microfinance insights vol. 13 (july/aug 2009) highlights

InterviewsSequoia and Sandstone

Mergers & AcquisitionsThe Next Frontier

How toWin an Investor in 12 Steps

Last WordThe Curious Case of Co-Investments in Microfinance

Features

A bimonthly publication from Intellecap www.microfinanceinsights.com

Cover Price: US$12/EUR 8/INR 75

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Fueling the Growth of MicrofinanceThe Role of Private Equity:

Vol.13, July/Aug 2009

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NeWs BOardUS$180,000 for Global PartnershipsJune 26, 2009 - Global Partnerships, a Seattle based microfinance organization, has received a grant of US$180,000 from M.J. Murdock Charitable Trust of Vancouver to manage its loan funds, which have attracted more than US$45m in capital since 2006. The grant will primarily be used to hire a director of investment operations and will allow the organization to better manage its three investment funds and improve its overall management. CBK License for Nine Microlenders to Accept DepositsJune 25, 2009 - Faulu Kenya Limited has received a license from the Central Bank of Kenya (CBK) to accept deposits. At least nine more microlenders are expected to receive similar licenses by this year end. Faulu is one of the nine companies that have submitted formal applications to become deposit-taking institutions. The license was granted in accordance to the Microfinance Act that came into effect in May 2008 to promote a culture of savings in Kenya.

Congressional Gold Medal for YunusJune 25, 2009 - Two bills have been introduced in the US Senate and the House of Representatives to award the Congressional Gold Medal, the highest award conferred by the US Congress, to Dr Muhammad Yunus. So far only a few international personalities, including the Dalai Lama, have been bestowed with this award.

Microfinance Association for the UKJune 24, 2009 - The Microfinance Association, a global professional body that will cater to the needs of microfinance practitioners, has been established in the United Kingdom. Membership is open to all microfinance practitioners worldwide and the members of the association will be offered an information center, a career advice center, and a knowledge management center.

LeapFrog Raises US$44m for World’s First Microinsurance Fund June 19, 2009 - LeapFrog Financial Inclusion Fund, the world’s first investment fund focused on microinsurance, has announced that it has raised US$44m. The capital has been raised from a range of public and private investors around the world, including the European Investment Bank, FMO, Omidyar Network, Triodos-Doen, Hivos-Triodos Fund, ACCION International, Calvert Large Cap Growth Fund, Felipe Medina, and the LeapFrog team.

SKS to Raise US$104m through DebtJune 17, 2009 - SKS Microfinance, the largest microfinance player in India, is planning to raise US$104m through a mix of debt products to fund loan demands of its customers. A non-convertible debenture is issued for a fixed maturity, normally a year, and cannot be converted into equity.

SAP and PlaNet Finance Join Forces to Create Sustainable Business Models June 17, 2009 - SAP has made a commitment to provide financial, software and technical assistance to PlaNet Finance. To improve the microfinance sector, PlaNet Finance and SAP will together target three main areas: technology development for the field, development of software solutions for

MFIs and deployment of SAP technology for PlaNet Finance’s corporate initiatives.

ADB Unveils Energy Program June 17, 2009 - ADB has launched a program to provide access to modern energy to an additional 100 million people in the Asia-Pacific region by 2015. The Energy for All Partnership will support an initial phase of six working groups on domestic biogas, solar lanterns, liquid petroleum gas, financing for energy services, and energy enterprise development.

Grama Vidiyal Raises the First Equity Investment in India in 2009June 16, 2009 - Grama Vidiyal Microfinance Private Ltd (GVMFL) has announced the successful completion of the second round of equity infusion worth US$4.25m. The MFI intends to use the newly acquired fund to support its expansion plans over the next year and meet the enhanced capital adequacy norms set by the Reserve Bank of India. The investment in GVMFL came from MicroVest’s newly launched equity fund, MicroVest II, which invests with Tier I microfinance institutions. Unitus Capital (UC) acted as financial advisor to GVMFL.

New Payment System for CREDOJune 16, 2009 - CREDO has launched a new type of payment system for clients that allows them to make loan payments free

Photo: Ian Britton


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 of modern microfinance

when NGOs and organizations such as Grameen Bank started lending to industrious, but poor, communities in Bangladesh. The sector now touches well over 100 million people worldwide and boasts a total loan portfolio in excess of US$40bn. Although significant growth was originally catalyzed by grant-led initiatives, such scale would likely not have been possible without the participation of commercial capital. In fact, with billions of individuals still lacking access to basic financial services, representing an estimated demand of US$300bn in loans, the future role of commercial capital will be even more critical. The reality is that it

is impossible for microfinance to achieve its full potential without the participation of private equity and debt investment. Quite simply, there is nowhere near enough grant capital available to meet the funding requirements of the world’s microfinance institutions (MFIs) as they continue to scale.

A role for grant capital in microfinance, however, still exists. Indeed, there are many

initiatives that simply fail to offer much potential for a commercial return, but are still critical to the continued development of the sector. These include programs for conducting social impact analysis or the development of microfinance products for “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 of the world’s poor into the formal economy.

Private equity in microfinance is mostly invested in the form of early stage start-up or growth capital. This type of investing is very different from the large-cap private equity techniques employed in the devel-oped world, where investee companies are often over-leveraged and streamlined in

although the microfinance sector cut its teeth on grant-led funding, much of the astounding growth and reach we have seen over the past 2-3 years in the sector has been achieved through outside investment from private equity players. This new velocity for the sector has been received with mixed reaction from more traditional microfinance leaders and practitioners. It’s too much growth, too fast, they say. are they right to be concerned? or should they see value in reaching more poor people in a shorter span of time? justin Wilmott, vice President at legatum ven-tures, shares his perspective.

Wilmott finds that it is impossible for microfinance to achieve its full potential without the participation of private equity. Are MFIs ready to fly far and fast? Photo: Steven DePolo

11july/aug 2009 l microfinance insights lwww.microfinanceinsights.com

cOmmeNtary

Justin Willmott is a Vice President with Legatum Ventures, based in Dubai. Legatum Ventures has invested over US$60m of private equity to support the microfinance sector globally since 2007, and continues to be an active supporter of the sector as it develops towards reaching its full potential.

the pursuit of a short-term exit and return on capital. In contrast, private equity in microfinance often serves to strengthen balance sheets, not to weaken them, and the greater corporate governance require-ments of such investors inevitably results in stronger organizations. An increasing flow of this type of 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 financial services landscape, microfinance stands to substantially benefit from the increased participation of private equity investors. Through the provision of risk capital, such investors will actively support new business models and lending methodologies. With this in mind, consider the interesting parallel of the positive role played by private equity in other emerging sectors, where it has often resulted in the financing of hundreds of 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 information, 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 of success without the risk capital, strategic support and commercial networks that private equity investors provide.

While the volume of private equity in-vested in microfinance to date has barely scratched the surface of the sector’s re-quirements, there are already a number of examples of the positive role that this

capital has played. In India, a series of no-table investments has provided the foun-dation for increased outreach, greater geographic diversity, the introduction of new products and improved mechanisms to attract and retain high quality talent. Over the past two years, the five largest MFIs in the country have been the benefi-ciaries of approximately US$180m in pri-vate equity investment, which has helped them to grow their combined active client bases from 2.2 million to over 4.7 million, a compound annual growth rate of 45%. Four of 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 of investor support. Of particular note are the branchless banking technologies currently enabling millions of previously unbanked individuals to efficiently access deposit accounts, government disbursals, insurance products, and even secure pay-ment platforms.

Despite the positive impacts of such in-vestments, some still criticize private eq-uity backed MFIs for their rapid growth rates. This is potentially a valid concern, but prudent investors will always seek to temper such growth with conservativism, since a default-ridden loan portfolio is of limited value no matter how large it is. This ensures that the interests of private capi-tal are aligned with those of the recipients of MFI credit – both parties benefit from growing a quality loan portfolio, promot-ing greater operational efficiencies and technological sophistication, and ultimate-ly from accessing public capital markets. These benefits all serve to lower the oper-ating costs of the MFI, therefore resulting in a lower cost of capital and more efficient service for the end client.

As we reflect on the evolution of the microfinance sector from its origins in 19th century Germany,1 and its subsequent

development in South Asia, it is clear that an increasing participation of private capital has already stimulated greater competition amongst for-profit MFIs. This will ultimately lead to lower interest rates, a higher quality of service, and a greater diversity of products. Further private equity investment will be a key factor in enabling the sector to reach the billions of unserved clients who still live outside the formal financial system. It will also help more MFIs take a number of important steps towards better serving this market in securing banking licenses (enabling cheaper funding through deposits and a much needed saving tool for their clients), attracting world class talent and accessing cheaper capital markets. As we have seen, private equity and grant capital are far from being mutually exclusive and can actually co-exist. Grants have already realized many valuable developments, and in the future it is likely that this type of capital will also address many more important issues such as the measurement

of microfinance’s social impact, the best way to serve the poorest of the poor, how to increase financial literacy, and how best to deliver complementary services like healthcare and education. Each of these is very valuable, not only for the clients concerned but also for society at large, strengthening the sector overall and thereby complementing the ongoing efforts of private equity investors. n

Raiffeisen Banks were founded in 1846 in rural Germany and are early examples of microfinance institutions. Many of them are still in operation today, functioning as 1. co-operatives or savings banks.

“…private equity in microfinance often serves to strengthen balance sheets, not to weaken them, and the greater corporate governance requirements 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 private equity investment, which has helped them to grow their com-bined active client bases from 2.2 million to over 4.7 million, a compound annual growth rate of 45%.”


Microfinance Insights (Insights): Just five years ago, SKS was an NGO. Sequoia is now India’s largest MFI. How do you think these inflows of capital have changed SKS?Sumir Chadha: One of the things I love about Vikram [Akula, the founder of SKS Microfinance] is that he’s always been a man with a large vision: solving the poverty problem in India. The only way to solve it is to have tremendous scale. And scale requires massive equity infusions. Without it, unfortunately, it’s not scaleable. The sad reality is, if you want to hit 150 million people in this country, you need to raise a lot of money, and you have to have a management team that is highly professional, highly driven. So, SKS had two choices: one choice was to remain small and nonprofit, but frankly not very impactful, or try to really change the country and adopt a lot of the best practices from business.

Insights: There are several investors—mainstream and not so mainstream—with a stake in SKS. Unitus. Sandstone. SVB. Kismet. How do you handle the changing priorities of different investors? How does the board manage each investor’s expectations? Since no one has the majority stake how do you find balance?Chadha: There is this outside perception that there is a conflict among the board. But there really isn’t. If you were to attend one of our board meetings, I can tell you I am just as concerned about service quality as a social investor. There really hasn’t been this big social versus profit debate. In practice it has been a non-issue.

Insights: In terms of Sequoia’s perspective on things regarding financial versus social priorities and returns, would you say it’s 50-

50, 60-40, 70-30? How would you weigh each of those priorities?Chadha: Sequoia doesn’t have a social bucket. Let me explain. What’s interesting about us is that virtually all our investors are not-for-profits. So we are in the fortunate position of choosing the clients that we work for (meaning our investors). Interestingly, a lot of the social investors are for-profit investors.

Insights: Usually, an MFI promoter is not permitted to exit. And, yet, I’ve been told that Vikram has sold his stake. What is your position on this?Chadha: Vikram has sold a small stake in the company. We typically do that in many of our companies. I know in the social sector people frown upon making money. We don’t think it’s a crime. We think it’s okay to make money, we don’t think it’s anything we have to hide or be embarrassed about. It is ok to do good by doing well.

GROWTH, VALUES, RATESInsights: You have said you want SKS to “dominate” the industry. But that word has some negative connotations, when we’re talking about a social sector. There’s talk of SKS poaching a lot of clients from other MFIs. What is your take on that?Chadha: I think it’s very positive. Why should a poor woman have to suffer because it’s a social sector, and you can’t compete for her attention? If SKS does a better job for that poor woman, that poor woman must benefit. If we charge a lower interest rate, or provide better customer service, I personally think that’s a good thing. There should be competition for the poor woman’s interests. With SKS a tiny part of the growth has come from taking other people’s clients – perhaps five percent. Ninety

five percent of the growth has come from going into new areas where no one has been offering microfinance services. That makes it so exciting.

Insights: SKS has been growing at astronomical rates: in FY 2007-08, it grew at a rate of 200%. At what rate of growth would you say, “Beyond this, it’s too risky.”Chadha: Well, we are slowing down the growth rate. This year the growth is going to come down to slightly above a 100%. The growth rate is slowing down with scale. There are high risks to rapid growth.

Unfortunately, I don’t think that if we grow, others can grow at that scale, because SKS is about 25-30% of the market share in the industry, and that share is growing. One of the challenges is that if we want to solve the poverty problem and slow the growth rate, it does have a negative consequence in terms of the whole industry’s growth. So there is a strong social feeling in the pressure to grow.

One of the tensions is that we want to make sure that the service quality to clients remains very high, and that we keep following our processes, and our systems. I think what the company has done very nicely last year is to make huge investments in IT systems. There has been a huge emphasis on training. What I find impressive is that if we were to go and visit a center meeting in Bihar versus a center meeting in Andhra Pradesh – the center meetings run exactly the same way. What that standardization allows you to do is not dissimilar to what Henry Ford did with the Model T, and created a car industry in the U.S. This standardization allows you to produce a lot more and a lot faster.

The Truth about Private Equity and MicrofinanceInterview: Sumir Chadha, Managing Director, Sequoia Capital Indiaone of the first “mainstream” investors to take the plunge into microfinance was Sequoia Capital. Its entry was one of the first indications that microfinance could be seen as purely profit-driven investment. Better known for its venture capital investments into google, yahoo, youTube and apple Computer, Sequoia invested uS$11.5m into SKS microfinance, based in Hyderabad, India, in 2007. Since then the company has made an additional investment into ujjivan, an urban microfinance institution based in Bangalore, India. microfinance Insights sat down with Sumir Chadha, managing Director with Sequoia Capital India, to learn about the motivations of the company with regards to microfinance, and the innerworkings of SKS.

iNtervieW


Think about this: 240 to 400 million target population; an estimated potential of

US$30-50bn; the largest microfinance institution (MFI) has less then US$1bn in assets, and—hold your breath—there are 800 small and large MFIs vying for the space. Add to this a growth rate of 70% year on year and an average capital adequacy in excess of 25 to 30% at large for-profit MFIs, and you are staring at the exciting potential of Indian Microfinance.

These highlights are the reason behind the positive interest that Indian microfinance has generated among investors. However, the implication of challenges such as complex geography, cultural and linguistic diversity, and

nascent infrastructure development, especially in rural India, are yet to be understood.

Geographic Outreach: Not as Broad as You ThinkAs a sector, Indian microfinance remains a concentrated phenomenon with most of the microfinance operations still focused in Andhra Pradesh and other southern states. The increasing size of operations, influence of banks and private equity investors, and general counsel from the credit rating agencies pushed the microfinance institutions (MFIs) to make an effort in building a more diversified geographical outreach.

The above strategic move, though being

implemented with greater intensity after the Krishna episode in the state of Andhra Pradesh,1 has yet to make a serious difference to the portfolio concentration of many large MFIs. Interesting insights may emerge if one analyzed the share of portfolio from new states among the top 10 MFIs with presence in more than 5-7 states. The numbers would reveal that the contribution of Andhra Pradesh to the portfolio remains above or close to 50% for most of them and interestingly, despite the talk of concerns about multiple borrowing, concentration and saturation, the portfolio growth in Andhra remains high for all of them.

What could explain this behavior? Maybe

Indian microfinance has been growing like wildfire, with some institutions adding hundreds of thousands of borrowers to their rosters each month. However, a closer look at the numbers indicates that penetration is still not that geographically diverse, with many mFIs still being supported by a portfolio with 50% of borrowers in just one state. What are the pitfalls that make expansion into new states difficult? Should microfinance institutions consider acquiring existing organizations in new states, instead of treating each new area as the next frontier? vineet Rai, Co-Founder of aavishkaar venture management Services, explores the prospects for mergers and acquisitions in microfinance.

The Next Frontier:Is M&A a Feasible Strategy for Expansion?

Is acquisition of small, regional MFIs a strong growth strategy for large MFIs expanding into new states?Photo: Mike Johnston

mergers & acquisitiONs


it is not as easy to scale up in other states as we think? Or maybe the MFIs are not serious about scaling up in new states and the expansion plan and new branches are just a smoke screen to keep the lender and investors convinced that there is an “in principal” agreement on diversifying the portfolio?

Barriers to ExpansionA quick discussion with some of the CEOs of microfinance institutions partially allays such fears. What seems to be the case is that large MFIs are witnessing variable performance and some states are performing much better than others. Ability to find strong on-the-ground leadership that can allow a push toward scale seems to be a major constraint. Other constraints cited include the low level of education of the borrowers in some states and the lack of discipline and understanding of loan products. In addition, dealing with local politicians and bureaucracies, that are yet to learn about microfinance, presents a challenge.

From an analytical point of view the problem appears to be related to classical organic growth challenges and may thus need a strategic shift in thought process. A question that may be relevant is whether there is merit in looking for inorganic growth through merger and acquisition (M&A) for these Indian MFIs to expand more rapidly. Additionally, would M&A strategies work in an essentially demand-driven space in terms of adding value to growth strategy?

Considering M&A for Growth Both the above questions need to be looked at closely. M&A as a strategy works best if organic growth appears to be slowing down

(if the protagonist is already set in the market and competition is heating up). Conversely, if you want to enter into a new market that has huge potential but has reasonably established competition, an acquisition may give you sound footing to compete in the market.

With that background, it would be interesting to see if there is merit in Indian MFIs thinking about M&A and discovering whether their stakeholders would support this approach.

A key point that needs to be looked at carefully while discussing M&A in the context of microfinance is its social evolution. Currently there seems to be a belief that microfinance continues to remain promoter-focused and hence not amenable to ownership swap strategies.

Is there Merit to Forging Inorganic Growth?Let me try to answer the first question by stating that while India is a single country, its diversity makes it a heterogeneous market. Each new state is a different market requiring a different mind set, different leadership and at times different products to successfully scale. For large MFIs, acquisition as a growth strategy to enter a new state may be a better strategy than rolling out its own branch network and going through start up growing pains again. Similarity of model (largely Grameen) would make the process of acquisition much less complex and acquisition of talent would solve the local leadership and management bandwidth issue making it easier to build value through this inorganic growth strategy.

Support from Stakeholders is NecessaryThe second question on the support from stakeholders including investors appears to be not such a big challenge if the strategy for M&A by the MFI is clearly articulated and based on quelling the challenges that they have faced while entering new markets. Investors would view favorably the idea of addressing local human resource challenges in new states through acquisition if it takes into account the

quality of manpower being acquired and the compatibility of processes and systems.

The third question about the social entrepreneur and his/her influence in the business is a real issue. The two emerging trends that may allow such challenges to be addressed are a) The definitive movement of banks lending toward larger MFIs, leaving a bigger challenge of survival for the small, regional MFIs, at times forcing them to be more favorably disposed toward such offers b) Professional promoters with banking backgrounds have started setting up MFIs that are regional, bringing in a depth of local leadership and an open-minded approach towards ownership swap and acquisition.

While the case for acquisition opportunities in Indian microfinance is quite clear, mergers remain a more complex and difficult proposition. It seems a merger in the Indian scenario can come about either driven by the goal of enormous scale to create value for investors, or by regional MFIs coming together to deal with larger pan-India partners. My belief is that many MFIs may not want to deal with the complexity of mergers, in addition to the management of egos, which are often the key drivers behind social enterprises. However, acquisitions may become a reality in the near future. n

Vineet Rai is the Co-Founder of Aavishkaar Venture Management Services, and the Co-Founder of Intellecap, the company that publishes this magazine.

“……the contribution of Andhra to the portfolio [of the top 10 MFIs in operation in more than 5-7 states] remains above or close to 50% for most of them and interestingly, despite the talk of concerns about multiple borrowing, concentration and saturation, the portfolio growth in Andhra remains high for all of them.”

1. A dispute between the government authority and MFIs in Krishna district, Andhra Pradesh. In 2006, accusing MFIs operational in Krishna district under the provision of the AP Private Lenders’ Act, of allegedly charging high interest rates and being responsible for the death of one of the borrowers, the district authorities closed down more than 54 microfinance branches. The root of the dispute was thought to be a competition between non-governmental MFIs and a subsided microcredit scheme provided by the state and the central government, which was caused by the rapid expansion and concentration of MFI’s presence in the area. The Economist reported this incident as a turf war. See http://www.economist.com/businessfinance/displayStory.cfm?story_id=7803631

“It seems a merger in the Indian scenario can come about either driven by the goal of enormous scale to create value for investors, or regional MFIs coming together to deal with larger pan-India partners.”

mergers & acquisitiONs


survey

Profile of General Partners (GP) ConsolidatedFundSize

Profile of Limited Partners (LP)YearsofExperienceinEquityMIVs

GP: Attractiveness of Microfinance Investment LP: Change in Risk Perception

Microfinance and Private Equity Traditionally, microfinance institutions (MFIs) have been funded by soft loans and grants mainly from Development Financial Institutions (DFIs) or foundations. However, the sector has been increasingly recognized as an “investable” asset class by global private players. Amid the global financial meltdown and the resulting liquidity crunch, the microfinance sector has been relatively insulated from the severe consequences of it, which further facilitated private equity investment stepping into the sector. In this issue, Intellecap, in collaboration with the International Association of Microfinance Investors (IAMFI) conducted a survey on private equity investment and explored private investors’ risk and return perceptions in microfinance investment.

Survey Sample Overview 46TotalRespondents:27GeneralPartners(59%)and19LimitedPartners(41%)

Risk Perception AlthoughamajorityofbothLPsandGPsagreethattheimpactoftheglobalcrisisonmicrofinanceisfarlessthanonotherasset

classes,LPshavefelttheriskmoreseverelythanGPs

30%

25%

30%

5% 10%

Profile of General Partners Consolidated Fund Size

0<US$50

US$50<US$100

US$100<US$300

US$300<US$500

>US$500

33%

17%

50%

GP: Attractiveness of Microfinance Investment

More Attractive

Less Attractive

No Impact

41%

42%

17%

LP

Increased

Decreased

No change

16%

46%

15%

23%

Profile of Limited PartnersYears of Experience in Equity MIVs

< 1 year

1 Year < 4 Years

5 Years < 9 years

10 Years <

Current Risk Perceptions about the Microfinance Sector

General Partners (GPs) Limited Partners (LPs)

1.MFIs’ManagementQuality 1.MFIs’ManagementCapability

2.Exits2. Inadequate internal systems to handle high growth and associated risks

3.Valuation/PortfolioQuality3.Currencyriskandvolatilityoftheeconomic environment

m

m

m

m

m > 10 years

Datapoint

SocialImpactandBetterRisk/Returnprofilesarethetwomain•motivationsforMFIinvestment 62%• havelessthan4yearsofexperienceinmicrofinanceequitymarket •82% invested through MIVs Half the respondents have less than • 25%ofmicrofinanceinvestmentintheirtotalPEportfolio

Datapoint

58%• of GPs were able to raise target amount of funds during the past 12 months •56%ofGPsdidnotplananyexitduetotheglobalcrisis •40%ofGPssawa“increase”inequitydealflowduringthelast 12 months “Lowcorrelationtootherassetclass”and“Lessimpact•fromglobalfinancialcrisis”arethetop2reasonsthatMFIsarethoughtofasanattractiveassetclass(GP)

Datapoint

•70% are MIVs •50%makealltheirequityinvestmentinmicrofinance

microfinance insights vol. 13 (july/aug 2009) highlights

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