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Bond Financing: What Nonprofit Borrowers Need to Know

Nonprofit organizations have unique financing challenges, and equally unique financing opportunities too. Bond financing is one potential avenue open to 501(c)3 organizations looking to raise money for new construction, renovations or other capital projects. It’s a type of tax-exempt financing that may help nonprofit organizations secure a loan with more attractive terms than traditional financing. Each organization’s needs are unique. Nonprofit leaders need to work closely with their business and banking attorneys and other advisors to determine whether bond financing makes sense as a way to meet the organization’s financial goals.  

How Does Bond Financing Work for Nonprofits?

Essentially, bonds are loans issued by state or local government entities as conduits for the benefit of non-profit organizations. Laws and procedures around bond financing vary by state. Bond transactions involving 501(c)(3) nonprofits are sophisticated arrangements with a number of moving parts. 

Here’s a simple overview of how they work. There are generally at least three parties involved in these transactions. The municipal or state government entity serves as the technical issuer of the bonds for a fee. In Massachusetts, the statewide issuer is Massachusetts Development Finance Agency. The bondholder is typically a commercial bank or other lender with a specialized nonprofit lending capability. The bondholder buys the bond from the issuer. The nonprofit borrower receives the loan proceeds and makes interest and principal payments to the bondholder. With tax-exempt financing, the non-profit borrower benefits from significantly lower interest rates (typically 20% less) and more attractive loan terms as compared to traditional taxable financing.

Nonprofit borrowers work with their attorneys throughout this process and also work with intermediary consultants who advise them on their options and help them structure and close a deal with a lender. That’s the role Susan Winshall plays as Managing Director at Zions Bank’s National Non-Profit Finance Group. Non-profit leaders consult with Susan Winshall on how best to finance a given capital project (new construction, building acquisition or refinancing) through the use of tax-exempt or, where appropriate, taxable financing. Her team offers credit evaluation and strategy for financing a specific capital project. Unlike a direct lender, Susan’s team conducts a competitive solicitation for the bond/loan from several bank lenders to negotiate tailored and cost-effective financing for her clients. 

What are the Benefits of Bond Financing for Nonprofits?

Bonds “look and act just like a commercial loan except the borrower receives the benefit of a tax-exempt adjusted rate,” says John Mannila, Senior Vice President of business banking at Webster Five Cents Savings Bank. Because bonds may be exempt from both federal and state taxes on interest income they generate, they are an attractive investment for many lenders. Banks can offer lower interest rates for these bonds than nonprofit borrowers could get through taxable bonds or other financing. Fixed interest rates and longer maturity dates are other advantages to bond financing.

Many lenders have an appetite for this kind of financing so nonprofits can be choosy about where they place their debt. For nonprofit borrowers, multiple lending options may make selection of a lender difficult. “Don’t merely focus on interest rate,” John Mannila cautions. “Everybody does that, everyone wants to pay the lowest cost. But there’s also a price to be paid for that and it typically comes in the form of service.” 

When Does Bond Financing Make Sense?

Bond financing isn’t always the best financing option for a nonprofit raising money for capital projects. Restrictions associated with tax-exempt financing include what types of organizations are eligible and how the money can be used. Tax-exempt financing may not be the best solution for an organization looking to raise less than $5 million. Generally speaking, tax-exempt bond financing makes sense for nonprofits seeking large loans. It is advisable for an organization to chat with a consultant such as Susan Winshall of Zions Bank when seeking options to finance capital projects. 

What Else Should Nonprofit Borrowers Know?

Plan for upfront costs. While tax-exempt financing may save an organization money in the long run, it can be expensive in the short term. Borrowers need to be prepared to pay large lender and professional fees to close these deals. Bond issuers charge for their services. Intermediaries like Zions Bank may charge a consultation fee or may be paid when a deal is closed.  

Start planning early. Bond financing needs to be preplanned. Exactly how long it takes for a deal to close often depends on the borrower, but three months is typical. Call your attorney to get started sooner rather than later.

The more information you can provide, the better. Be prepared to share clear and substantial data with your financial and professional advisors. Audited financial statements (rather than compiled, reviewed or management-prepared financial statements) can make the job of a lender or  investment banker/consultant easier.  Forward-looking cash flow projections will be required by all lenders. 

Think long-term when choosing a lender. “The choice of a financial partner really comes down to relationship,” John Mannila says. “You can bank anywhere you’d like when things are going well. It’s very easy, there’s no heavy lifting on anyone’s part. The problem you run into is, if there are some bumps in the road, who’s going to stand in the wind with you? Who’s going to work with you when times are difficult or challenging?” 

John Mannila of Webster Five points to COVID as a good example of the importance of prioritizing relationship when choosing a lender. When struggling organizations have gone to their lenders for help, some financial institutions have increased fees and reporting requirements, making things harder for nonprofits that are in financial distress. Think about a lender’s reputation and whether you trust them to help your nonprofit weather a storm before making a deal for tax-exempt financing.

It’s okay if you don’t know what you need. Nonprofit financing is complex and organization leaders may not know where to begin or how to assess their needs. Lean on your attorney and other advisors for guidance. Susan Winshall urges borrowers to ask questions as they evaluate tax-exempt financing. Current interest rate environment, market lending appetite, cost of financing and annual debt service figures are among the issues to explore.

As your nonprofit looks to expand or make other improvements ahead of its next chapter, evaluating the merits of bond financing is just one piece of the puzzle. The business and tax attorneys at Sassoon Cymrot Law, LLC work with our network of referral sources to help our nonprofit clients meet all their organizational goals. We welcome your questions. Contact us today.

Devon A. Kinnard is a Partner at the firm focusing on finance and commercial transactions, including bilateral and syndicated asset-based and commercial real estate loan facilities; state and federal tax credit financing; bond and public finance transactions; private securities offerings and debt and equity capitalizations; joint ventures; mergers and acquisitions and other corporate transactions arising out of the day-to-day operations of closely- and publicly-held companies.
Mark Bressler concentrates his practice in commercial and residential real estate and financial services. Mr. Bressler represents businesses, real estate developers, investors and lenders in connection with their financing and development needs. He handles legal due diligence for real estate transactions including corporate structuring issues, lease review, title, survey and zoning analysis.
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