But this approach is changing. Loans are now often used to help purchase or refurbish property, and overdraft facilities are being used to help ease cash flow.
This implicitly means a judgement about risk. There is a low risk of a property losing value over time, which means we cope with the high risk of a secured loan. We would select a 25-year mortgage rather than a two-year loan to spread the impact.
Assessing the risk
But what if the investment is inherently risky? Who can accurately judge the potential of new IT systems or extra staff to help grow the activity of the charity?
In the business world, a variety of investors such as business angels, private equity, venture capital and the stockmarket would be canvassed to help underpin the risk to the company.
In our sector, larger charities can invest some of their unrestricted reserves. But what of small charities, those whose reserves barely cover working capital needs, let alone development? Capacity-building grants distributed over a number of years are the best answer, but are rarely available.
A few social investors are testing out a new financial model. Awkwardly called 'quasi-equity', it attempts to reflect some of the benefits of equity.
An investment is made to support growth by a charity. If the charity does grow, the investor gets its money back through a royalty payment - a fixed percentage on income. If there is no growth, or failure, little or nothing is returned. If there is exceptional growth, the investor could double their money.
At Venturesome, we call this revenue participation: investor and investee share the pain and the gain.
Matching risk with your sources of finance is part of building financial resilience. This means being able to withstand delayed grants, unexpected income loss or a bolt from the blue. A mixture of income sources reduces dependency, and building a matched balance sheet strengthens organisations against the unknown.
- More charities are turning to loans and overdrafts to fund periods of growth.
- This can be risky, but there are ways of underpinning the risk.
- 'Quasi-equity' is a financial model whereby investor and investee share risk.
- The investor is rewarded in line with growth.
- John Kingston is director of Venturesome, an initiative of the Charities Aid Foundation.