Last Metric Monday, we explored Administrative Expense Percentage. This time around, we’ll be zeroing in on our Loans to or From Related Parties metric.
For starters, making loans to related parties, like staff and board members, is not an industry norm. When a charity gives a loan to a related party, it is taking away funds from mission related expenses for an indefinite period of time. Moreover, giving loans to related parties can lead to real and perceived conflict of interest problems. Say a board member receives a $100,000 loan from the charity whose board they sit on. A month later, this same board member votes in favor of cutting program expense by 50%. Shrinking program size can be a healthy, strategic decision that inevitably benefits the charity, but can we be sure that this board member is thinking in the charity’s best interest versus their own?
The IRS is so concerned with this practice that it requires charities to report on their Forms 990 any loans they’ve given to or received from related parties (current and former officers, directors, trustees, key employees, and other "disqualified persons”), to detail how much the loans were for, and how much is currently owed on the loan. Influenced by the IRS and sector standards, some state laws go so far as to prohibit loans to board members and officers. And while it's perfectly legal for employees and trustees to make loans to charities, this practice can result in conflict of interest problems for the charity, as there’s potential for a board member who loaned money to a charity to have greater influence on board happenings.
On top of all this, making or receiving loans suggests that the organization isn’t financially secure. If they were, they likely wouldn’t need to borrow money in the first place. To learn more about our Accountability & Transparency metrics, check out our Methodology.