ACEVO Guest Blog – Loan finance: Are charities missing an opportunity?

Many charities don’t realise that they could use loans to invest in their work or help them take on new contracts. A survey by the Guardian Voluntary Network showed many charities feel they need more information before they would consider taking a loan.

Although loan finance is not something to be taken lightly and won’t be suitable for all, there is an argument that many charities are not sufficiently open to a source of income that can bring huge benefits to beneficiaries. Here are some things to consider.

Benefits of loan finance

The simplest reason for taking on loan finance is that it allows a charity to move from its current position to a future one without destabilising its reserves policy. Time can also be a crucial factor; while it could take years to gather enough money for a big project via traditional fundraising, loan finance can allow charities to get a project underway within 3-6 months of the initial decision.

Loan finance is most frequently used as capital expenditure. Often it is used for purchasing land or property, such as buying a building the charity currently rents or buying land on which to construct a new building. Alternatively, a charity may need to refurbish a warehouse or regenerate homes in a deprived area.

Loans may also be used to provide working capital. This is increasingly the case now that grant funding is reduced and contracts are being administered on a payment by results basis. As a result, charities are having to deliver services before they have the money to do so, and need loans to bridge the gap.

In most cases, loans are used for projects that open up new sources of income, thereby ensuring the debt is repaid.

Risks and mitigation

Of course, the obvious risk is that if a new project or activity does not yield the anticipated income, then charities may find themselves unable to pay without compromising other activities. In unincorporated charities, the trustees may even become personally liable for the debt. This is why it is critical that charities make sure they prepare thoroughly before taking out loans and only do so in the right circumstances.

Simon Proctor, head of lending at CAF Bank (the bank owned by Charities Aid Foundation), says his organisation has been approached by charities with unmanageable debts in the past, but the root cause is usually that they didn’t take out the correct loan for their needs. “Often charities have resorted to loans because they have driven down their reserves too much, find themselves running short, and aren’t getting as much money through the door. In this situation we would suggest a recapitalisation, or perhaps a social investment bond or social lender such as CAF Venturesome which would be prioritising the social impact”.

“Alternatively, if they had considered loan finance before spending their reserves and made sure they used it to generate new income, they may not have found themselves in that situation.”

Most lenders are looking for evidence that a charity will be able to repay their loan. However, charities cannot rely on lenders to protect them, and must protect themselves by having a robust business plan. As Ian Mansfield, senior client relations manager at CAF, puts it: “One of the things we would hope to see is the ‘what if’ scenario. ‘What if interest rates rise in the next two years?’ ‘What if the charity doesn’t get the income it’s expecting?’ This sort of planning gives charities a bit more leeway – if they’re right up against it at the start, there’s only one way afterwards and that’s down.”

Proctor also emphasises strong internal structures and processes for sound decision-making. “The first factor for success is what the charity’s executive management team looks like. Do the people running the charity have the skill set to properly account for loan financing? The second point is whether they have got the governance controls in place to make sure they can oversee what the money is going to be used for. And finally, have they asked questions? There are no wrong questions and trustees should always interrogate the executive.”

Take a look at the main types of loan finance available for charitable organisations

Unsecured overdraft

Usually used for working capital purposes, these are similar to the overdraft on a personal current account. For a charity, the size of the overdraft could in theory be as high as £500,000, but this would be very much dependent on the stability of the charity’s operations, the strength of its balance sheet and its annual income and surplus levels. The interest rate would usually be 5-8%.

Secured overdraft

Here an asset such as a property is tied to the overdraft, and if anything goes wrong that asset is liable. This gives the opportunity to borrow more at a lower interest rate than when using an unsecured overdraft, with an interest rate of roughly 4-6%. However, because the amount being borrowed can fluctuate quite significantly, this rate is usually higher than for a secured loan.

Standard term loans

With standard loans, an amount of money (anything up to £5m) is borrowed and then repaid over a particular period of time (2-25 years). Like overdrafts, these can be either secured or unsecured, but unlike overdrafts they cannot be recalled within the specified period of time. They are generally used for capital projects, and often have interest rates in the region of 2-4%.

Junior loans

Junior loans are where one organisation is lending part of the money required but is unwilling to give the full amount. In order to bridge the gap, another organisation may offer the remaining amount at a higher interest rate because it is taking on the riskier portion of the loan. These can be complex and are not the norm; they often appear on larger capital deals in excess of £7m.


This is usually for start-ups or expanding organisations that are looking for a capital injection. Here the objective is to grow the organisation, but it may not be exactly clear how that will be achieved. Effectively, the charity will be saying that it believes it can grow its operations sufficiently to make regular surpluses, which will then be used to pay back the loan.

CAF Bank is owned by a charity and we only lend to charitable organisations. We can help bridge a funding gap, provide capital to make major plans a reality, or simply support your cashflow so you can focus on what’s important: your mission.

If you are considering loan finance and would like a free consultation with one of our experts, please call us on 03000 123 444.

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