Voluntary and community organisations have used loans:

• to manage the funding gap between producing goods and services and receiving money for them
• to kick start new ventures or projects
• to support organisational growth and development
• to buy equipment, buildings, land, vehicles
• to develop land or buildings.

But loans have to be paid back – with interest – and equity investors will take a slice of any surplus generated so you need to be confident that the development will generate enough new income to support any repayments.

And an important factor when considering who to accept a loan from is the ethical and environmental track record of the financial institution.

An example of a finance package aimed at the sector is CAF’s Venturesome, which offers loans of between £20,000 and £250,000, and normally expects the loan to be repaid in three years. Another is Futurebuilders, which provides tailored finance packages, including grants and loans, specifically for voluntary and community organisations developing public service delivery contracts. Some lenders offer support to help organisations prepare for a loan.

From a social enterprise perspective, loans and equity finance have the following advantages and disadvantages:

Advantages

• Loans can give greater independence than grants, as the borrower is not tied to outputs or outcomes;
• Loans are usually quicker to obtain than grants;
  The funds received from a loan can be put to more flexible use;
• A loan application will be assessed on its own merits, rather than in competition with other applications as grants are;
• Taking a loan can have positive side effects, such as improved financial management and a greater focus on commercial objectives.
  

Disadvantages

• Lenders will often look for security over assets, such as land, buildings or equipment. If a bank takes security over the organisation’s assets, these could be lost in the event that things go wrong and the loan cannot be repaid;
• It can be difficult to obtain a loan if the social enterprise does not own any assets that can be offered as security;
• Loans have to be repaid with interest, which can make them seem a more expensive form of finance than grants. However, organisations need to consider the hidden costs of grant funding when weighing the pros and cons of loans;
• Lenders usually look for an operating history and a track record of income generation. For this reason, commercial finance providers tend not to lend to start-ups.
  

Equity is fundamentally different to debt, as in exchange for receiving capital, the owner of the organisation cedes part-ownership of the enterprise.
Unlike debt, equity finance is permanently invested in the organisation. The social enterprise has no legal obligation to repay the amount invested at a set point in time, or to pay any interest.
Equity investors typically look at the growth potential of an organisation; they invest in enterprises they believe will perform well in the future. They expect to be compensated for this through:

• Dividends paid out of the enterprise’s earnings; and/or
• Capital gain realised upon sale of the enterprise, or realised from selling their equity interest to other partners.

Equity can help to strengthen an organisation’s balance sheet by increasing the ‘cushion’ that it can fall back on should things not go as planned. This increased capital base can also help an organisation when it is looking to secure loans in the future.

Advantages

• Larger sums can sometimes be obtained through equity than through debt, which allows for large-scale developments and can strengthen the balance sheet;
• No security is required;
• There is no contractual agreement to repay;
• A hands-on equity investor can provide the social enterprise with expertise it may lack.
  

Disadvantages

• Taking an equity investment involves giving up part-ownership of the business. There is a danger that conflicts could arise if investors have different objectives and priorities from those of the social enterprise’s founders (for example if they are more interested in financial rather than social returns);
• The legal and ownership structures of social enterprises can restrict their ability to take equity finance;
• Social enterprises will not always exhibit the characteristics that equity investors typically look for, such as high growth potential or capital gains;
• Investors may be discouraged by the lack of an obvious avenue for selling their stake in the enterprise in the future.