In response to examples in the news and client inquiries, we have prepared this paper to address the topic of nonprofit borrowing. For sake of clarity, we will start by identifying the two most common approaches: borrowing from an endowment and borrowing against an endowment. As a preface, it is important to note that many endowments, especially those with restricted funds, will not easily be able to engage in either method; furthermore, the charter, investment policy statement, or other policies may also prevent borrowing in any form. We are not able to give legal advice as to the feasibility of borrowing, and suggest an organization consult with its legal services provider before taking any action.
Why are nonprofits borrowing?
Simply put, nonprofits’ budgets are increasingly strained due to the increasing needs of the communities and missions that the nonprofits serve.
There are just not nearly enough resources to address every inequity, every need, and every cause.
Further exacerbating this is the composition of recent donors: a recent interview by NPR identified that while 2016 was a record year for American donations ($373 billion), early analysis would suggest that 98% of the donations originated from 2% of donors, in contrast to the long time “rule” where 80% of donations originate from 20% of donors. According to Chuck Collins of the Institute for Policy Studies, this “means there's more volatility and unpredictability for the independent sector.” Volatility and unpredictability of fundraising, in turn, can cause the potential for an operating cash shortfall if investment income is not sufficient to meet budgetary requirements. Further complicating things, donations are increasingly coming with donor restrictions attached. A study by the Stanford Social Innovation Review found that even the restriction on the reimbursement of indirect costs (typically 15%) is leaving nonprofits with excessive, and sometimes unexpected, bills that, in turn, can also lead to an operating cash shortfall. Regardless of the cause, an endowment might borrow to make up the shortfall.
A second major reason for a nonprofit to borrow is to fund large-scale, long-term capital projects. These projects could include a new building, major renovations, or new equipment , and would likely need to be funded (at least partially) through borrowing.
The loan or debt, in most cases, would have to be paid for through a combination of donations, investment income and operating income, if applicable.
The major issue with this is that, given donations and investment income streams are not adequately predictable, nonprofits without substantial operating income sometimes have to pay a higher rate of interest (meaning higher cost of borrowing) than a comparable (with regard to leverage), for-profit entity would pay.