1 l  microfinance insights  l july/aug 2009

cOmmeNtary

The Case for Private Equity Investment

“Quite simply, there is nowhere

near enough grant capital

available to meet the funding

requirements of the world’s mi-

crofinance institutions (MFIs) as

they continue to scale.”

Much has been accomplished since the

early days o modern micronance

when NGOs and organizations such

as Grameen Bank started lending to

industrious, but poor, communities in

Bangladesh. Te sector now touches well

over 100 million people worldwide and

boasts a total loan portolio in excess o 

US$40bn. Although signicant growth

was originally catalyzed by grant-led

initiatives, such scale would likely not have

been possible without the participation o 

commercial capital. In act, with billions

o individuals still lacking access to

basic nancial services, representing an

estimated demand o US$300bn in loans,

the uture role o commercial capital will

be even more critical. Te reality is that it

is impossible or micronance to achieve

its ull potential without the participation

o private equity and debt investment.

Quite simply, there is nowhere near

enough grant capital available to meet

the unding requirements o the world’s

micronance institutions (MFIs) as they 

continue to scale.

A role or grant capital in micronance,

however, still exists. Indeed, there are many 

initiatives that simply ail to oer much

potential or a commercial return, but are

still critical to the continued development

o the sector. Tese include programs or

conducting social impact analysis or the

development o micronance products or

“ultra-poor” clientele. In this respect, both

commercial and grant capital can work 

hand-in-hand as the sector continues to

evolve and bring more o the world’s poor

into the ormal economy.

Private equity in micronance is mostly 

invested in the orm o early stage start-up

or growth capital. Tis type o investing is

 very dierent rom the large-cap private

equity techniques employed in the devel-

oped world, where investee companies are

ofen over-leveraged and streamlined in

athugh the micrfnnce sectr cut its teeth n grnt-ed unding, much the stunding grwth nd rech wehe seen er the pst 2-3 yers in the sectr hs been chieed thrugh utside inestment rm prite equitypyers. This new ecity r the sectr hs been receied with mixed rectin rm mre trditin micrfnnceeders nd prctitiners. It’s t much grwth, t st, they sy. are they right t be cncerned? or shud theysee ue in reching mre pr pepe in shrter spn time? justin Wimtt, vice President t legtum ven-tures, shres his perspectie.

Wilmott nds that it is impossible or micronance to achieve its ull potential without the participation o private equity. Are MFIs ready to y ar and ast?

Photo: Steven DePolo

 

11july/aug 2009 l  microfinance insights  lwww..

cOmmeNtary

Justin Willmott is a Vice President with Legatum Ventures, based in Dubai. Legatum Ventureshas invested over US$60m o private equity to support the microfnance sector globally since2007, and continues to be an active supporter o the sector as it develops towards reaching itsull potential.

the pursuit o a short-term exit and return

on capital. In contrast, private equity in

micronance ofen serves to strengthen

balance sheets, not to weaken them, and

the greater corporate governance require-

ments o such investors inevitably results

in stronger organizations. An increasing

ow o this type o capital will not only al-

low the sector to scale, but will also lead to

greater accountability and transparency.

As an emerging sector within the

global nancial services landscape,

micronance stands to substantially 

benet rom the increased participation

o private equity investors. Trough the

provision o risk capital, such investors

will actively support new business models

and lending methodologies. With this in

mind, consider the interesting parallel

o the positive role played by private

equity in other emerging sectors, where

it has ofen resulted in the nancing o 

hundreds o innovative young companies.

Not only have these companies generated

attractive returns on equity, but many 

have also contributed considerable social

 value by improving productivity, health,

and access to inormation, not to mention

the many new employment opportunities

they have brought to the market. Examples

include technology, telecommunications,

biotechnology and, most recently, clean

technology, all sectors that would not

have achieved the same level o success

without the risk capital, strategic support

and commercial networks that private

equity investors provide.

While the volume o private equity in-

 vested in micronance to date has barely 

scratched the surace o the sector’s re-

quirements, there are already a number

o examples o the positive role that this

capital has played. In India, a series o no-

table investments has provided the oun-

dation or increased outreach, greater

geographic diversity, the introduction o 

new products and improved mechanisms

to attract and retain high quality talent.

Over the past two years, the ve largest

MFIs in the country have been the bene-

ciaries o approximately US$180m in pri-

 vate equity investment, which has helped

them to grow their combined active client

bases rom 2.2 million to over 4.7 million,

a compound annual growth rate o 45%.

Four o these organizations are now serv-

ing well over a million active clients each.

Furthermore, numerous new business

models have been launched as a direct re-

sult o investor support. O particular note

are the branchless banking technologies

currently enabling millions o previously 

unbanked individuals to eciently access

deposit accounts, government disbursals,

insurance products, and even secure pay-

ment platorms.

Despite the positive impacts o such in-

 vestments, some still criticize private eq-

uity backed MFIs or their rapid growth

rates. Tis is potentially a valid concern,

but prudent investors will always seek to

temper such growth with conservativism,

since a deault-ridden loan portolio is o 

limited value no matter how large it is. Tis

ensures that the interests o private capi-

tal are aligned with those o the recipients

o MFI credit – both parties benet rom

growing a quality loan portolio, promot-

ing greater operational eciencies and

technological sophistication, and ultimate-

ly rom accessing public capital markets.

Tese benets all serve to lower the oper-

ating costs o the MFI, thereore resulting

in a lower cost o capital and more ecient

service or the end client.

As we reect on the evolution o the

micronance sector rom its origins in

19th century Germany,1 and its subsequent

development in South Asia, it is clear that

an increasing participation o private

capital has already stimulated greater

competition amongst or-prot MFIs. Tis

will ultimately lead to lower interest rates,

a higher quality o service, and a greater

diversity o products. Further private

equity investment will be a key actor in

enabling the sector to reach the billions o 

unserved clients who still live outside the

ormal nancial system. It will also help

more MFIs take a number o important

steps towards better serving this market

in securing banking licenses (enabling

cheaper unding through deposits and a

much needed saving tool or their clients),

attracting world class talent and accessing

cheaper capital markets. As we have seen,

private equity and grant capital are ar

rom being mutually exclusive and can

actually co-exist. Grants have already 

realized many valuable developments,

and in the uture it is likely that this type

o capital will also address many more

important issues such as the measurement

o micronance’s social impact, the best

way to serve the poorest o the poor, how

to increase nancial literacy, and how

best to deliver complementary services

like healthcare and education. Each o 

these is very valuable, not only or the

clients concerned but also or society at

large, strengthening the sector overall

and thereby complementing the ongoing

eorts o private equity investors. n

Raieisen Banks were ounded in 1846 in rural Germany and are early examples o micronance institutions. Many o them are still in operation today, unctioning as1.co-operatives or savings banks.

“…private equity in

microfinance often serves to

strengthen balance sheets,

not to weaken them, and the

greater corporate governancerequirements of such investors

inevitably results in stronger

organizations.”

“Over the past two years, the

five largest MFIs in India have

been the beneficiaries of ap-

proximately US$180m in privateequity investment, which has

helped them to grow their com-bined active client bases from

2.2 million to over 4.7 million, acompound annual growth rateof 45%.”