When Community Nonprofits Get Into Financial Trouble

Banks with troubled nonprofit portfolios can be in a difficult position. Nonprofits often operate on tight cash flow and insufficient surplus to withstand delayed reimbursements, decreasing revenue or unexpected expense increases. Their very nature creates the need for a line of credit and/or loans to purchase basic operating equipment. When nonprofits delay loan payments it’s usually the tip of the iceberg. At this point, if the bank enforces loan provisions the community might view them as pushing an essential or beloved nonprofit toward demise. Proper underwriting and urging nonprofits to be more business savvy, is a long-term community stewardship strategy.

While banks generally follow sound procedures and collaborate professionally with community nonprofits, because Benoit Consulting has helped troubled nonprofits, I have come across some astoundingly poor banking practices. Banks who fail to work smarter with their nonprofit portfolios will see damaging loan defaults.

Just when you think you’ve seen it all . . .

It may be hard to believe the examples described here but they are real.

>>A nonprofit Executive Director (ED) provided excuses as to why financial statements weren’t provided to the bank holding their mortgage (a condition of the mortgage). The bank accepted these excuses. Several months later when the statements surfaced, unresolved payables had grown to over $100,000 and several monthly losses materialized for this nonprofit with very tight cash flow. The Ed was later removed.

> A small nonprofit providing mental health services had a CEO male, whose wife was the CFO. Over an 18 month timeframe, the two explained away the dismissal of 4 different bookkeepers alleging incompetence. In addition, they offered one excuse after another for the lack of full financial statements. It turns out, each successive bookkeeper would get so far, discover that the couple’s personal household expenses were being run through the nonprofit bank accounts and the bookkeepers would be terminated. Employees finally disclosed their suspicions to the board. The CEO and CFO were put on administrative leave and eventually terminated. The organization pivoted and survived but not before the board tried to quit and were put on notice by the state Attorney General, that they were required to stay and work it out.

>Bankers claim that they were prevented by banking privacy provisions from contacting board members when a local nonprofit bounced several checks over a 12-month period. In this case the seriousness of checking account issues was successfully hidden from the board by the ED. Several important local vendors had outstanding accounts and had experienced the bounced checks as well. The board, not the ED was the nonprofit’s bank account owner. Neither the bank nor the local vendors ever contacted the board which was made up of local volunteers. The employees eventually disclosed bounced paychecks and the malfeasance was discovered. This nonprofit was eventually dissolved.

>>A bank extended a personal loan to a nonprofit employee for the purpose of helping his/her nonprofit employer, creating a dual role that is hard to overcome in which the employee is also an investor/creditor. This nonprofit eventually dissolved.

>>A small nonprofit had an ED who deposited all the revenue, wrote and signed the checks, and produced the financial statements while basically cooking the books. The board, unaccustomed to dealing with a criminal, hadn’t been concerned as revenue shortfalls were never quite resolved over time. They trusted this well known ED. They were not aware of the concepts of checks and balances or financial controls. This ED surved time for tax evasion. No payroll taxes had been remitted.

>>A small nonprofit focused on elderly services had excess income from a program that was dissolved. The funds were kept in a separate account. They didn’t replace the revenue or tighten their belts but simply used the funds to balance the budget for a few years until the money was running out. The ED either didn’t see the problem down the road or chose to ignore it until they were out of work for a while and the issue became clear. This nonprofit survived with a new ED.

Key financial differences between Nonprofits and For-Profits 

When for-profit business human resources, technology and financial practices are used by disciplined nonprofits these organizations run more effectively and responsibly. However, the core business foundation is where significant differences between commercial businesses and nonprofits can be found. The nature of these differences creates implications for lenders particularly if a banking institution’s commercial loan underwriting practices are based upon for-profit operations.

Mission, programming and funding

The areas of greatest difference are in three factors: the social mission, program development and funding. Nonprofits must concern themselves with ethics and stewardship regarding the use of public funding AND demonstrate the achievement of social outcomes. Program and service development is often confined by available funding sources. Unfortunately, state funding can shrink as other priorities rise, so that grants rarely cover the actual cost of providing a program or service. This results in squeezing already tight “suplus” margins. Regarding funding adequacy and improvements, nonprofits don’t have commercial investors to support capital improvements. They must set up an infrastructure to pry loose numerous small donations from interested private donors in competition with other nonprofits with equally compelling missions. Private donations are difficult and costly to raise. Finally, cash flow management is essential to avoid overburdening debt.  Some nonprofits barely have cash sufficient to cover payroll and expenses. When they dip into the “red” they must be very careful to know where future funds will come from to cover budgeted deficits and formal debt.

Sound banking and community “ownership”

Bankers have told me that they had concerns about an executive director’s financial management practices but didn’t speak to the board thinking it’s not “their place.” On the matter of the public trust, transparency and ethics, a nonprofit is accountable to its “shareholders” which is the local community donors and funders. This is most important when the board or executive director have not been responsible mission stewards. In my view, bankers, insurance companies and other community vendors (office supplies, printers, even the person who plows the driveway) have an obligation to speak up when they suspect something is amiss such as: when payment for their services are more than once returned for insufficient funds. These vendors do represent the community but they often don’t speak up in hopes that things will turn around and they will get funds owed to them. If an executive director has hidden financial matters from the board the first notice they receive might be from an external community member. Speaking up might prevent a nonprofits’ demise.

SIX Strategies of successful banks (when lending to nonprofits)

For the best overall results banks can:

1. Know the fundamental differences between nonprofits and for-profits – if you don’t have this expertise, get some training particularly regarding nonprofit financial statements.

2. If the nonprofit can’t produce readable financial statements – there is no excuse. This is available at very low-cost via a couple of hours per week with a contracted bookkeeper or office manager using QuickBooks.

3. Underwrite the loan – if you can’t get the proper documents or nonprofit representatives don’t return your calls, take notice and speak to a board member. If the financials are troubling help the nonprofit get in a better financial position by recommending action steps, consulting support or consider serving on the board.

4. When trouble surfaces – begin the dialogue with ED AND the board right away.  You can negotiate on some loan provisions but don’t  let them slide altogether.  The situation doesn’t usually solve itself and the longer a financial issue goes unattended, the harder it will be for the nonprofit to correct it.

5. If a nonprofit agrees on a corrective course – set up a specific date and time to meet and check in with the board AND ED. This will prevent day-to-day operations from distracting them from required improvements.

6. Understand that your account holder is the entity which is represented by the governing Board, not the executive director. If you have questions about the executive director, request that a board member (preferably the treasurer) sit in on meetings with the ED or meet with the board member privately.

(c) Copyright Benoit Consulting, LLC 2011 all rights reserved