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Social investment: 10 top tips for trustees

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For trustees of a charity, taking on debt for operational or expansion purposes may be an unfamiliar concept, but could be a useful addition to financing options as traditional sources of funding, such as grants, are declining

1. Understand the options

Trustees should understand various elements of how loan-based financing works and the types of finance on offer before deciding whether it is appropriate. All alternatives should be analysed prior to making a decision.

In this innovative and growing market, the different investment options open to voluntary organisations continue to evolve. These options should be considered by the trustees and management team before the most appropriate type of financing is chosen.

Prior to approaching social investors organisations could first talk to banks with which they have existing relationships as borrowing may be cheaper.

2. Ensure loan finance is appropriate for the organisation

Trustees must ensure the organisation is able to take out a loan. The organisation’s governing document (ie its Memorandum and Articles of Association) may need changing to enable this.

Trustees should have in depth knowledge of their organisation, from regular monitoring and evaluation reports to operational and financial information. With this, the board will be in a better position to determine the feasibility of financial options.

3. Articulate the financial need

Before approaching an investor (or intermediary), an organisation should have a clear plan for its future and articulate its financial needs. For example, is the money sought for bridging grant income, managing working capital, investing in growth plans or buying assets, to name but a few.

Although a lack of experience in borrowing funds may hinder the analysis of these needs, there are various intermediaries able to support this process. This will help a voluntary organisation understand what kind of funding might be most suitable for different requirements and to become investment ready. For example, UnLtd provides practical support to social entrepreneurs. In addition, a social investor will also be able to provide some guidance, but the borrower should know the intended purpose of the funds.

4. Involve key stakeholders

The decision to take on loan-based finance should be made internally, with consensus from trustees and the management team to ensure stakeholder buy-in. Staff should be informed about how funds will be used to benefit the organisation and their social impact, so they will support the decision.

A carefully prepared business plan will help explain the use of the finance, determine if the income generated from the loan will be sufficient to repay it, and also verify if this type of finance will enhance or maintain the organisation’s objectives. The business plan should include the objectives of the organisation, biographies of key staff and trustees, an analysis of strengths and weaknesses, the financial and social impact of external finance, potential risks, and a realistic budget and cashflow.

5. Consider personal liability of the trustees

In a limited liability company, the liability is only limited if the trustees have acted in good faith and in the best interest of the organisation. As long as they have acted legally and prudently, they will not be held personally responsible. If an individual trustee or the board has acted negligently, legal action may be taken against them by the lender.

Also, trustees may be exposed to personal liability for a loan if the charity is unincorporated.

6. Be ready for due diligence

Before investing, an investor will embark on a due diligence process. This will involve probing questions regarding the governance structure, the skills of the management team, past operational and financial performance, as well as future projections. This is necessary to determine if the loan is right for an organisation and its objectives.

This process will also establish if the organisation can repay the loan. Otherwise, grant funding and fundraising may be more suitable in the short term before the organisation is investment ready.

As a social investor has social as well as financial goals, they will pay attention to the social impact of the organisation, to ensure the impact is genuine (and of sufficient depth) and that loan-based finance does not hinder it.

7. Seek advice and/or assistance to become investment-ready

Organisations that provide support and training for investment readiness can offer support at all stages of the investment journey, from sourcing funding that enables a charity to make a business case and apply for an investment, through to managing the investment and demonstrating social impact. For example NCVO consultants, CAF, CAN and Social Business Trust.

8. Ensure financial sustainability and resilience

Financial sustainability comes from a diversification of income sources and not being over-reliant on one particular funding source.

Building reserves will develop financial resilience and an organisation’s ability to withstand unexpected shocks. Yet building reserves can be difficult, especially as competitive tendering for contracts is compelling some service providers to achieve very challenging financial efficiencies.

This process must be driven internally to ensure that it can be sustained in the long run.

9. Understand and build a relationship with an investor

An organisation should always seek to understand an investor and their motivations before taking on any investment. Some investors may want a seat on the board, which may not be appropriate for all charities. Careful communication from the outset will enable an organisation to select the investor which best fits with an organisation’s aims.

The borrower should maintain open and honest lines of communication with the investor, so any difficulties can be addressed and dealt with at an early stage. Missing repayments, for example, will have consequences, but these will be more severe if the lender is not given sufficient notice.

There are many reasons why an organisation may not be able to make a loan repayment on time, such as cashflow problems due to delays in receiving income, cost increases and a project starting late. However, if a lender knows about these problems in advance, they may be able to work with the borrower to find a solution, or be flexible in rescheduling the loan repayments.

10. Be aware of other advantages of seeking social investment

Good communication with social investors may also bring about other benefits such as access to expert advice, contacts and specialist networks.

Working through the process of applying for, and managing, a social investment can provide trustees with more confidence to grow and take on risk.

Successfully attracting social investment can increase the confidence of external stakeholders such as potential commissioners. This is because, for an organisation to receive social investment, they will have undertaken a very robust process of due diligence as described above.

Through the due diligence process, the lender is likely to identify areas for organisational improvement. This impacts on the whole organisation, and can instil confidence in the management team and trustees to implement a growth plan, or invest in a fundraising campaign, as part of the process of preparing for the investment.

The due diligence process, as a dialogue between the investor and investee, usually helps an organisation to thoroughly understand what its financial needs are. This process of dialogue and self-examination often builds the capability of an organisation to problem solve and develop financial sophistication.

Page last edited Nov 26, 2015

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