Capital for Social Enterprises: Debt
Sources of loan funding
There are four common sources of loan funding for social enterprises: foundations, commercial banks, impact investors, and community development finance institutions.
Examples: FB Heron and The Kresge Foundation are foundations with reputations for PRIs – you can find many more of them at www.missioninvestors.org
You will find the best terms if you are fortunate enough to secure a loan from a foundation. Commonly called a program related investment (PRI), these are generally very favorable, better-than-commercial terms offered to non-profits from foundations.
While foundations are required to disburse 5% of their endowment per year, this still means 95% sits in their endowment. As a result, some foundations are looking to deploy some of that endowment in the form of loans to nonprofits and social enterprises. The bad news is that almost all loans made from foundations are made to existing grantees. So you can try to get a PRI from a foundation where you have not received a grant, but chances are you will be unsuccessful. If you have received a grant in the past from a foundation, you’re in a much better position to secure a loan from that foundation.
Examples: CITI and Sunrise Banks (big, multinational to smaller, known for doing a lot of work with nonprofits)
The key thing to know about commercial banks is they are focused on financial return only. The other lenders discussed here are looking for a combination of financial and social return. But commercial banks are really interested exclusively in financial return.
However, it’s helpful to know why you may have an advantage as a social enterprise in securing a loan from a commercial bank. In addition to looking to be paid back, commercial banks are also normally deeply interested in making connections to your board of directors and what’s known as the “community halo effect”. Keep this in mind when approaching a bank: can you dangle the possibility of the bank developing relationships with your board of directors and the companies that they work for or own? Or will there be a community halo effect and will the bank be able to be associated with the good work that you’re doing?
Examples: RSF and Living Cities
These are lenders looking for mission fit and they’re looking at finances. The good news is there’s often times a little wiggle room around the mission fit, so you may have a chance to push on that area.
Community Development Finance Institutions (CDFI)
Similar to impact investors, but since the source of most of their funding is the government you should recognize that mission fit they have far less wiggle room about where they can operate and the loans that they can make.
Uses of loan capital
Loan capital can be needed and obtained for any number of uses. Here are three common uses:
A classic case to secure a loan is to secure real estate. Generally speaking, across all of those 4 categories of lenders, lenders will be expecting the SE to contribute a minimum of 5%, up to 20%, towards the purchase of a building. Meaning the most you can borrow ranges from 95% to 80% for a building.
When a lender is looking to make a real estate loan, one of the key things they’re going to be doing is looking at the SE’s history of paying rent and how much they’ve been paying vs. how much of a mortgage they’ll be facing on a monthly basis.
Equipment is also a major use of loan money. So you may think about your own SE and whether there’s a need to upgrade or add equipment to what you’re doing. Sometimes you can secure up to 100% financing in the case of equipment and generally speaking you can expect terms that range from 3 to 7 years for equipment financing.
Line of Credit
A good way to think of a commercial line of credit is that it’s like a credit card for a business and it helps you manage the timing gaps between when you incur costs and when your social enterprise gets paid.
In the area of workforce development, you will definitely have a weekly or bi-weekly payroll that you need to make and your clients, whether they’re the federal government or a big corporation or small companies, maybe paying you much more slowly. So a line of credit helps you manage the inventory needs and the payroll needs that you have, to bridge that time between when you incur costs and when you get paid.
What are lenders looking for?
Typically, these lenders are looking for different things than a traditional grantmaker will be looking for. Lenders are looking to make loans that are incremental, predictable, and secure.
An example of an incremental need is a social enterprise that currently has 4 sites and is adding a 5th This might be a need that is very appealing to a lender. Another example is a janitorial SE that is moving into the landscaping business. Again, an incremental need for borrowing. Whether for a building, or for landscape equipment, or an increase in access to working capital since there’ll be more clients and more bills outstanding.
You want to demonstrate as much as possible that your social enterprise has a predictable business model. What this means is recurring sources of grant funding, diffuse sources of grant funding. It mean you have a credit worthy and steady customer base. And it means you have lots of clients – you don’t have all of your eggs in one basket. So as much as you can put your best foot forward and explain why your SE has a predictable business model.
You want to make the case that this is a secure loan to make. An example would be that your SE has a lot of cash to make a down-payment on that building you’re looking to acquire. Or demonstrating that your SE has a rainy day fund in case things don’t quite go your way.
Make sure you can make a compelling case of why your social enterprise has incremental needs, has predictable results, and why this is a secure loan to make.
Key questions to address
With any of these lenders, these are the big questions you’re going to need to be ready to concisely address:
- How much money do you want to borrow?
- What are you going to do with that money?
- How will you repay that loan?
- What does the lender get if you’re unable to repay the loan?
Two additional questions that are key to CDFI, impact investors, and foundations:
- What results have you delivered in the past?
- How will this loan further the impact you aim to have?
Which source of debt would be appropriate for a start-up social enterprise?
Social enterprises, just like any business, may struggle to get debt capital or debt financing for a brand new entity. New social enterprise starting within an established non-profit organization will find it substantially easier, especially if it’s a large and well established non-profit that’s starting a relatively small social enterprise.
For any start-up social enterprise, commercial banks are the least willing to accommodate something brand new. Many lenders require at least 3 years of operating history. Of the four, foundations tend to be the most willing to accommodate a new venture, assuming there is a compelling impact story and, ideally, if it’s related to an established parent nonprofit.
Recognize that all lenders are looking at how they’re going to be paid back and if you don’t have a track record of selling a product or delivering a service, it’s a very big leap of faith for a lender to be able to project repayment for a brand new operation. However, if you have measured expectations you can really approach any of the 4 buckets.