The Hidden Cost of Borrowing for Nonprofits: When Today's Debt Limits Tomorrow's Mission
A recent playbook published by The Chronicle of Philanthropy, titled “Why More Nonprofits Are Borrowing, Not Just Raising Money,” explores how organizations increasingly use loans and impact investments to finance expansion, bridge revenue gaps, and accelerate their work. It presents an interesting financial option, but one that deserves considerable caution.
I understand the attraction. A nonprofit identifies an opportunity to expand services, construct a facility, or introduce a new program. The need is immediate, but philanthropy takes time. Borrowing provides access to capital today, allowing leadership to move forward without waiting for a campaign to conclude.
Yet, I worry about the long-term implications, particularly for smaller nonprofits.
Debt creates an obligation that extends well beyond the excitement surrounding the original investment. Principal and interest payments become recurring financial commitments. Those commitments remain even when donations decline, government reimbursements arrive late, operating expenses increase, or organizational priorities change.
Today's opportunity can become tomorrow's financial constraint.
Consider a small nonprofit that borrows $2 million to expand its facilities. The organization anticipates increased program demand and additional revenue. Five years later, staffing costs have increased, philanthropic support has softened, and the community has developed different needs. Leadership recognizes that resources should shift toward a more effective service model.
Unfortunately, the organization still has debt payments associated with yesterday's strategy.
This is where borrowing affects much more than the balance sheet. Debt can limit planning, restrict innovation, reduce operating flexibility, and influence decisions that should be driven primarily by mission. An organization might postpone hiring, reduce services, or redirect unrestricted contributions simply to satisfy its financial obligations.
For smaller nonprofits, the consequences can be especially significant. Their revenue streams are often less diversified, reserves may be limited, and the loss of a single major donor or contract can materially affect operations. Even favorable borrowing terms cannot eliminate these underlying vulnerabilities.
There are circumstances when borrowing makes strategic sense. A modest, temporary loan supported by a confirmed receivable may provide reasonable financing. A capital investment with dependable cash flow, adequate reserves, and conservative repayment projections may also justify consideration.
But leadership must examine whether the organization can repay the debt under unfavorable conditions, without compromising essential services. The board must also understand loan covenants, collateral requirements, and the potential consequences of default.
My preference is to begin with philanthropy.
If an organization has identified a compelling opportunity for growth, why not translate that opportunity into a philanthropic investment proposition? Demonstrate the community need, quantify the anticipated impact, and invite donors to participate in creating something meaningful.
A compelling vision supported by credible financial planning can attract transformational gifts, campaign commitments, and multiyear philanthropic partnerships. These approaches require time and disciplined donor relationships, but they can also strengthen an organization's financial foundation.
Philanthropy creates another benefit: donors become invested in the organization's future, often providing relationships and support that extend beyond their initial contributions. A loan finances an opportunity. A philanthropic relationship can help sustain it.
Before signing a loan agreement, nonprofit leaders should ask whether they have fully explored the philanthropic possibilities. Have they presented the opportunity to their most committed donors? Have they engaged their board? Have they built a compelling case for the impact this investment could produce? Borrowing can be appropriate. However, the desire to move quickly should never outweigh the responsibility to preserve future choices.
The mission must endure long after today's expansion plans are completed. And tomorrow's leadership deserves the financial flexibility to pursue it.
