Reserves, deficits, annual accounts & trustee terms - a look at grant due diligence

Welcome to the Secret Grantmaker, published by Lime Green Consulting. These blogs are designed to give fundraisers and charity folk insights from "the other side", cloaked in anonymity.

The Secret Grantmaker has spent six years working with various funders. They've been privy to countless discussions with the people who make the decisions and hold the purse strings. Their experience in no way reflects trusts and foundations as a whole – there’s a huge variety of practice in the sector. We merely want to give some warts-and-all access to the processes and practice that rarely get aired in public.

In this edition, the Secret Grantmaker draws on their experience to look at the unglamorous but vital first steps in assessing an application: the due diligence process. 

A good chunk of a Grant Manager’s (GM) time is devoted to trawling through annual reports and management accounts. Usually this is done with a tinge of dread, willing there to be nothing untoward in the accounts that would trigger further investigation.

As uninteresting as it may be, the financial and governance due diligence is the first hurdle for charities to jump over on the funding journey. Essentially, this is boiled down to the question of trust: can the keepers of money (the Trust or Foundation) trust the charity to use its money effectively?

As with much of the accounting world, this was often more art than science. 

The thorny issue of reserves: how much is too much, or too little?

The process starts with the basics: does the charity have enough unrelated trustees, are the accounts submitted on time, are they considered a going concern if externally audited?

​Very few charities succumbed to these checks, so normally it was straight on to more subjective matters, such as reserves, governance, and deficits.
 
The thorny issue of reserves got the Trustees going if they were too high (why should take OUR money when they can pay for it themselves?), and worried Grant Managers if they were too low (are they risky for a multi-year grant?).

Generally, my view was that these concerns could be assuaged with a decent policy and reasonable commentary in the annual report. Unravelling what was actually free cash and not tied up in buildings wasn’t always straightforward, even with the SORP requirements.

Anything outside of 3-9 months of expenditure was generally investigated, though I rarely saw anything approaching a year from place-based, community driven charities. A nice problem to have if so.

Unexplained issues with reserves are not helpful and should be avoided, as anything that adds time into the due diligence process lessens the attraction felt by the GM to your organisation. GMs are generally aware of the tightrope charities tread regarding reserves, so a clear explanation on the current predicament is all that’s needed.

Deficits: what should you say about them?

As for deficits, these pose different issues.
 
One former colleague was adamant that no charity with a couple of years of deficits should be funded as it was ‘throwing good money after bad’.

Putting aside this view for a second (as it doesn’t take into account how effective the charity is at delivering its service), clearly there are a myriad of reasons why a charity might have logged deficits: deliberately to run down high reserves, an unexpected legacy dropping the year before, loss of a government contract, or not least that fundraising is increasingly like trying find needles in moving haystacks.

I always checked in with the charity if there were unexplained multiple deficits as I wanted to avoid the Barbara Streisand effect associated with highlighting any financial issues with a charity: i.e. the Trustees wouldn’t know it was there until we highlighted it, but once we did they wouldn’t think about anything else.

Once again, financial commentary within the annual accounts, or within the annual accounts can give the GMs confidence that the charity is going to be around for all or most of the grant duration. There seems to be more of an opportunity for charities to explain anything unusual in the accounts within funding applications now. This is a good use of time, as otherwise GMs could be using out of date information.
 
On the rare occasion that charities were honest about their existential crisis, it didn’t land well with Trustees. The old adage of ‘dependency’ still looms large, Trustees didn’t want to be ‘saving’ charities as what would happen when the Trusts funding came to an end and the Trustees head was turned in another direction?

The world of charity closures is complex, and not one I will go into here (instead check The Decelerator) but it suffices to say that unless they have a deeply personal connection (ever the caveat to process), your average Foundation Trustee won’t be pounding the table for funding to be granted to a charity on its last legs.

What else might the Trustees look out for?

Other governance checks included trustee recruitment and trustee length of service. Only Trustees who were particularly interested in governance (and probably sat on multiple committees), or those who lacked trust in the GM asked questions on this topic. When charities gave some transparency on the trustee recruitment process and terms, it was useful and generally hit the brief, as that often trumped the governance standards of the Foundation itself. Do as I say, not do.
 
Generally, the annual accounts of charities are referenced in board papers, so Trustees can get under the financial bonnet if they so desire (many don’t, but given the amount of reading normally required with the board papers, it's hard to blame them).

This can cause awkward questions for the executive (as mentioned earlier regarding reserves) but these questions generally relate to a charity being perceived to be too strong (i.e. high reserves, high incomes, government contracts etc.), which can be dealt with if the GM has the right information and has the trust of the Committee. Sadly, the charities who are in a weak financial position were often screened out before the meeting, or not recommended for funding.

As due diligence becomes more important, can you get ahead?

In short, Trustees want confidence that the money is needed and isn’t a ‘drop in the ocean’ (although this only applies to charities not personally associated with the Trustees) and that the charity isn’t going to misuse the funds or cease to exist.

Again, clarity in annual reports and application is key here. Don’t shy away from any potential issues, instead recognise them and state your plan to address it. This approach gives the GMs confidence to answer questions on your behalf.

Due diligence is becoming increasingly brutal as the volume of applications increases and GMs and Trustees look to rule out applications using (seemingly) objective measures. Get ahead of it and jump that hurdle with confidence.