Let the right loan in
Debt is an essential (but perilous) tool for nonprofit arts organizations. Know its nature before inviting it in.
And you must treat it as a powerful stranger,
Must ask permission to know it and be known.
—David Wagoner, from “Lost”
Nonprofit organizations face a bit of an obstacle course when they need operating cash or capital. And unfortunately, that need arises quite often. For example:
When they want to flatten the peaks and valleys of revenue and expense.
When they have an important opportunity.
When they aspire to a major purchase.
When they’re reeling from an unexpected blow and need time to recover.
When they’re already in a thicket of debt and want to consolidate.
Where for-profit organizations can consider a wide variety of cash and capital sources in these moments – including equity, investment, and profitable operations – nonprofits face a narrower path, due to legal and cultural constraints.
To define the term, debt is “a financial instrument that breaks the timing link between the consumption of a good and payment for that good” (Yetman 2007). It’s a way of solving a cash or capital problem when you don’t have cash or capital at hand. And while debt is a right and proper solution for many situations (see below), it comes with some obvious and sneaky strings attached.
For one, debt is rarely patient or flexible. Once you agree on terms with a lender, they don’t tend to care if your plans go astray. This is tricky not only for cash flow and compliance, but also because it puts another entity’s hand on the wheel. Says Yetman (2007):
“By borrowing, a nonprofit necessarily invites a for-profit party into its managerial decision-making process. This new party, the lender, has but a single objective – to maximize its own profits.”
For another, debt can be a signal to other constituents (donors, peers, partner organizations) that you’re on shaky ground – even when you’re not. As Mitchell and Calabrese describe it, nonprofit managers are judged against an array of “proverbs of nonprofit financial management.” These include “imperatives to (a) minimize overhead, (b) diversify revenue, (c) be fiscally lean, and (d) avoid debt” (Mitchell and Calabrese 2019).
Rising debt (like rising overhead) is often considered a mark of shame.
Still and all, there are many moments when debt is an appropriate way to bridge the gap between financial need and financial availability. When the expected revenue is reliable and the costs/benefits of growth are smooth, for example, debt is often a cheaper and quicker way to patch the road (Miller 2013). As Propel Nonprofits (2023) advises:
“The right time to consider seeking a loan is when you know how the funds will be used, have a plan for repayment that is based on reasonable assumptions for future income, and have the support of the board.”
The problem is, “reliable revenue” and “smooth growth” are often strangers to nonprofit arts organizations, which intentionally make new and unusual things that can’t be clearly predicted or understood in advance.
Your best bet is to identify revenue streams that are reasonably reliable, and imagine whether and how debt might be a good dance partner with them. Or, build up your own reserves over time and borrow from yourself.
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From the ArtsManaged Field Guide
Function of the Week: Accounting
Accounting involves recording, summarizing, analyzing, and reporting financial states and actions.
Framework of the Week: Statement of Financial Position (Balance Sheet)
The Balance Sheet is a required reporting framework that captures every financially valuable resource an organization owns (more broadly, that it owns rights to hold and control) as well as every obligation it has to the outside world.
PHOTO by Fabian Blank on Unsplash
Sources
Miller, Clara. “Capital, Equity, and Looking at Nonprofits as Enterprises.” Nonprofit Quarterly, Summer 2013.
Mitchell, George E., and Thad D. Calabrese. “Proverbs of Nonprofit Financial Management.” American Review of Public Administration 49, no. 6 (2019): 649–61.
Propel Nonprofits. “Loans: A Guide to Borrowing for Nonprofit Organizations.” Propel Nonprofits, 2023.
Yetman, Robert J. “Borrowing and Debt.” In Financing Nonprofits: Putting Theory into Practice, edited by Dennis R. Young, 243–68. Lanham, MD: National Center on Nonprofit Enterprise and AltaMira Press, 2007.