board have found this approach to be highly successful. Initial property purchases enabled it to snowball its efforts in purchasing additional properties that further support its services. The close relationship with the bank has also enabled the bank manager to waive some of the usual loan application fees, as well as offering competitive interest rates. Loan financing for service providers 10

12 There are some common steps to take out a loan There are some common steps that service providers use to explore their loan financing options and begin the loan application process. These steps are summarised below. Assess Explore Assessing the need for loan financing is a critical first step. At this point service providers develop strategies and business plans that document their priorities. This should include where and how they will invest to deliver on their social purpose, and the role that loan financing should take to support this. Once the purpose of a loan has been agreed, service providers can explore the loan products that are available to them and the lenders that are best placed to provide these. This can involve gathering information about different lenders to understand: the loan products they provide the costs involved, including interest rates and any fees and charges the approach the lender takes to work with organisations about their financing needs. This process can be used to make a short list of potential lenders. Contact Gather Apply Once you have developed a short list, it s a good idea to contact potential lenders and have an initial meeting with them. This can help you understand their products in more detail, as well as the level of support the lender is able to provide. This is also an important step for the lender. They need to understand your organisation and how you are planning to use a loan. Speaking to them about your plans can help them advise you on potential loan options. Once you have decided on a preferred lender you should prepare the information that will be required for the loan application. This can vary between different lenders, but would generally include the following: Audited financial statements from the last 2-3 years A cash flow forecast for the next twelve months. This should show on a month by month basis all revenues and expenses (including loan repayments), and the anticipated cash position at the end of each month. The current strategic plan, business plan and organisational chart. Details of the organisation s financial position, including major assets (such as property, vehicles and savings) and liabilities (such as existing loans and debts) Some lenders may also require details of board members and the management team. Once you have the relevant documentation, fill in the lenders loan application form. When making the application it s a good idea to keep in contact with the lender to understand how the application is progressing, and to provide any more information that they may need. You should also update the lender on any changes that occur that could affect their decision, such as changes to income or changes to the management team or the Board. Once the loan is approved the lender will develop a loan contract. This should be reviewed carefully before it is signed. If you are unsure about any aspects of the contract speak to the lender about this or seek independent advice. If the loan is not approved, make sure that the lender explains their reasons so that you can address these in future applications. Loan financing for service providers 11

13 Assessing your organisation s readiness to use loans Loan financing should only be pursued if you are confident that it is the right option for your organisation, and that you will be able to make loan repayments when they fall due. There are a number of factors that should be considered if you are intending to pursue loan financing. The checklist on the following pages is a useful starting point for understanding how ready your organisation is to explore loan financing. Component Commentary Key checks Notes Planning The organisation has a clearly defined and agreed long term strategic plan. A business plan is in place that identifies how strategic priorities will be achieved. The anticipated social and financial benefits are clearly understood. The potential risks of using loan finance have been identified and mitigated. The Board and management are aware of the lenders and loan options available. Oversight and direction The organisation has a clear mission that is documented and agreed upon by the Board. The Board has agreed in principle to use loans. A strategic plan outlines the direction the organisation will take over the long term (usually the next 3-5 years). A strategic plan is based on an assessment of the external environment, and an understanding of the strengths, weaknesses, opportunities and threats for the organisation in this context. A business plan is usually developed once a year and outlines how the organisation will work towards its strategic objectives over the next 12 months. It includes details of specific initiatives, responsibilities for carrying these out, measures of success and budget information. Before taking out a loan the organisation should clearly define what social and financial benefits will be achieved, such as improved or expanded services for clients, or more secure finances for the organisation. A risk management plan should include identified risks to the organisation, an assessment of their likelihood and consequences should they occur, and approaches to manage these risks. It s important to understand a range of different lending options in order that the board and management can make informed decisions. Any loan should align with the organisations overall mission, so it s important that this is clearly documented, understood and agreed. The Board should consider the idea of using loans and come to in principle agreement early on about what a loan can and can not be used for. Has a strategic plan been developed and signed off by the Board? Does the plan specify investment priorities, including the role of loans in financing? Has a business plan been developed? Does the business plan clearly outline specific actions, budgets and timeframes? Is it clear how loan finance will enable benefits to be achieved? Have the anticipated benefits been documented? Has a risk management plan been developed? Has the organisation explored different lenders and loan options? Has this been communicated and tested with the Board and management? Has a mission statement been developed and agreed? Is the mission statement readily understood by those outside the organisation? Are Board members engaged in using loan finance? The Board has established decision making mechanisms to support lending decisions. Skills and expertise The Board has the right mix of skills to make informed financing decisions. The management team has sufficient financial expertise to manage loan financing. Management is able to communicate financial and social benefits. Where additional financial expertise input is needed to make informed decisions about using loans the Board could establish a Finance Subcommittee or invite an expert financial advisor to attend a board meeting. Boards need a variety of skills to make informed decisions. Developing a skills matrix can be a useful way of understanding what skills are available, identifying additional skills that may be required, and how these gaps can be addressed. The management team should have regular access to financial expertise to help manage a loan. Ideally, this should be a finance manager who has formal qualifications. Alternatively, an external financial advisor or accountant can provide ongoing advice and support. In applying for a loan, it will be important for managers to be able to demonstrate the value of taking out a loan to potential lenders, both in terms of financial benefits and the social benefits that will be achieved. Is a Board subcommittee and/or external advisor available to support a loan decision? Has a Board skills matrix been developed? Does the Board have skills to make financing decisions (e.g. financial, business skills) Does the management team include an individual with expertise in finance? Does the organisation produce information about the benefits it delivers? Can financial information be produced to enable conversations with lenders? Loan financing for service providers 12

14 Component Commentary Key checks Notes Financial management The reporting of financial information is reliable and timely. Future cash flows and the impact of borrowing on financials is clearly understood. There is a clear understanding of the organisation's assets and liabilities. Financial modelling incorporates a sufficient buffer to cope with unforeseen events. Supplementary materials are available to support a loan application. Management of the organisation s finances is proficient and forward-thinking. The organisation complies with all legal and financial requirements. Financial risk management is assessed and addressed on at least an annual basis. Operations and management The organisation has a clear management structure. Policies and procedures are in place to ensure that loans are used for appropriate purposes. Reliable and timely reporting of financial information is important in taking out a loan, both to demonstrate to lenders that a loan is affordable and to ensure that managers can manage the loan appropriately. Understanding what future cash flows will be is important to making the decision to take out a loan, and for lenders to decide to enter into a loan. A cash flow forecast is a key report to inform managers, the Board and lenders of a loan s affordability. In some instances, existing assets (such as buildings and equipment) can be used as collateral for a loan. This can make it more likely that a lender will be prepared to enter into a loan. Understanding existing liabilities is also important to know whether a loan is affordable. Before taking out a loan it s useful to do some financial modelling of what the future could look like. Building in a financial buffer is a good idea to make sure the organisation is able to respond to unforeseen events. Lenders may require a range of documents as part of the loan application, such as audited financial statements, cash flow forecasts, strategic and business plans, and information on the board and management. It is a good idea to collate this prior to making an application. It s important to budget for the future and understand how well the organisation keeps to its budget prior to entering into a loan. Lenders may hesitate to enter into a loan with an organisation that is unaware or in breach of government requirements. Organisations should make sure they understand their obligations and are compliant prior to entering into a loan. The interest rate of loans can change, and organisations should include the potential for interest rate changes in their management of risks. Before taking out a loan it s important to be clear about which staff will be responsible and accountable for making loan decisions and using loan products. Only these staff should have the delegated authority to use the loan (e.g. make credit card purchases, sign agreements with the lender). Policies and procedures should be clear about which staff have the delegated authority for using loans, and which staff do not have this authority. Are financial reports prepared on a regular basis? Is this information reliable and well understood? Has a month cash flow forecast been developed? Is it clear that the organisation can make repayments when they fall due? Does the organisation have assets that could be used as collateral for a loan? Is it clear what the liabilities the organisation currently has? Does the organisation have any reserves that can provide a buffer for unforeseen events? Has material to support a loan application been collected? Can the organisation demonstrate an ability to repay a loan? Is an annual budget developed and agreed? How well is the organisation tracking compared to the annual budget? Is management aware of and comply with any legal and financial reporting? (e.g. Australian Tax Office, Commonwealth and State government regulations) How does the organisation assess financial risks? How are any financial risks managed? Is there a clearly defined, current organisational chart? Are individual accountabilities clear? Are policies in place about sign-off on financial decisions and major purchases? Is it clear who has delegated authority for making major financial decisions? Loan financing for service providers 13

15 Service providers overcome common challenges to access loans There are some common challenges that service providers can experience in exploring loan financing. Some of the most common challenges are outlined below, together with some strategies to overcome them. Future cash flows need to be understood Understanding future cash flows can be challenging, particularly when there are changes in funding arrangements. It is important to understand what future cash flows should be to understand whether a loan can be repaid. Lenders will generally not lend unless a service provider can evidence what future cash flows will be. Many organisations use software that can provide reports on future cash flows based on either the budget or past transactions. This can be a great place to start to understand what future cash flows might be. There are also some useful resources available to help understand future cash flows a selection of these are listed on page 15 of this toolkit. Some loans require a deposit Not all organisations have a deposit to take out large loans like mortgages. Taking out a smaller loan can be a useful first step, as it demonstrates an ability to make repayments and builds credibility with lenders. Another approach is to speak to a lender about getting conditional approval on a loan, and use this as part of a fundraising campaign to save for a deposit. Some decision makers can be averse to risk Some members of the board and management team can be risk averse, and unwilling to use loans. Sometimes this can be due to concern about whether a loan is affordable, or about their own personal liability and reputation. Some steps that can help board members and management understand the risks and benefits are to: provide information about loan finance, such as this toolkit speak to other service providers who have previously used loans to get their perspective invite a lender to come and speak to the board and management team about using loans. Some financial skills are needed Some boards may not have the financial skills to make decisions about loans. When a new board member is needed to fill a vacancy, seeking someone with a background in finance or accounting can help the board make these decisions. Alternatively, an external financial expert can be used to provide advice or be a temporary member of a finance subcommittee. Loan financing for service providers 14

16 Frequently asked questions How would I know if loans are the right approach for my organisation? Loans are just one financing option. A loan may or may not be appropriate for your organisation and its investment needs. Loans should only be used where it is clear that they can be repaid, and when they help the organisation deliver on its overall purpose. Before taking out a loan it s important to be clear about what the loan is for, and whether other funding options (such as savings and fundraising) may be more appropriate. When several funding options are available, working out the timing and social value they can deliver (such as number of clients served in the future) and the financial impact on the organisation can help in making the choice. We ve tried to get a loan before but been knocked back. What else can we do? Some traditional lenders have strict lending criteria that can be difficult for service providers to meet. Speaking to multiple lenders or using a loan broker can help in this situation. Social finance providers can also be a practical approach, as the products they provide and their lending criteria are designed with the social sector in mind. They can also support organisations as they explore loan financing options, helping them to become loan ready. What should I do to better understand loans? There are a range of additional resources available if you would like to understand more about taking out a loan. A selection of these are included on the following page. Traditional and social finance providers can also provide you with information about loans, and speaking to them about your needs is a great place to start. Do I need a deposit for a loan? Deposits are important for some major loans, such as mortgages. Deposits are generally not needed for many other types of loans, including credit cards and business loans. Speak to lenders about whether a deposit is needed for any loans you are considering. Loan financing for service providers 15

17 Do directors have to guarantee a loan? Traditional lenders loans may require directors to guarantee a loan as part of their lending criteria. Social finance providers recognise that this can be a barrier for many social sector organisations, and have developed loan products that do not require director guarantees. What happens if we can t repay our loan? Depending on the loan product and lender there are different implications of not repaying a loan. Prior to submitting an application for loan finance you should make sure you understand the terms and conditions of the loan, including what will happen if you are unable to make repayments. In many instances lenders are willing to work with organisations to renegotiate repayment arrangements where this is necessary. Loan financing for service providers 16

18 Further information and resources For more information about loan financing see the resources below. Government resources Ageing, Disability and Home Care has developed a series of resources to assist service providers explore their financing options. This includes information and a tool to help manage cash flows, a unit costing tool, and information about community asset building. These resources can be found at the following web site: Social finance providers Social Ventures Australia: Social Enterprise Finance Australia: Forester s Community Finance: Community Sector Banking: bankmecu: Resources from major banks Commonwealth Bank s Not-for-Profit Sector Banking Solutions page: ANZ Trustees charities and not-for-profit page: Westpac s Social Sector page: National Australia Bank: Other useful resources Third Sector Magazine s Finance page: Loan financing for service providers 17