44890 Transforming NGO MFIs: Critical Ownership Issues to Consider A significant proportion of microfinance institutions make a transformation unnecessarily costly, difficult, (MFIs) in developing countries operate either and sometimes unworkable. as nongovernmental organizations (NGOs) or as PAPER projects run by international NGOs. Many of these NGO MFIs plan to "transform" into a for-profit Introduction company--often, a regulated financial institution. The microfinance sector is, in many ways, at the In most cases of transformation, NGO MFIs have two threshold of knowledge and experience regarding primary objectives: (i) to provide clients with a range this type of transformation.1 A key component of the of financial services beyond credit,5 including savings transformation of an NGO MFI into a company--the and transfer services,6 and (ii) to increase access to establishment of ownership--presents issues for the capital, whether through commercial borrowings NGO as well as the founders and funders of both the (which remain inaccessible for many NGO MFIs today), NGO and the newly established institution. These deposits, raising equity, or all three. (See Box 1.) issues include the following: Box 1. Why Transform? · Legal limits on an NGO's ownership of the NGOs transform for various reasons: transformed institution, which may have · toofferfinancialservicesbeyondlending consequences for mission and governance · toaccesscapital · Legal restrictions affecting the ability of the NGO · to comply with new legislation requiring or permitting transformation MFI to contribute its assets to the transformed · togainlegitimacy institution · toenableemployees,clients,andotherstakeholders · Effective transfer of liabilities to become owners · Limitations related to the NGO's grant funding · Issuance of shares to management, employees, Increasingly, transformations are triggered by and other stakeholders legislative change.7 Sometimes the change requires · Future divestiture by initial shareholders NGO MFIs to transform. In other cases, new legislation or regulations provide new institutional options for This paper provides insights and guidance for those engaging in microfinance activities. Several NGO who plan to carry out a transformation.2 Thus the MFIs have transformed into regulated financial paper's discussion of issues is likely more detailed institutions in an effort to gain legitimacy in the eyes and technical than most general readers will care of investors, commercial lenders, and other financial to wade through. At the same time, this is not a institutions and policy makers. In a few cases, NGO "how to" manual nor does it identify right and MFIs have transformed specifically to enable wrong answers.3 Such an approach would not be employees or clients to become owners. feasible, primarily because of the different scenarios transforming institutions will face depending on local In some transformations, NGOs bring in outside OCCASIONAL law and regulation. Although this paper touches on investors,8 usually to access new capital or specific matters that have raised difficult ethical and "double expertise and technical assistance (TA). (In several bottom line" issues in recent transformations and completed transformations, a TA provider had been post-transformation sales of shares, it does not deal working with the NGO for years and was a catalyst with these issues in depth because they have already for transformation.) However, not all NGOs want been discussed in various publications.4 to bring in outside investors. Some prefer to have No. 13 June 2008 complete control over the transformed institution. NGO founders and funders should consider the This is most common with international NGOs Kate Lauer topics addressed in this paper long before beginning (INGOs) that have transformed their local projects a transformation. Early planning and consultation with or locally established NGOs into local companies. local counsel will help them avoid pitfalls that may 2 Typically, these transformations are driven by legislative changes or the desire to provide new services. Box 2. Transformation Iterations (Rarely is the demand for capital a motivating factor Variations on an NGO establishing Newco as a subsidiary and selling or transferring its microfinance for INGOs.) In fact, many INGOs that already have business to Newco in exchange for shares include gone through one transformation plan to transform the following: all of their local operations as part of an institutional · NGOacquiresanexistingcompanyorregulated design approach.9 For similar reasons, several local financial institution and transfers all or a portion of NGOs have declined to bring in outside owners. It is its business (its portfolio, other assets, liabilities, and employees) (India BWDA Finance Limited) important to note that in several cases, where an NGO · NGO"merges"withoneormoreNGOs;they considered transforming into a regulated financial transfer their collective portfolio to Newco or institution, NGO senior management--fearing the to an existing company or regulated financial loss of their jobs--opposed the transformation and institution (Bolivian Eco Futuro) · NGOMFIdoesnottransferportfolio;instead,as prevented it from taking place. Ultimately, however, each loan is repaid, the transformed institution the path taken by the NGO may be determined by makes a new loan (i.e., client list is transferred local law. For instance, in some countries, an NGO but not loans) (Peru MiBanco) -- Other assets and liabilities may be transferred is permitted to be the sole or majority owner of a in one or several steps financial institution while, in others, the NGO may be -- employees may be transferred up front or required to have outside investors and even reduce after Newco has taken over all or part of the its ownership interest below 50 percent. portfolio · NGOtransfersbranchestoNewcoonbranch- From Ownerless to Owned: by-branch basis (e.g., Philippine CARD NGO and CARD Bank) Understanding the Implications · NGOMFIcontinuestoengageinmicrofinance activities alongside Newco (e.g., K-Rep and K- RepBank;CARDNGO,andCARDBank) In microfinance lexicon, "transformation" is a catch- · NGOisreorganizedfromanownerlesscompany all term that refers to a variety of transactions in limited by guarantee into a company with which a microfinance business is transferred from shareholders (FINCA Uganda) one institution to another. But for purposes of this paper, the term "transformation" refers specifically to · NGO management (even if not Newco the transfer by an ownerless NGO of all or a part its management) microfinance business to a for-profit company: a new · Newco management (often formerly NGO or preexisting legal entity with owners who exercise management) rights proportional to their ownership interests.10 · NGO employees · Newco employees (typically, some but not all of A generic transaction could be described as follows: the former NGO employees) an NGO transfers its loan portfolio and other assets, · Newco clients (formerly NGO clients) liabilities, and employees to a new company (Newco) · technical advisers in exchange for shares of Newco or payment (cash, · unaffiliated outside investors (e.g., international debt, or a combination thereof). The NGO is the financial institutions and local and foreign private sole shareholder, majority shareholder, or a minority investors) shareholder of Newco. (Variations on the generic · government bodies structure are identified in Box 2.) Other owners of Newco may include the following: It is essential that those discussing the possibility of a transformation be aware of the significant differences · NGO founders (e.g., an INGO or individual between an ownerless NGO and a company with founders) owners. Volumes have been written on how to · NGO board members or trustees define an NGO. (NGOs go by many different names: · Newco board members (who may also have been association, foundation, not-for-profit corporation, board members of the NGO) company limited by guarantee, public benefit 3 company, etc.) For purposes of this paper, an NGO has the following attributes: it has no owners, cannot Box 3. Different Types of Ownership Interests distribute profits, is not part of the state, and has Owners of a share company can hold different types voluntary membership. of interest, including common shares, preferred shares, and convertible preferred shares. Although there is variation across countries, usually the governing body of an NGO includes a general · Common shares carry voting rights and have the most upside and downside. The owners of assembly that meets annually and/or a board of common stock are entitled to receive dividends if directors that is appointed by the members or the everyone else (including preferred shareholders founders (and, in some cases, is self-perpetuating) and creditors) has been paid. · Preferred shares pay an annual fixed income and assumes a governance role between annual and have priority over common shares in the meetings. A primary role of the governing body is to payment of dividends and in the return of capital ensure that management pursues the objective of the in the event of bankruptcy. Preferred shares may NGO, which in the case of an NGO MFI, is typically or may not carry voting rights, although these rights typically would pertain only to certain to provide low-income and poor people with access events, such as a new share issuance. Sometimes to financial services. voting rights are triggered only when preferred dividends are in arrears. In contrast, a company is formed by individuals · Convertible preferred shares are preferred shares that provide the holder with the right, on a and legal entities that invest equity in the company specified date, to convert into common shares. and then generally determine its direction through exercising voting rights at annual and special meetings. (Companies also can have owners who have no Factors That May Interfere voting rights. See Box 3 for a description of different with the NGO Retaining types of ownership interests in a share company.) Control over the Transformed Depending on local law, the owners of a company Institution may be entitled or required to elect a governing board that is responsible for ensuring the executive In most transformations, the NGO has (at least in the management runs the business in accordance with initial stage) retained, or wanted to retain, control the wishes of the owners. The company's constituent over the transformed institution--as sole shareholder documents (certificate of incorporation or articles of or otherwise. In several transformations, one or incorporation and company bylaws) may specify which more of the legal restrictions discussed below have shareholders--typically determined by percentage interfered with the NGO's original intent of being the shareholding--have the right to appoint or vote for sole shareholder or the controlling shareholder. one or more board members. 1. Maximum Ownership Limitations. Many countries Unless there are restrictions on transferability of limit the percentage of shares that an individual or shares (or participations), ownership may change over entity may own in a regulated financial institution.11 time. Generally, owners are interested in ensuring the One-third of the 143 countries in a 2007 survey set company generates a profit and in receiving dividends a maximum percentage for bank ownership (Caprio, (or at least realizing a gain on the sale of their shares). Levine, and Barth 2007).12 It is likely that a country There may be social investors who may have other applying a maximum ownership limit with respect interests that equal or exceed their interests in profit to banks would also apply such ownership limits to making, although this factor is not guaranteed to depositary MFIs, if such a legal category exists.13 result in an institution pursuing the NGO's mission This maximum usually applies to the aggregate and prioritizing the clients' interests. holding of any group of related persons. For legal entities, this typically would include all entities that are tied by significant ownership or control. Often, these restrictions apply only to owners who are not themselves regulated financial institutions.14 4 The rationale for these limits is usually a belief that 4. Initial Minimum Capital Requirement. Often, a governance of financial intermediaries with diverse regulated financial institution is subject to an initial ownership will have more checks and balances and minimum capital requirement. The owners typically consequently will be safer. Another potential benefit must deposit the initial minimum capital or a portion of diverse ownership relates to the ability of owners thereof into an account of the central bank on receipt to satisfy capital calls. (In both cases, these benefits of a license or, in some countries, when submitting will turn on the specific qualities, experience, and the license application. In some countries, the entire financial situation of the owners. Additional owners requirement must be satisfied with cash; in other with little experience and knowledge or with countries, a portion of the requirement may be satisfied insubstantial liquid assets may not, in fact, benefit with noncash items, such as a loan portfolio. Requiring the company.) However, maximum ownership limits an all-cash initial capital contribution or restricting the can be problematic for an NGO that wants to protect noncash portion can cause hardships for NGO MFIs the social mission of the Newco or that cannot find that are short on cash.15 If the NGO cannot fund the interested investors that share its commitment to the minimum required amount on its own, then it may same mission. More than one INGO has negotiated have to raise funds through outside investors. with regulators for a specific exemption from the maximum ownership limit based on the NGO's track An NGO with a sizable loan portfolio could face the record as a successful owner of financial institutions inverse problem if the NGO is subject to a maximum (e.g., FINCA Uganda). However, this is not easy and legal ownership percentage and sufficient funding is likely to depend on the success of the financial cannot be raised from outside investors. That is, if institutions owned by the NGO. the NGO were to contribute 100 percent of its loan portfolio as capital, it might not be able to raise 2. Regulatory Approval of Significant Owners. Local sufficient capital from outside investors to keep the law may require regulatory approval of any acquisition NGO's ownership percentage below the legal limit. that would result in an individual or legal entity, In this case, the NGO might consider selling the together with related parties (including companies portfolio to the transformed institution, either for that are controlled, controlling, or subject to common cash, for a loan, or for convertible notes, as was the control), owning a "significant interest." Approval is case with the K-Rep transformation in Kenya. K-Rep typically based on a "fit and proper" standard, which convertible notes were treated as capital reserves by may include an assessment of the potential owner's the Central Bank of Kenya. financial condition and trustworthiness. This may pose problems for NGOs that do not have "deep 5. Minority Shareholder Rights. Some countries pockets," something few NGOs have. give minority shareholders statutory rights that may not be contracted away in an agreement among 3. Restrictions on Foreign Ownership. Some shareholders. In this situation, even if the NGO has countries--for instance, Ethiopia--restrict foreign majority ownership, certain matters may require ownership of financial institutions, although this is less approval by the minority owners. Rights regarding prevalent than it was two decades ago. For INGOs, appointment of members to the board of directors this would prevent direct ownership altogether. are particularly important. Depending on the particular law, it might be possible to own indirectly, through a local subsidiary. 6. NGO Post-Transformation Activities. In almost Alternatively, local persons could be owners and all countries, an NGO must be engaged in a public- the INGO could exercise rights through either (i) benefit activity. Often, this requirement would not a loan agreement with Newco, pursuant to which be satisfied solely by virtue of the NGO owning a Newco would make certain affirmative and negative company, even if such company is engaged in the covenants or (ii) a side agreement with the owners, same activities that would satisfy the charitable although the enforceability of such an agreement activities requirement for NGOs. Some countries' would depend on local law. laws may absolutely prohibit an NGO from owning, 5 in whole or in part, a for-profit entity or from having Box 4. NGOs Engaged in Microfinance that ownership be its primary activity. If an NGO Post-Transformation is prohibited from owning shares in a for-profit The first microfinance transformation on record company, then it may be able to structure the occurred in 1992, when the Bolivian NGO transformation transaction so that the NGO receives Promoción y Desarrollo de la Microempresea cash instead of shares. If the NGO dissolves, then in (PRODEM) created the commercial bank Banco Solidario, S.A., or BancoSol. PRODEM transferred many countries, its assets must be either distributed only its already profitable branches to BancoSol. to another nonprofit (often, it must be another The two institutions agreed that, on an ongoing nonprofit that engages in similar activities) or turned basis, the NGO would develop new markets and over to the state. transfer its new branches and clients to BancoSol once they became profitable. However, the initial arrangement resulted in a falling out between Sometimes, the law is not clear: In the case of the two institutions. PRODEM developed a rural Georgia, the new microfinance law required all portfolio but transferred it to a finance company (Prodem FFP) that the NGO established in 1999. foundations and other nonprofits to cease engaging Postscript: Today, Prodem FFP is the third largest in microfinance by December 31, 2007. The various MFI in Bolivia, serving more than 250,000 clients NGO MFIs had different interpretations of the law and through 90 rural and urban branches. Currently, whether it prohibited any future NGO involvement more than 600 Prodem employees are also shareholders. in microfinance. Some interpreted it to mean that the NGO could retain ownership in the transformed In contrast, the Philippine NGO CARD has an institution;othersinterpretedittomeanthatthe ongoing arrangement with CARD Bank (established NGO was not permitted to hold shares in an MFI. in 1997, 11 years after the establishment of the NGO). Since the transformation, the NGO has In contrast, the new Bosnian regulations applicable continued to open new branches. When a branch to microcredit organizations include the unusual is financially sustainable, it is absorbed (subject to requirement that, on transformation, the NGO MFI regulatory approval) by CARD Bank. must initially hold at least a 51 percent interest in the transformed institution. The regulations also specifically require an NGO MFI that transfers assets Restrictions on NGO's Capital to a for-profit company to continue to engage in Contribution of Loan Portfolio microcredit activities post-transformation. and Other Assets In fact, many NGOs post-transformation have Establishing ownership in the transformed institution provided business development or other nonfinancial involves a capital contribution by each owner. An support services for microentrepreneurs and the poor. owner's percentage interest and corresponding voting If the NGO continues microlending and other financial rights depends on the amount of capital contributed. services (which some have done post-transformation), (Votingrightsalsodependonthetypeofsharesheld; then it may ultimately be competing against the new as described in Box 3, preferred shares generally do company it created. In some such cases, the NGO not carry voting rights.) Often, the NGO's capital or the transformed institution have agreed not to contribution is comprised, in whole or in part, of the compete (e.g., they divide geographical areas). Such loan portfolio and the NGO's other assets. an arrangement may raise issues under competition law in some countries. In other transformations, the 1. Transferring the Loan Portfolio. The NGO should NGO has pursued new geographic regions or new be sure it understands the law governing the exchange clientele who had not been served by the NGO before of a loan portfolio for shares. In many countries, local the transformation. (See Box 4 for a description of law does not permit the transfer of a loan portfolio two such arrangements.) in exchange for shares, because of perceived risks associated with the collection of the loans.16 As noted earlier in "Factors That May Interfere with the NGO 6 Retaining Control over the Transformed Institution-- In those countries that prohibit the exchange of a Initial Minimum Capital Requirement," even in the loan portfolio for shares, the NGO may be permitted absence of such a prohibition, an NGO that intends to sell the portfolio to the transformed institution for to contribute its entire loan portfolio as capital may cash or some other consideration besides shares. face limits on whether any or all of it could be used to (Alternatively, it could transfer its list of borrowers, satisfy the initial minimum capital requirement. as described earlier). However, the NGO should determine the tax consequences of such a sale.19 Some countries have no limit on how much capital may be contributed in-kind (whether a loan portfolio The transfer of a loan portfolio to a regulated institution or other asset), but they may require that the in- may introduce additional requirements aside from kind contribution be accompanied by an expert's those already discussed. Perhaps most important, the valuation. Occasionally, the expert must meet certain transaction may require the approval of the financial objective criteria established by regulation or must be regulator. When the Peruvian NGO ACP transformed on a regulator's list of approved experts. An expert into MiBanco, the Banking Superintendency approved valuation can be very costly.17 the transaction but only performing loans were permitted to be transferred.20 Delinquent loans were On more than one occasion, an NGO has decided required to remain with the NGO. against transferring its portfolio and instead structured the transaction as a transfer of clientele: as 2. Regulatory Treatment of Loan Portfolio. Even each loan was repaid to the NGO, the client received if local law permits the transfer of a loan portfolio the follow-on loan from the transformed institution. in exchange for shares, if Newco is a bank, it will This approach has consequences on the already be important to establish whether the loan portfolio complicated process of transferring employees over would qualify for purposes of regulatory capital, also to the new institution. (The transition doesn't take referred to as tier 1 capital or core capital.21(As noted longiftheNGOismakingshort-termloans;however, earlier, 57 out of 143 countries surveyed permit initial Asian MFIs and an increasing number of other MFIs or subsequent capital injections to be made with make many loans of a year or longer.) assets other than cash or government securities (Caprio, Levine, and Barth 2007). The 57 include most There are two possible solutions: the NGO could industrialized countries, such as the United States. If retain some or all of its employees to service the loans a loan portfolio does not qualify as core capital, then and transfer them when all of the loans are repaid or the NGO must determine how the loan portfolio will it could transfer the employees to Newco and have be transferred (which may depend, in part, on the them service the loans for a fee or as secondees.18 In tax treatment of a sale versus exchange of assets for at least one case--the transformation of the Peruvian shares) and what additional funds it will need to raise NGO, ACP, to MiBanco--MiBanco administered to meet the initial capital requirements. ACP's loan portfolio at no cost. In fact, MiBanco paid the NGO $1 million for access to ACP's client base. 3. Transferring Other Assets. Most often, for regulatory reasons, initial discussions regarding Structuring the transaction as a transfer of clientele transformation of an NGO and the transfer of the requires the shareholder(s) of the transformed NGO's assets focus on the loan portfolio. However, institution to fund the minimum capital requirement a transformation usually involves the transfer by the with cash. If the NGO does not have sufficient NGO of some or all of its other assets, including fixed resources to fund its portion of the capital, it will assets (computers, desks, chairs) and intangibles, such need the other shareholders to agree that it may as lending methods, and reputation of the NGO. The pay in capital as the loans are repaid. This may affect agreed value of intangible assets can be the subject the price at which the NGO will purchase shares. If of protracted negotiations when outside investors the microloans are short term, this should not be a are involved. significant issue. 7 As noted in "The Long Term--Ownership and A further complication occurs if a transformed MFI Mission--Asset-Stripping and Expert Evaluations" on starts to take deposits. At that point, the unsecured page 16, when an MFI is valued as a business (i.e., in loans transferred by the NGO to the transformed MFI its entirety, as opposed to its component parts), there are likely to be legally subordinated to depositors' are three different methods of valuation: multiple of claims. In the event of problems, the unsecured loan net assets, discounted cash flow, and multiple of net will be paid only after all deposits have been paid. earnings.22 With the first method, often book value is used with a premium or discount applied. According When the NGO negotiates its original loan agreement, to a recent survey of the members of the Council of it should try to include a provision permitting it to Microfinance Equity Funds, this method is the most transfer the loan (i.e., to assign rights and delegate commonstartingpoint;butithasitsdisadvantages, responsibilities) to a successor company under including its focus on past performance as opposed defined circumstances. to future possibilities. NGO-Related Parties as Owners Transferring Liabilities Many NGOs and outside investors are interested in In general, a transforming NGO MFI needs to be providing management, employees, and occasionally alert to whether an asset transfer or a change in legal board members and trustees with an opportunity form would violate any of its preexisting contractual to be owners in the transformed institution. The obligations. An NGO MFI that has outstanding reasons may be both to reward people for building borrowings must review whether these liabilities will the institution and to align the interests of the be assigned to and assumed by the new company transformed institution and its management. In some or stay with the NGO. Although typically the loans transformations, management, board members, and may stay with the NGO if the lenders agree, few occasionally employees of the NGO have claimed a lenders will want to be in the position in which they right to ownership in the transformed institution based can look only to the NGO for repayment after it has on the argument that their work built the successful transferred its loan portfolio--the principal source MFI undergoing transformation. In general, providing and guarantee of repayment--to another entity. employees, management, and occasionally board members or trustees of the NGO with ownership is If the loan was formally secured by the loan portfolio, more complicated than bringing in "outside" owners then the NGO will not be able to transfer the that have no connection or affiliation with the NGO, assets unless the company receiving those assets especially if the individuals do not pay market value also assumes the loan. The lenders may insist on for the shares. adjustments to the transformation structure before they will approve the assignment of their loan to 1. The NGO as "Grantor" of an Ownership Interest the transformed institution. These negotiations may in the Transformed Institution. Insiders may be time-consuming and costly for both sides. At purchase shares (either at the general offer price least one lender has incurred substantial legal fees or at a discount) or receive them without having to in working through and negotiating the terms of a pay themselves in one of the following ways: the transformation. NGOmaygrantsharestoindividuals;theNGOmay negotiate a grant from a donor to fund the individuals' Occasionally a lender may be willing to convert the purchaseofsharesinthetransformedinstitution;a debt into equity in the transformed institution, as private investor may fund the issuance of shares to FINCA International did in Ecuador. In a few other the individuals. transformations, FINCA converted the debt owed by its local NGO into surbordinated debt, making it The granting by the NGO of shares to individuals easier to borrow from other sources. raises the question of whether public-purpose donations are providing private gains. Under most countries' laws, the NGO and its operations are 8 intended to benefit the public and thus enjoy tax- 2. Management and Board Members. Issuing shares exempt status and receive donations that sometimes in a transformed MFI to former NGO managers and have tax preferences themselves. If the NGO, on board members has sometimes led to protracted transformation, awards shares to individuals without and divisive negotiations, even when the shares receiving fair market value, this gifting appears to be are paid for by the individuals. (In some cases, the a contradiction of the basic principle of a nonprofit. transformation has not gone forward because an Furthermore, if the NGO or its donors enjoy tax agreement could not be reached.) Such negotiations benefits, such a gifting would involve a transfer were said to have added a year to one transformation of public assets (i.e., the foregone tax revenue) to process. In theory, one would specify up front--for private individuals. As discussed in "Use of Grant instance, on establishing the NGO MFI or in an Funds," page 12, if the NGO received a grant from employment contract--the ownership interest to a tax-exempt donor or received one or more grants which management would be entitled in the event intended to benefit the public (regardless of the tax of a transformation. However, if the NGO were to status of the NGO), the awarding of shares without gift the shares to the individuals, this could present requiring payment of fair market value would also a serious issue for the tax-exempt status of the NGO involve the transfer to private individuals of grant MFI and for the NGO's tax-exempt donors as well. funds intended to benefit the poor and low income. Whether management, a board member, or a trustee Aside from whether local law would permit the is purchasing or being granted shares, entering granting of shares by an NGO to private individuals, into such an arrangement post-fact presents a clear the basic fact--the compensation (through the conflict of interest issue: that is, the individual being granting of shares) of former NGO management, awarded shares is on both sides of the transaction. employees, board members, or trustees over and How can such a purchase or grant be done on an above the compensation they had agreed to before arm's length basis? Who should represent the NGO's the transformation--poses a contentious ethical interests, if not its managers and board? There are a question. However, this type of reward is becoming few possibilities: an institutional founder such as an increasingly common as more private investors--who INGO, donors, or lenders. However, in many cases, are accustomed to such rewards--come on to the INGOs and donors have "moved on" to other projects scene as participants in NGO MFI transformations. and may not be in touch with the NGO or informed (See discussion of awarding of shares by parties about its developments.24 For INGOs and donors other than the NGO in "Management and Board who would want to be involved in the discussions Members.") regarding the issuance of shares to management, the board, or trustees, they will need to consider how The statements here should not be interpreted to their participation could be ensured. Even if the donor mean that an NGO may not use performance-based has not "moved on," the typical grant agreement compensation for its employees. An employment does not address this type of situation and would not agreement that constitutes an arm's length transaction provide the donor with clear legal standing to object and provides that the employee may be awarded to a proposed sale or grant to insiders of shares in the shares as compensation for future performance transformed institution. should not necessarily present problems,23 although it will turn entirely on local law. Anyone considering The problems presented by the transfer of an NGO's this route should seek tax counsel. Of course, the assets to private individuals would not necessarily devil is in the details: the most important factor prevent others (for instance, outside investors who in determining the legal permissibility of such are interested in rewarding management and high- an agreement probably should be whether the performing employees) from funding the grant of agreement was negotiated at arm's length, especially shares or other bonus compensation. In fact, various where senior managers are involved. donors have been involved in providing direct funding for the purchase by employees and clients of shares in transformed institutions. However, the same problem 9 would exist if outside investors provided the funding have decided against bringing employees in as and considered such compensation a part of the total shareholders out of concern about blurring the lines value of the MFI, thus reducing the shares or funds among governance, management, and employees. In received by the NGO.25 general, this concern reflects a more Anglo-American perspective on governance. In fact, such risk may be 3. Employees. For some NGOs, one of the benefits of a minimal: if shares are owned directly, it is unlikely that transformation is the possibility of offering employees employees will influence governance much unless they (i) ownership in Newco. And the awarding of shares to hold a significant number of shares in the aggregate and NGO nonmanagement employees is less controversial (ii) organize themselves and their voting. If employees than the awarding of shares to management and own only nonvoting shares, their ownership is purely a board members because nonmanagement employees profit-sharing plan and does not affect governance of typically do not control the transformation process the institution. Even if employees hold shares through an nor determine whether and how many shares will be ESOP, whether this translates into a role in governance awarded to whom.26 depends on the specifics of the ESOP. For instance, the K-Rep ESOP holds a 10 percent interest in the bank but Employees of a transforming NGO MFI have become is not represented on the board even though all other owners of the transformed institution either through investors with at least 10 percent are represented. the direct purchase or grant of stock or an employee stock ownership plan (ESOP). Typically, shares are 4. Clients. In a few transformations--SHARE Microfin awarded or allocated for purchase to employees (India), SKS (India), CARD (the Philippines)--the NGO based on objective factors, such as length of time has brought in clients as owners. (In the case of CARD, employed and seniority. In some transformations, described in Box 6 on page 10, clients hold nonvoting only employees being transferred to the new preferred shares.) In some instances, the NGO issued institution were brought in as owners.27 In a number shares to clients in exchange for their savings. (See of transformations, the NGO or donors have provided Box 7 on page 11 for a description of the SHARE funds for the employees' purchase of shares or have Microfin transformation.) Some have queried whether fundedanESOP;inothers,theemployeeshavehad investing savings in an illiquid asset is an advisable to self-finance their purchase of shares, either at full use of clients' limited funds, especially given the price or at a discount. greater risk of loss when compared to the alternative: a deposit in a savings account. While there has been much discussion recently of MFI transformations and ESOPs, they are in fact not Recently, in India, some NGO MFIs have had clients hold common in MFI transformations.28 (See Box 5 for shares in the NBFC--either directly or through mutual a brief description of three different ESOPs.) First, benefit trusts--allegedly without the clients' knowledge. many developing countries have no convenient It appears that, in some instances, this may have been legal framework for ESOPs.29 Second, some NGOs done to sidestep a provision in the income tax law stating that a charitable organization loses its tax-exempt status if it makes an equity investment in a for-profit private Box 5. Transformations and ESOPs sector company (although there is an exemption for In the case of K-Rep, the NGO set aside 10 scheduled banks and cooperative banks). percent of the bank shares for purchase by the ESOP, Kwa Cooperative. A CGAP grant financed Corporate Governance both the establishment of the cooperative and the initial purchase of shares. Shares were allocated to employees depending on seniority and their The term "governance" refers to a system of checks and time with K-Rep. However, it was structured as a balances put in place to ensure that decision-making matching grant: one share was granted for each share purchased. In contrast, Banco ADEMI and power is properly distributed among management CARD Rural Bank awarded shares to staff. Staff of and the governing body and that the resources of Banco ADEMI hold 20 percent through an ESOP an organization are managed well. A key aspect of and have a seat on the Board. CARD assigned good corporate governance, whether for an NGO or preferred nonvoting shares to staff. a company, is the active involvement of the board of 10 Box 6. CARD Bank and Client Ownership CARD Rural Bank is an example of a transformation NGO client members (as well as staff) were issued that involved the issuance of both common and preferred shares instead of common shares. Campion preferred shares. The founder of the Philippine and White (1999) attribute this decision to two NGO CARD Inc. set out to create a bank owned and factors: (i) holders of common shares would have managed by landless rural women. The objective was been required to be present for the annual meeting, to have members of the NGO own 75 percent of the which would be a very high burden for many and bank and have the NGO own the balance. (Because (ii) common shares are a riskier investment than of the low minimum capital requirements applicable preferred shares. (According to the Campion and White to rural banks, CARD did not need to raise equity paper, bank management believed that members' from outside investors.) As part of the transformation input would be taken into account through the NGO's transaction, the NGO board set aside P7.5 million meetings.) The shares owned by NGO members and (approximately $250,000 in 1997) of clients' "center staff are nontransferable and are assigned to another fund savings"--mainly compulsory savings as well as member or staff on departure or death of the holder. penalties and interest income--to be used by qualified In essence, the members' and staff's shareholdings members to purchase their shares. Members were represent a form of profit-sharing plan. permitted to purchase only as part of a group that met certain requirements. Based on description in Campion and White (1999). directors. The board must provide proper guidance and composition of the board as well as members' to management regarding the strategic direction for terms.31 How many board seats should there be the institution and oversee management's effort to (the number may be limited, both in minimum and move in this direction. The main difference between maximum, by law) and how will they be selected/ NGO governance and company governance is that elected? What will the different shareholders' voting a company is controlled by owners who have an rights be? Do minority shareholders have a statutory incentive to protect their private financial interests, right to elect a director? Will there be independent while an NGO has no owners and depends on the directors (i.e., individuals who don't themselves have social motivation of its governing body.30 an ownership interest and aren't tied to any of the owners)?32 Individual board members and/or senior If the NGO is not the sole owner, it will no longer management may be subject to the approval of the have control of the board unless the minority regulator, based on objective or subjective factors. shareholders cede control (or are otherwise inactive) "Fit and proper" standards commonly address or the constituent documents of the transformed trustworthiness (primarily, absence of a criminal institution provide that the NGO will control the record or involvement in failed financial institutions) board. If the NGO is a minority shareholder, it will and professional experience in finance. have to adjust to a more limited role in determining the direction of the company. Even if the NGO is the In addition, an NGO has to consider legal requirements sole owner, it will have to adjust to new measures regarding the board's powers, residency/nationality, of accountability, especially if it becomes subject to and matters requiring approval by more than a simple regulatory oversight or supervision. The change in majority. accountability is significant and requires listening to and accommodating new stakeholders' interests. 2. Shareholders' Agreements. It is possible to have an agreement among shareholders that includes a 1. Board of Directors. The Board of Directors plays statement on the mission of the company and also an important role in determining how the new for- addresses issues regarding general operations. A profit institution will grow, be profitable, manage its shareholders' agreement can provide for the post- risk, and at the same time, preserve its vision. The transformation relationship among shareholders, board structure is key to ensuring the right balance including governance matters, such as supermajority between holding management accountable and approval, board representation, preemptive rights, enabling management to retain its independence and transfer restrictions.33 and flexibility. The main aspects include the size 11 Box 7. SHARE Microfin and Client Ownership In 1999, after 10 years of operating as a nonprofit, the premium of 50 percent. Because of the requirement Society for Helping and Awakening Rural Poor Through that SHARE Microfin return all clients' savings as well Education (SHARE) completed the first transformation as other factors affecting its financial situation, the in India of an NGO into a nonbank finance company institution faced a severe liquidity crisis. (NBFC): SHARE Microfin Limited. On transformation, 99 percent of the paid-up capital of $1.2 million was In May 2007, a Dubai-based privately owned finance contributed by over 26,000 poor women clients via firm, Legatum Capital, purchased a majority interest in the conversion of their compulsory savings into shares. the NBFC for $25 million (Rs100 125 crore).* Staff sold For three consecutive years, clients received an annual 18percentoftheirsharestoLegatum;thebalanceof dividend of 10 percent on the shares. In 2005, SHARE the Legatum investment constituted a fresh injection Microfin was required to return clients' savings. In of capital (i.e., the purchase of newly issued shares). part to effect this, the shares held by clients and Today, SHARE Microfin is owned by Legatum (65%), by mutual benefit trusts (which held the shares on Aavishkaar Goodwell (5%), the NGO promoters (5%), behalf of clients) were purchased by staff and other and approximately 3,100 other staff members and individuals known to staff (but not involved in the other individuals (25%). NGO's activities) as well as the NGO promoters at a *Source: SHARE Microfin Limited. The Legatum investment constituted the second major investment by a foreign investor in an Indian MFI. · Typically, most matters are subject to majority However, in some countries, shareholders' approval. The agreement can specify that certain agreements are unenforceable. In other countries, matters will be subject to supermajority approval the law governing companies subjects certain or veto rights. These could include appointment matters to approval by minority shareholders or and removal of senior management, material prohibits a requirement of unanimous approval for transactions (including material borrowings), certain matters. These provisions usually cannot be dividends, and related party transactions. Any overridden by a private shareholders' agreement. change to the provisions specifying supermajority approval also should be subject to supermajority 3. Arm's Length Transactions. Dealings between vote. the NGO and the transformed institution should · The shareholders' agreement typically would be at arm's length, whether or not the NGO is the specify the number of board seats, the number of sole shareholder. Regulations already may require directors appointed by each shareholder, and how arm's length transactions between related parties. A this will change if an owner's equity stake changes, classic example of what can happen when a parent committee membership, and whether there will be and subsidiary fail to deal with each other on an independent board members and, if so, how they arm's length basis occurred in the transformation will be selected. of Colombian NGO Corposol into the finance · Preemptive rights of any new share issuance company Finansol. Although Corposol transferred (i.e., capital increase) entitle shareholders that to Finansol a loan portfolio of over 25,000 borrowers are party to the agreement to purchase their of excellent quality, a proven methodology, and respective allocations (determined by their operational profitability, Finansol's financial position percentage ownership) of any new share issuance deteriorated rapidly due to, in large part, the flawed and are intended to prevent dilution of initial relationship between the two entities.34 Finansol's shareholders. statutes mandated that majority control of its board · To preserve the relative ownership and control remain with Corposol. The two organizations used existing on transformation, shareholders may this control to side-step requirements applicable agree to include transfer restrictions applicable in to regulated financial institutions.35 By the time the the first few years post-transformation. Thereafter, bank supervisor became aware of the situation, owners may have a right of first offer or right of loan collection had deteriorated to the point where first refusal. Corposol was insolvent and could be rescued only by converting into equity its unpayable debt to a government wholesale fund. 12 Perhaps one of the increasingly common (and by headquarters as well as the particular convictions problematic) examples of inappropriate decision of grant officers, and (iii) the department from which making by an NGO that controls its transformed the microfinance program originates (e.g., private entity is the NGO's resistance to raising new equity sector development, rural development, etc.). capital for the transformed institution out of fear of losing control. Today, most donors feel the primary purpose of grant funds is to increase the poor's access to financial Use of Grant Funds services and that if funds are used to create a sustainable institution (i.e., the transformed institution) In general, grant funding provided to nonprofit that is able to serve more of the poor, then the funds institutions engaged in microfinance is intended to have accomplished their purpose. This is not to imply benefit poor and low-income people by supporting that donors favor uncompensated transfer of assets the development of institutions that provide them fromtheNGOtoprivateparties;rather,inmostdonor- with access to formal financial services. Grants may approved transformations, the NGO receives shares provide nonearmarked core support or may be or other value in exchange for its transfer of assets directed to loan capital, TA, infrastructure (e.g., to the new institution. Even so, some NGOs have management information systems), or legal and other viewed the funds as restricted post-transformation support services. The intent of these grants--whether and have taken steps to ensure grant-sourced funds they come from a bilateral donor, multilateral donor, are effectively kept by the NGO (e.g., Mercy Corps' or a private foundation--is not to benefit private interest in XAC Bank). Some donors require grant owners of microfinance companies.36 However, a funds for loan capital either to remain with the transformation of an NGO into a for-profit company NGO or to "stay in the country"--which typically may effectively involve the transfer by the NGO to the means that the NGO must, on transformation, own a new company of grant funds although the NGO--if percentage of the company equal to the grant funds it negotiates well and knows its own value--should divided by the total initial capital of the transformed receive fair market value for its assets, including those institution and be required to retain such ownership assets built out of grants. The permissibility of such a position indefinitely (e.g., the Ugandan Women's transfer depends on the following factors: Finance Trust transformation).37 Other donors place no restrictions on NGOs in transformation. · the specifics of the transformation transaction · the terms of the grant agreement (in particular, the 2. The Transformation Transaction. Typically, the stated purpose of the grant) and whether the grant NGO transfers its assets in exchange for cash, debt, agreement has expired or shares. If the NGO is the sole owner of the new MFI, · the identity of the grantor then the benefit of the grants has not been transferred · local law to private individuals. If there is more than one owner, but the NGO retains ownership of assets equivalent 1. Historical Treatment of Grant Funds in to the aggregate value of the grants received, then Transformations. Until recently, donors did not there should be no issue. Even if the NGO transfers all contemplate the possibility of an NGO transforming of its assets, if they are properly valued and the NGO into a for-profit company, so their policies did not receives shares of equivalent value, then the NGO address a situation in which the grantee would transfer effectively retains the benefit of the grants, which it will its assets to a company with private owners. Thus, the presumably continue to use for some public purpose. treatment of grant funds in NGO MFI transformations In this last case, the other owners of the transformed depends largely on the particular donor, although institution will reap the future benefits (in the form many donors themselves have not been consistent in of dividends) of the microfinance business that was their approach. The lack of consistency reflects (i) an developed with the assistance of the grants, but this evolution in donors' internal discussions over time, should not present any legal problem nor an objection (ii) inconsistent approaches of donors' various field on principle if the assets (tangible and intangible) were offices because of the absence of a policy articulated properly valued on transfer. 13 Some argue that transformed MFIs often have inappropriately, then the donor likely would not been undervalued because of their own lack of have a legal basis for reclaiming the funds.39 (Many experience and lack of understanding of the sector donors would not want to reclaim the funds for various among consultants performing valuations.38 On the reasons, including--with respect to U.S. foundations-- other hand, determining a "fair market valuation" is tax requirements on meeting an annual minimum thorny in situations where there are in fact no truly distribution level.) Notwithstanding this, there have commercial funders who are willing to invest because been several instances in which donors, NGOs, and the sector is perceived as too new and risky. The potential investors in transformations have insisted absence of a standard objective valuation method for on incorporating mechanisms that would ring-fence MFIs creates particularly serious conflict-of-interest any grant funds and prevent their transfer to private issues if the NGO principals who are negotiating the individuals.40 (Ring-fencing refers to the practice of price of the NGO's assets stand to gain personally placing funds in a separate and isolated facility or from the transformation. otherwise limiting their use or exposure to risk.) The argument has been that retained earnings may end up 3. The Grant Agreement. The confusion about the in private hands but not the grant itself. proper resting place of grant funds in the case of a transformation is largely a result of the absence--until If the grant is made to a network with the intent that recently--of provisions in grant agreements specifying the funds be transferred to one or more NGOs in who would own what on transformation donor grant the network, then the network may try to reclaim the agreements. This is because most donors did not funds on transformation or at least assert an ownership anticipate that NGO MFIs would transform into for- interest in the transformed institution. For this reason profit companies and therefore did not plan for it. and others, grant agreements should be explicit about Ideally, each donor should be clear about its view on the treatment of grant funds in a transformation.41 treatment of grant funds and grant-sourced funds post- transformation, and each grant agreement should be 4. The Identity of the Grantor. The question of specific about ownership and restriction of such funds the rightful ownership and resting place post- on transformation. Some donors have started adding transformation of an NGO's grant funds triggers strong general language that would apply to a transformation and varied reactions from the many camps involved. in their grant agreements. Bilateral Donors. Perhaps the most heated discussion Grant agreements usually contain conditions for the involves grants by a bilateral donor, because the use of the grant over a specified term. If a grant is recipient country expects the money to remain in ongoing (i.e., it has not been fully disbursed or it has country. been fully disbursed but the term of the agreement has not yet expired), then the grantor can enforce the When NGO MFIs first started transforming, bilateral terms of the agreement and ensure the grant is being agencies debated whether their grant funds should used according to its stated purpose. If the grantor is be retained by the NGO.42 This is easy to do when a tax-exempt entity, the grantor is legally obliged to the NGO is the only owner of the transformed ensure the grant funds are being used for the stated institution and continues to engage in microfinance purpose. Tax-exempt donors may have made grants or microfinance-related activities, but eventually there to NGO MFIs with the understanding that the grantee will be a problem if the NGO decides to sell all or part would be prohibited under the law of the MFI's country of its ownership interest. As MFIs started bringing from distributing funds or other assets to individuals, in new owners, agencies began to hear complaints or using them for other nonpublic purposes, and that from various stakeholders, including government local regulators would enforce this. officials and citizens of the recipient country. The primary argument was that the grant funds belonged However, if the agreed grant term expires and to the people of the recipient country and that it was the NGO subsequently distributes or uses assets a violation of the grant's intent for the benefit to be 14 transferred to private owners.43 Many voiced concern National wholesale funds (apexes) may have internal regarding the flow of funds out of the country because restrictions regarding the use of grant funds, or they of foreign ownership in the transformed institution.44 may insert such restrictions into the grant agreements. Afghan MFIs that received grant funds from the apex Today, most bilateral aid agencies make it clear that MISFA have agreed, pursuant to negotiations with repayment of grant funds on transformation is not MISFA and the government, to return the grant funds required, and most do not impose conditions or received from MISFA in the event of a transformation restrictions on an NGO's transformation. However, to a for-profit company, and to include such a provision some still argue that all grant funds should "stay with in their own articles of association. the NGO."45 This is easier to do if the NGO continues operating, either engaging in microfinance or other Private Tax-Exempt Donors. The treatment of grants activities, such as business development services. from private tax-exempt donors presents different However, there will still be a problem if the NGO problems. A U.S. tax-exempt foundation,47 when wishes to divest entirely or in part, as evidenced making a grant to a foreign NGO, must be sure by the recent initial public offering (IPO) of shares that under local law (i) the NGO is not permitted to of the Mexican Banco Compartamos. Compartamos distribute funds for the private benefit of its members funding sources included grants from various donors, or others and (ii) the NGO is required to transfer its including a bilateral (USAID). As a result of the IPO distributable assets to another charity in the event (which involved solely the sale of shares by the of liquidation. A U.S. foundation may make a grant original shareholders), Compartamos shareholders directlytoafor-profitentity;however,itmustensure realized huge profits--approximately $300 million in both that the grant-financed activities are for charitable total. Most of these profits accrued to shareholders purposes and that the benefit will be passed on to the who were themselves public-purpose not-for-profit charitable recipient and not inure to the owners of the institutions, but a third of the profits went to private company. In a transformation of a NGO grantee, the individual investors.46 Among other protestors were U.S. foundation will generally accept the transaction U.S. taxpayers. provided that the transformed entity continues serving poor and low-income clients. Local Government Donors and National Wholesale Funds. The situation may become complicated 5. Local law. Local law may prohibit the transfer of and political when an MFI has received government grant funds that is effected by a transformation, even funding. Specifically, the government may resist the if due consideration is paid. For example, a new Uzbek transformation because of concerns regarding the resolution provides that a microfinance organization appearance (or reality) of public funds benefiting private is entitled to tax-exempt treatment with respect individuals. In addition, some government actors may to funds received from a donor only if the funding resist losing control of an institution that it helped. This agreement stipulates that the donated funds and may be an even greater problem in socialist countries interest income earned thereon remain the property or countries that have a socialist agenda or orientation. of donor organization. In other countries, lawyers For example, Agrocapital in Bolivia is a nonprofit rural have suggested that grant funds received by NGOs-- lending foundation that commenced as a project of regardless of the source--are received "in trust" for the government of Bolivia with the assistance of ACDI- the benefit of the people and, as such, may not be VOCA. When Agrocapital initiated efforts to convert distributed to private individuals. into a private finance company, the finance ministry and a part of the bank superintendency refused, stating that the capital of Agrocapital belonged to the public, notwithstanding that only a portion of the funding came from the government. 15 The Long Term--Ownership and Mission Box 9. Compartamos Compartamos began as an NGO in 1990 and transformed into a limited-liability finance company Will anyone ensure the NGO's original mission is (Financiera Compartamos S.A. de C.V. SOFOL) in pursued once the NGO no longer controls Newco? 2001. At the time of transformation, the company Will there be remaining shareholders with an equally had 18 owners: the NGO, ACCION Gateway Fund, ProFund, and 15 individual Mexican shareholders. In strong interest in pursuing the original mission?48 2006, Financiera Compartamos converted into a joint stock company and received a license to operate as 1. NGO Divestiture. Many NGOs, including some a commercial bank. In 2007, Banco Compartamos INGOs, plan ultimately to divest. Some NGOs and had an IPO of shares pursuant to which existing shareholders sold approximately 30 percent of INGOs may wish to divest: an INGO may have decided their holdings. The new shareholders were primarily that microfinance will not be a part of the organization's mainstream investors (i.e., international fund coreongoingactivities;theMFIsimplymaynotbe managers) and other commercial investors. doing well. Occasionally, applicable law requires an NGO to divest itself of any stake in a transformation to a new for-profit institution. Even if the NGO doesn't 2. Protecting the Mission. One way to protect the plan to divest, future ownership and control can be mission is to include a statement in the transformed unpredictable unless the initial investors all agree that institution's constituent documents and/or in a their shares may not be sold (nor new shares issued) shareholders' agreement and to require unanimous other than to each other. (See Box 8 regarding the shareholder agreement for it to be changed. However, surprising purchase of Prodem FFP by the Venezuelan local law sometimes prohibits unanimous consent development bank.) And if a transformed institution has requirements, and some jurisdictions will not enforce multiple owners, the NGO's interest may be diluted as shareholders' agreements at all. the institution brings in new shareholders to increase its capital base.49 The transformed institution eventually Another approach is to require initial shareholders (who may be owned by shareholders whose objectives differ may be selected because of interest in the mission) to significantly from those of the NGO's founders.50 The hold their shares for a specified period. Such transfer starkest illustration of this occurs when there is a public restrictions need to be clearly set forth in enforceable offering of shares. See Box 9 for a description of the agreements, to avoid problems. (In the case of the evolution of the shareholding of Banco Compartamos. Bolivian Eco Futuro--formed by the "merger" of four NGOs--one of the founding NGOs unexpectedly For some observers, this uncertainty regarding the decided to sell its shares post-transformation.) future course of transformed MFIs raises serious questions about the direction of microfinance. Or, instead of imposing an outright prohibition on the sale of shares, the founders of the transformed Box 8. The Case of Prodem FFP institution can agree to subject new owners to the The Bolivian Prodem FFP was established in 1999 approval of existing owners and provide the initial by the NGO PRODEM. In February 2008, the owners with a right of first refusal (i.e., if an owner Venezuelan national development bank purchased finds a purchaser, the other owners are first given the a majority interest in Prodem FFP. (This transaction right to purchase the shares on the same terms, and followed a year of negotiations between Prodem and another Venezuelan government-owned any new shares issued by the company are offered first bank, Banco Industrial de Venezuela or BIV.) The to existing shareholders).51 However, a right of first purchase price was between 1.8 and 2.5 times refusal may reduce the value of the shares because book (depending on the identity of the seller), of the unpredictability of the transaction closing. The with employees being paid the higher price. Many expressed concern with the initial proposed extent to which the value is reduced depends in part purchase by BIV and of the risk the Venezuelan on the prescribed period during which the existing government would cause Prodem to charge below- shareholders must act or lose their right to purchase market loans. The outcome remains uncertain. the shares. 16 3. Asset-Stripping and Expert Valuations. there is a ready market for the company's shares--is Asset stripping refers to a variety of schemes that also likely to influence the price. Third, social investors inappropriately move assets from the NGO into private may be willing to pay more than others for shares of a pockets.52 This can happen if the NGO's business is company whose mission they want to support. transferred to a transformed institution with private shareholders at well below the business's likely market Conclusion value, followed by a sale of the assets or the shares in the transformed institution at a higher value. (It Transformations--especially those involving the will not be unusual for the business to become more introduction of new owners and/or the establishment valuable after the transformation than it was before, of a regulated financial institution (in particular, a so the fact that assets or shares may eventually be depositary institution)--have often required more time sold for more--even far more--than their purchase and been more costly and disruptive than planned. price does not necessarily mean that illegitimate asset However, there has been significant upside to some stripping has occurred.) To avoid asset stripping, it is transformations because they are permitted to offer essential that the NGO get a competent independent additional services, access commercial capital, and valuation. A recent survey of Council of Microfinance work toward better governance. Some of this upside Equity Funds listed 10 qualitative valuation factors (in can be traced specifically to the introduction of outside order of importance):53 owners, who may bring financial expertise, important connections to providers of capital, and the potential to · quality of senior management contribute to effective governance. There are also risks, · sophistication of the MFI's governance and board including in particular the possibility of mission drift. structure · long-term planning and vision as indicated by a The upsides and downsides are determined in large part detailed business plan by the selection of outside owners and their involvement · financial performance to date in the governance of the institution, as determined by · customer base and portfolio quality their type of ownership and their availability. (Outside · level of competition and the MFI's position in the owners who don't have voting rights have little if any marketplace say in the direction of the company.) For this reason and · regulatory environment and whether the MFI is able others, it is crucial that the NGO familiarize itself, well to offer a broad range of products (whether as a in advance of transforming, with the legal and financial bank or otherwise) considerations that may affect the NGO's selection · MFI's future capital requirements and existing of outside investors. Potential investors also will want sources of funds to familiarize themselves with the limits they will be · local political and macroeconomic factors subject to before entering into negotiations. These · currency risk issues can be especially complicated when more than one NGO is transferring assets to the new company. In the context of a transformation, some of these factors may change depending on how the transaction is Almost without exception, participants in past MFI structured.Forinstance,seniormanagementmaychange transformations have encountered unexpected (eithervoluntarilyorbecauseoflegalrequirements);the restrictions and problems, often with serious negative governanceandboardstructurewilllikelychange;the consequences. This paper has tried to flag the most transformed institution may very likely offer products important issues and pitfalls related to ownership additional to those offered by the NGO. as revealed by those experiences. We believe that careful investigation of these issues in the specific Other circumstances also can affect post-transformation context of each future transformation will pay a big sharevalue.First,thebuyerofacontrollinginterestwould return in terms of smoother, quicker, less expensive, normally pay a premium. Second, liquidity--whether and more effective transactions. 17 End notes 1 As of December 2007, there had been at least 84 such 15 For example, if no more than 30% of the initial capital transformations in more than 30 countries. See Annex 1 requirement of $1 million may be contributed in noncash for a chart of transformations. (This list does not include items and the loan portfolio is valued at $600,000, then the transformations from or into a cooperative or other similar NGO could contribute half of the portfolio as capital and type of member-owned organization.) Many of these would need to invest an additional $700,000 in cash (if it were transformations are considered simple because they do not permitted to own 100%) or find investors to contribute all or involve outside investors. part of that amount. If the NGO wished to have a majority 2 See Annex 2 for a list of persons consulted. These people interest, it would need to contribute at least $200,001 in cash. consist primarily of microfinance practitioners, founders In some cases, the NGO has borrowed funds to capitalize and funders of MFIs (both those that transformed and those the new institution, although this often is prohibited by local that did not), and other experts who have been involved law. with, advised on, or are otherwise familiar with NGO MFI 16 According to a 2007 survey of 143 countries, 57 countries transformations. permit the initial injection of capital or subsequent capital 3 Ledgerwood and White (2006) is as close to a "how to" manual injections to be made with assets other than cash or as one could ask for and is an excellent resource and guide for government securities--i.e., possibly a loan portfolio (Caprio, any institution considering transforming. Levine, and Barth 2007). 4 See Rosenberg (2007) for a discussion of the tensions between 17 If the transformation involves bringing in new shareholders, social and commercial objectives. it may be in the NGO's best interest to hire a valuation expert 5 Approximately half of the transformed institutions are credit- to value the entire business as opposed to merely the loan only institutions. For example, in Peru, which has the highest portfolio. See O'Brien (2006) arguing that the absence of number of transformations of any country (see Annex 3 for valuations has resulted in MFIs being sold at prices below a list of transformations by country), nine of the 10 MFIs what they should be commanding. transformed into nondepositary regulated institutions. 18 This paper does not address labor law issues that may arise in 6 In most cases, engaging in these activities would necessitate connection with the termination of employee contracts by the being licensed and prudentially regulated and supervised by a NGO and rehiring by the transformed institution. financial regulator, such as the central bank or the ministry of 19 A sale may be subject to a transaction tax while the exchange finance. In contrast, in most countries, credit-only institutions may be subject to a capital gains tax. A donation by the NGO either are not regulated or are subject to only minimal of the loan portfolio (to avoid taxes on a sale or exchange), if nonprudential regulations. permitted under local NGO law, may raise other issues: the 7 Of 11 transformations completed in 2007 (see Annex 1), transformed institution may have to pay income tax based on seven were mandated by new legislation. All seven resulted in the value of the loan portfolio; if the NGO is tax exempt, the the establishment (at least initially) of for-profit institutions tax authorities may view the donation as violating the rules engaged in credit-only activities. regarding private benefit. 8 The process of selecting investors is crucial to the success of 20 The loans remained on ACP's loan book until repaid, but the transformed institution and the continued pursuit of the MiBanco administered them at no cost. On each loan's NGO's social mission. However, because this topic has been repayment, MiBanco would issue the new loan. covered by various papers and books, it is not discussed in this 21 Bank regulators divide bank capital into two (and sometimes paper. For a detailed discussion, see Ledgerwood and White three) tiers for purposes of calculating a bank's capital (2006). adequacy ratio. In all countries, Tier 1 capital (or core capital) 9 At least one INGO has set up a wholly owned for-profit consists of equity capital (issued and fully paid ordinary company and another has set up a nonprofit that, in each case, shares/common stock and noncumulative perpetual preferred owns or will own all of the INGO's MFI subsidiaries. stock, but excluding cumulative preferred stock) and disclosed 10 Although cooperatives and other member-owned institutions reserves (i.e., retained profits minus accumulated losses). (e.g., credit unions, mutuelles) play an important role in Tier 2 is supplementary capital. At least 50% of the capital microfinance in certain countries, transformations of such adequacy requirement must be satisfied by Tier 1 capital. institutions are not addressed in this paper. The member- (Many countries follow the Basel requirement that a bank's owners of such institutions typically have only one vote capital must be equal to or greater than 8% of the bank's risk- each regardless of the equity contributed. For this and other weighted assets.) reasons, transformations involving these institutions present 22 See O'Brien (2006) for a discussion on valuing an MFI (as issues that are quite distinct from those associated with NGO opposed to its components). transformations. 23 Such an arrangement may, for those in positions of management 11 Rarely are owners of unregulated finance companies subject or control, ultimately create skewed incentives. For instance, to maximum ownership limitations. Company law may a manager may be more inclined to run the NGO so that it require that there be more than one owner, but the ownership has maximum value as opposed to considering institutional interest of new owners could be nominal and, in most cases, growth (and sustainability) as well as the benefits to its clients the requirement would not prohibit owners from being related and potential clients. The arrangement could theoretically or part of a group. In Kyrgyzstan, the MFI law allows certain present the manager with a conflict of interest between her institutions to own 100% of an MFI; however, the company fiduciary duty to the organization and her personal financial law requires a joint stock company (JSC) to have at least one interest. minority shareholder (who can be related to or in a control 24 In one recent transformation that is still under way, the relationship with the majority shareholder) to hold at least INGO--which for years was not involved with the NGO one share. it had helped found--was unaware of the transformation or 12 Based on the survey, it appears that with exception of Canada, the protracted negotiations between the NGO's lenders and Luxembourg, and Norway, developed countries do not have NGO management and board members regarding the issuance bank ownership limitations. of shares to management and board members. 13 For example, in Uganda, the maximum ownership requirements 25 The perception (if not the reality) of the NGO being swindled are 49% for banks and 30% for microfinance deposit-taking would be hard to dispel if those receiving the bonuses were institutions. involved in negotiating the transaction on behalf of the NGO. 14 In some countries, competition law also might place 26 However, the awarding by the NGO of shares to employees restrictions on the ownership by one financial institution of who do not pay for the shares or pay below market value another financial institution or prevent the owner of one MFI raises the same concern discussed in "Management and from holding a significant interest in another MFI. Board Members" (page 8) regarding the transfer to private individuals of assets intended to benefit the public. 18 27 While typically an ESOP would be established for employees of 42 USAID initially argued--with respect to its microfinance the transformed institution (including, if applicable, employees who activities in the Caucasus--that an NGO MFI's loan portfolio had worked for the NGO), in the case of K-Rep in Kenya, staff was a fixed asset, like a car, and the NGO had to approach who were not transferred over to the transformed institution the agency for disposition of the asset. In 2000, the USAID were permitted to become owners through the ESOP. general counsel announced that after money was "recycled" 28 The following five transformed institutions have established once through the loan portfolio, it lost its identity and could ESOPs: Banco ADEMI (Domincan Republic), ACLEDA not be recaptured. This does not mean, however, that USAID (Cambodia), Hattha Kaksekar (Cambodia), XAC Bank has not, since such announcement, required a transforming (Mongolia), K-Rep Bank (Kenya). NGO to ring-fence the USAID grants. 29 The handful of ESOPs formed in NGO MFI transformations 43 In several instances, bilateral aid has been directed specifically have been structured in various ways: as trusts, cooperatives, to support the transformation process (e.g., to fund a and companies. transformation manager or to fund the technical steps of 30 At least one country--Afghanistan--has the unusual legal transformation), to capitalize the new institution or to fund the situation in which a nonprofit is formed as a share company. purchase of shares in the transformed institution by a network However, the shareholders are owners in name only because or TA provider. These grants are less problematic because they they have no rights to receive dividends or sell their shares. are made specifically to facilitate transformation. 31 At least one transformation has been stalled because of a 44 This argument is more powerful with respect to grant disagreement between the INGO founder and the executive agreements that provide that grant funds may not be director (together with the NGO board members) regarding transferred from a local NGO operation in a particular country the future composition of the board of the transformed to the NGO's international headquarters. institution. The NGO brought a legal claim and as of the 45 One agency has attempted to require that its grant funds publication of this paper, the matter remains unresolved and become statutory capital of the transformed institution. with the local courts. Statutory capital cannot be distributed. Interestingly, in one 32 In some countries, independent directors are required by law, transformation, it was the new investors who required ring- especially for regulated institutions. fencing of the grant funds because they did not want to be 33 Much of this discussion draws on Cleary, Gottlieb, Steen, and seen as benefiting from grants intended for the citizens of the Hamilton (2006). country. 34 See Inglesias and Castello (1997). 46 See Rosenberg (2007). 35 Specifically, Corposol, which was an NGO and not a regulated 47 The illustration regarding a U.S. foundation and other financial institution, kept a portion of the loans on its books. references in this document to U.S. tax-exempt institutions The two institutions developed a practice of shifting portfolios reflects the reality that a large portion of transformations between themselves, including delinquent portfolios, hiding involve U.S. tax-exempt funders and founders. this practice from regulators and misrepresenting both 48 The experience of Compartamos in Mexico suggests that institutions' financial positions. having socially oriented nonprofit investors doesn't guarantee 36 This discussion does not apply to grants that have been made that poor people's interests will take priority. Despite the fact specifically to finance investments in transformed MFIs. For that Compartamos was controlled by a Mexican NGO, an example, CGAP has funded the establishment of an ESOP as INGO, and an international development finance institution, well as the purchase by the NGO, clients, and staff members it funded much of its rapid growth by charging poor Mexican of shares in transformed institutions. USAID has funded the women interest rates that were much higher than its costs, purchase by a TA provider of shares in transformed MFIs in the even after it had access to other sources for this funding. See belief that the TA provider would strengthen the institution Rosenberg (2007). through its involvement as owner and board member. 49 This was the case with Mercy Corps and the Mongolian XAC 37 This requirement is reminiscent of what happened in the Bank. Mercy Corps wished to retain a controlling interest in the United States in the 1980s when the private sector began bank out of concern about the future course of a commercial acquiring nonprofit healthcare institutions (which were institution controlled by commercial institutions. Ultimately, laden with cash). In sum, the State Attorneys General and as a result of the bank bringing in new shareholders, Mercy local communities began looking into these acquisitions Corps' ownership was reduced significantly. Today, it no and determined that the acquirers would have to facilitate longer holds a controlling interest in the bank. the creation of spin-off "conversion" foundations that would 50 This risk of mission drift may introduce a tax complication hold the "equity" that had been contributed by government for tax-exempt owners that bring in for-profit shareholders. agencies and foundations (and generated by the nonprofits' At least one NGO has explored introducing language into the tax exempt status) and such funds would be used to benefit constituent documents of the transformed institution or into the community. One example of such a foundation is the a shareholders' agreement stipulating that, in the event of a California Endowment, established after a for-profit acquired conflict between serving the poor (or the specified clientele) Blue Cross Blue Shield in California. and maximizing profit, the former will prevail. Whether this 38 See O'Brien (2006). type of solution works (as well as whether there is a problem 39 An employee of a significant donor involved in many to begin with) depends on the law of the country of the tax- transformations of NGOs found it highly problematic that exempt institution. In the United States, a tax-exempt entity when grants were closed out there had not been an exchange may own an MFI that doesn't serve a charitable purpose of letters indicating that the NGO was entitled to keep the as long as the business is not substantial in relation to the grant funds and other assets. tax-exempt entity's activities. However, any income (i.e., 40 For instance, the Peruvian NGO ACP Inversiones y Desarrollo dividends) received by the tax-exempt entity from the MFI (ACP), which transformed in 1998 into the commercial may be taxable as unrelated business income. bank MiBanco, was required to ensure the donated funds 51 Existing shareholders may also have preemptive rights to remained in a "like institution" even though most of the grants purchase shares under local law. had expired by 1990. As of February 2008, when MiBanco 52 In some countries (e.g., Bosnia, where the concern has announced its plans for an IPO, ACP remained the majority been expressed not only by regulators but also by bilateral shareholder. aid agencies), there is heightened concern that transformed 41 One significant INGO plans to require each affiliated MFI, institutions will be effectively stripped of their assets by before transformation, to trace its grant funding and verify management or others controlling the institution. This is likely that donors have no ongoing claims to those funds. largely because of past experiences with privatization of state enterprises (in particular, in certain countries in Central and Eastern Europe and in certain NIS countries) that essentially amounted to theft by a few individuals of institutions built through the work of many. 53 See O'Brien (2006). 19 Annex 1 TRANSFORMED NGO MFIS (through December 2007) Name of INGO or Other Number of Transforming International Name of New Type of Formal Transformations Institution or Founder, Network, Financial Financial Year in a year Project or TA Providera Institution Institution Country 1992 1 Promoción y ACCION BancoSol Commercial Bolivia Desarrollo de la International Bank Microempresea (PRODEM) 1993 1 Corposol Finansol Commercial Colombia (dissolved in (restructured Finance 1996) and renamed Company FINAMERICA in 1997) 1994 1 Women's World Women's World Mutual Savings and Ghana Banking Ghana Banking (WWB) Assistance Susu Loan Company network Savings & Loan 1995 2 Procredito Internationale Caja Los Andes Finance Bolivia Projekt Consult Company (FFP) GMBH (IPC) (TA provider) AMPES Financiera Calpiá Finance El Salvador Company 1996 1 AzerCredit World Vision WV AzerCredit NBFI Azerbaijan (project) International (WVI) LLC 1997 3 SEPAR EDPYME RFI Peru Confianza CARE Peru CARE EDPYME RFI Peru EDYFICAR CARD CARD Rural Bank Rural Bank Philippines 1998 5 FIE FIE Fundo FFP Bolivia Financiero Privado ADEMI BancoADEMI Development Dominican Bank Republic ACP ACCION MiBanco Commercial Peru International Bank (TA provider) Habitat Arequipa Habitat EDPYME Crear RFI Peru Siglo XXI Arequipa Habitat Tacna Habitat EDPYME Crear RFI Peru Siglo XXI Tacna 1999 7 FEFAD ProCredit Bank Bank Albania PRODEM (rural PRODEM Fundo FFP Bolivia portfolio) Financiero Privado IDEPRO, CIDRE, ECO Futuro FFP Bolivia FADES, and ANED Fundo Financiero Privado K-Rep World Education K-Rep Holdings Commercial Kenya (which owns K- bank Rep Bank) Micro-Start MicroStart X.A.C. Ltd. Co. NBFI Mongolia program 20 Name of INGO or Other Number of Transforming International Name of New Type of Formal Transformations Institution or Founder, Network, Financial Financial Year in a year Project or TA Providera Institution Institution Country Nirdhan Save the Children Nirdhan Utthan Development Nepal Bank Ltd. bank Fundacion EDPYME Raiz RFI Peru Intervida 2000 8 ACLEDAb ACLEDA Bank Commercial Cambodia Plc. Bankc FUNADEH Financiera Private finance Honduras (Fundación FINSOL company Nacional para el Desarrollo de Honduras) SHARE WWB network Share Microfin NBFC India Ltd. Moznosti Opportunity Moznosti Savings bank Macedonia International (OI) CHISPA MEDA Corporacion Licensed Nicaragua Nicaraguense financiera Financiera, S.A. (Confia) (see 2005 for transformation to bank) Centro de EDPYME RFI Peru Estudios Sociales Solidaridad Solidaridad Habitat Crear EDPYME Crear RFI Peru Cusco Siglo XXI Cusco World Vision WVI EDPYME RFI Peru Credivision 2001 8 BRAC Holding BRAC Bank Commercial Bangladesh bank Ennathian EMT NBC licensed Cambodia Moulethan mf company Tchonnebat (EMT) (project) Hattha Hattha Kakesekar NBC licensed Cambodia Kakesekar Ltd. mf company Vision Fund WVI VisionFund Company ­ Cambodia (program) Cambodia Nacional Bank license in 2004 Asociacion ACCION Financiera Limited Mexico Programa International liability finance Compartamos (TA provider) Compartamos company S.A. de C.V. SOFOL (see 2006 for transformation to bank) XAC and Goviin Mercy Corps and XAC-GE Group, a Commercial Mongolia Ekhlel Co. others holding company bank [merger]d which owns XacBank Ltd. DEPROSC DEPROSC Development Nepal Development bank bank 21 Name of INGO or Other Number of Transforming International Name of New Type of Formal Transformations Institution or Founder, Network, Financial Financial Year in a year Project or TA Providera Institution Institution Country Habitat Crear Habitat EDPYME Crear RFI Peru Trujillo Siglo XXI Trujillo KMBI, ASKI, OI Opportunity Thrift bank Philippines TSKI,DSPI,RSPI; Microfinance APPEND Bank 2002 6 Microcredit OI Opportunity Bank Commercial Montenegro Montenegro Montenegro bank Center for Swalamaban Development Nepal Self-Help Nikas Bank (SBB) bank Development (CSD) Aga Khan Rural Aga Khan First Microfinance Microfinance Pakistan Support Program Bank bank ARDCI Vision Bank Rural bank Philippines E Zobel Banco Ng Masa Rural bank Philippines Foundation (program) La Asociación FINDESA Deposit-taking Nicaragua del Fondo NBFI del Instituto Nicaragüense de Desarrollo (FINDE) 2003 3 Thaneakea Phum Catholic Relief Thaneakea Phum Licensed Cambodia (project) Services (CRS) microfinance Camdodia companye FINCA FINCA FINCA Microcredit Kyrgyzstan Kyrgyzstan International Microcredit company (program) Company ADOPEM WWB network Banco de Savings and Nicaragua Ahorro y Crédito loan bank ADOPEM 2004 8 CREDIT (project) World Relief CREDIT Licensed Cambodia Microfinance microfinance Institution companyf FINCA Ecuador FINCA FINCA Ecuador Financiera Ecuador International (regulated financial institution) Financiera IPC (TA provider) Banco ProCredit Bank El Salvador Calpiag Sinapi Aba Trust OI OI Sinapi Aba NBFI Ghana S&L Ltd. Fondasyon Kole Sevis Finansye NBFI Haiti Zepol (Fonkoze) Fonkoze (Fonkoze Financial Services) Bullock Cart BWDA Finance NBFC India Workers' Limited (BFL) Development Association (BWDA) 22 Name of INGO or Other Number of Transforming International Name of New Type of Formal Transformations Institution or Founder, Network, Financial Financial Year in a year Project or TA Providera Institution Institution Country Rural Finance ADIE International Kreditimi Rural I LLC Kosovo Program of (project) Kosovo (KRK) Kosovo Ai-Ken, Ak-Peil Mercy Corps Kompanion Microcredit Kyrgyzstan Talas, Umai-Ene, Financial Group company Keremet-Kol, Ak- Maal Yug FINCA Uganda FINCA FINCA Uganda Micro Uganda Ltd. deposit-taking FI 2005 10 Caja Los Andesh IPC Banco ProCredito Commercial Bolivia bank Spandana Spandana NBFI India SKS SKS NBFC India Public Fund Mercy Corps Asian Credit Newly formed Kazakhstan Asian Credit Fund LLP subsidiary Fund of licensed institution Bai Tushum ACDI-VOCA Bai Tushum and Microcredit Kyrgyzstan Financial Partners company i Foundation Confiaj Banco ProCredit Commercial Nicaragua Nicaragua bank FORA Fund for OI FORUS Bank Commercial Russia Small Business bank Support RWMN WWB network RWMN NDCO Non-banking Russia deposit and credit organization ARC (program) ARC Finance Salone LLC Sierra Leone PRIDE Uganda PRIDE network PRIDE Micro deposit- Uganda Microfinance Ltd. taking FI Uganda ACCION Uganda Micro deposit- Uganda Microfinance International Microfinance Ltd. taking FI Union (TA provider) Uganda WWB network Uganda Finance Micro Uganda Women's Trust Ltd. (U- deposit-taking Finance Trust Trust) FI 2006 9 Aregak UMCOR Aregak Universal credit Armenia (program) organization (closed JSC) FINCA FINCA FINCA Armenia Universal credit Armenia International organization Horizon Nor Horizon Universal credit Armenia organization AMEEN CHF AMEEN JSC Financial service Lebanon company Compartamos Banco Commercial Mexico Financiera, S.A. Compartamos bank de C.V.k Agroinvest WVI Agroinvest LLC NBFI Montenegro Foundation 23 Name of INGO or Other Number of Transforming International Name of New Type of Formal Transformations Institution or Founder, Network, Financial Financial Year in a year Project or TA Providera Institution Institution Country Capa Finance WVI Capa Finance Nonbank Romania microfinance company CHF CHF Express Finance JSC Romania International Opportunity OI Opportunity Nonbank Romania Microcredit Microcredit microfinance Romania Romania company (OMRO) Agroinvest WVI Agroinvest LLC LLC Serbia (project) 2007 11 Mikrofin CARE Mikrofin Microcredit Bosnia organization MiBospo WWB network MiBospo Microcredit Bosnia organization Lider CHF Lider Microcredit Bosnia organization Constanta Save the Children Constanta (JSC) Licensed Georgia microfinance organization Crystal Fund Crystal (JSC) Licensed Georgia microfinance organization Small Business Oxfam GB Lazika Capital Licensed Georgia Development (JSC) microfinance Fund organization VisionFund WVI Credo (LLC) Licensed Georgia Credo microfinance Foundation organization Activists Grama Vidiyal NBFC India for Social Microfinance Ltd. Alternatives-- Grama Vidiyal (ASA-GV) Bandhan Bandhan NBFC India BSS (registered BSS NBFC India public charity) Kazakhstan Loan ACDI-VOCA KazMicroFinance LLCl Kazakhstan Fund Total 84 35 countries Note:NBFI=nonbankfinancialinstitution;RFI=regulatedfinancialinstitution;NBFC=nonbankfinancecompany aIn some instances, the founding INGO may not have been involved with the NGO at the time of transformation. References to networks and TA providers include only those involved with the NGO at the time of transformation. bAssociation of Cambodian Local Economic Development Agencies (established by UNDP and ILO). cInitiallylicensedasspecializedbank(withnameACLEDABankLimited);receivedcommercialbankinglicensein2003. dThis transformation constitutes a "second stage" transformation: an already transformed NGO is changing into a regulated entity. This type of transformation is not counted for purposes of column 2. eTPC became an LLC in 2002 and received its license in 2003. fCREDIT became an LLC in 2003 and received its license in 2004. gSecond stage transformation. hSecond stage transformation. iTo be converted in a deposit-taking microfinance company or microfinance bank. jSecond stage transformation. kSecond stage transformation. lPlans to become a bank in 2009. Sources: Fernando (2003), updated by William Steel, further updated by Kate Lauer. 24 Annex 2 List of Persons Consulted Jim Anderson, SME and Microfinance advisor, Tamar Lebanidze, board director, Constanta Mercy Corps Lisa Lindsley, managing director, CtW Investment Hay Assaad, head of Micro, Rural and Small Group (former ACCION Gateway Fund manager) Business Financial Services and E-Finance, Cesar Lopez, vice president, International International Finance Corporation Operations, ACCION International Jay Banjade, associate director, Economic Elissa McCarter, director, Office of Development Opportunities Development Programs for Finance, CHF (previously of Catholic Relief Children, Save the Children Services) Caitlin Baron, director of Global Microfinance Dawn McGee, general counsel and transformation Initiative, Michael & Susan Dell Foundation manager, Unitus Deborah Burand, independent consultant Jason Meikle, country director at FINCA Tanzania Tim Burgett, senior legal counsel, WVI (formerly country director at FINCA Kyrgyzstan) Mary Chaffin, general counsel, Mercy Corps Patricia Mwangi, Financial Sector Deepening Sita Conklin, economic opportunities specialist, Trust--Tanzania (formerly of CGAP) Save the Children Jorge Noda, executive president, AgroCapital Tamara Cook, program officer, Bill & Melinda Viswanatha Prasad, managing director, Bellwether Gates Foundation (formerly microfinance analyst Microfinance Fund at CGAP) Doug Rutzen, president and chief executive officer, Deborah Drake, vice president, Investment Policy & International Center for Not-For-Profit Law Analysis, ACCION International Rodney Schuster, co-founder Uganda Microfinance Sabina Dziurman, senior banker, European Bank for Union and Uganda Microfinance Limited Reconstruction and Development Beso Shengalia, general manager, Lazika Capital Pam Eser, director, Microenterprise and Economic (formerly general manager of Small Business Development, Mercy Corps Development Fund) Bill Farrand, senior technical adviser--Microfinance, Chris Shore, director, Microenterprise Catholic Relief Services Development, WVI Prabhu Ghate, independent consultant Stacie Shrader, Russia country director, Opportunity Geeta Goel, grants officer, Michael & Susan Dell International;chairmanoftheBoardofDirectors, Foundation FORA Bill Harrington, senior technical advisor-- Sanjay Sinha, managing director, M-CRIL Microfinance, Catholic Relief Services William Steel, independent consultant Martin Holtmann, head, Microfinance Group, Lloyd Stevens, vice president, Deutsche Bank International Finance Corporation Thierry van Bastelaer, associate vice president, Jim Kaddaras, Developing World Markets Economic Opportunities Development Programs Jean-Pierre Klumpp, chief operating officer, for Children, Save the Children BlueOrchard Gagik Vardanyan, executive director, MDF-Kamurj Udaia Kumar, managing director, SHARE Victoria White, vice president, International Microfin Ltd. Operations, ACCION International Levan Lebanidze, executive director, Constanta 25 Annex 3 Transformations by Country, through December 2007 First Last Country Transformation Transformation Total (no.) Albania 1999 1 Armenia 2006 2006 3 Azerbaijan 1996 1 Bangladesh 2001 1 Bolivia 1992 1999 5 plus 1 second-stage transformationa (2005) Bosnia 2007 2007 3 Cambodia 2000 2004 6 Colombia 1993 1 Dominican Republic 1998 1 Ecuador 2004 1 El Salvador 1995 1 plus 1 second-stage transformation (2004) Georgia 2007 2007 4 Ghana 1994 2004 2 Haiti 2004 1 Honduras 2000 1 India 2000 2007 7 Kazakhstan 2005 2007 2 Kenya 1999 1 Kosovo 2004 1 Kyrgyzstan 2003 2005 3 Lebanon 2006 1 Macedonia 2000 1 Mexico 2001 2001 1 plus 1 second-stage transformation (2006) Mongolia 1999 2001 1 plus 1 second-stage transformation (2001) Montenegro 2002 2006 2 Nepal 1999 2002 3 Nicaragua 2000 2003 3 plus 1 second-stage transformation (2004) Pakistan 2002 1 Peru 1997 2001 10 Philippines 1997 2002 4 Romania 2006 2006 3 Russia 2005 2005 2 Serbia 2006 1 Sierra Leone 2005 1 Uganda 2004 2005 4 35 countries 84 aA second-stage transformation is the transformation of a for-profit company that had already transformed from an NGO into a bank. 26 Bibliography Chaffin, Mary. 2005. 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ACCION. CGAP Web site at www.cgap.org. Sriram, M. S., and Rajesh S. Upadhyayula. 2004. CGAP "The Transformation of the Microfinance Sector in 1818 H Street, NW India: Experiences, Options and Future." Journal of MSN P3-300 Microfinance Vol. 6, No. 2. Washington, DC 20433 USA Tel: 202-473-9594 Fax: 202-522-3744 Email: cgap@worldbank.org © CGAP, 2008 The author of this Occasional Paper is Kate Lauer, lawyer and a valuable counsel and commentary. The author is grateful to Alexia policy advisory consultant to CGAP. This paper was conceived of by Latortue, Kate McKee, and Jeanette Thomas for their thoughtful Elizabeth Littlefield and its completion--following almost two years review and suggestions and to the many people (listed in Annex of research and writing--is due largely to the encouragement and 2) whom the author consulted in the research process. Any support of Timothy R. Lyman and Rich Rosenberg, who provided misstatements are the sole responsibility of the author. CGAP materials are frequently cited in other works. The following is a suggested citation for this Occasional Paper: Lauer, Kate. 2008. "Transforming NGO MFIs: Critical Ownership Issues to Consider." Occasional Paper 13. Washington, D.C.: CGAP, May.