80540 Access to Finance FORUM Reports by CGAP and Its Partners No. 9, April 2014 The Art of the Responsible Exit in Microfinance Equity Sales Daniel Rozas with Deborah Drake, Estelle Lahaye, Katharine McKee, and Danielle Piskadlo a As the microfinance industry matures, a question that has come into sharper focus is how social investors committed to advancing responsible finance practices should “exit responsibly” from the microfinance institutions (MFIs) in which they have invested over the years. As they prepare to sell their stakes, what options do development-minded investors have to help ensure responsible behavior by their partner MFI into the future and healthy development of the broader market? In this paper the Center for Financial Inclusion at Accion (CFI) and the Consultative Group to Assist the Poor (CGAP) seek to spark discussion among the stakeholders working to advance financial inclusion and in particular the investor community that will result in greater clarity around the goal of responsible exits and the policies and practices that would support it. Acknowledgments CFI and CGAP would like to thank the 50 investor staff and industry experts (see Annex H) who were willing to share their own experiences and insights. In particular, we would like to thank Accion Investments, Aavishkaar-Goodwell, CARE, Caspian Investments, Developing World Markets, Enclude, KfW and Triodos Investment Management for sharing the more in-depth experiences described in the case studies in the appendices. We would also like to especially thank lead author Daniel Rozas and our reviewers Elisabeth Rhyne, Mayada El-Zoghbi, Sarah Rotman, and Michael Tarazi. © 2014, Consultative Group to Assist the Poor (CGAP) and Center for Financial Inclusion (CFI) 1818 H Street NW, MSN P3-300, Washington DC 20433 Internet: www.cgap.org Email: cgap@worldbank.org Telephone: +1 202 473 9594 Rights and Permissions This work is available under the Creative Commons Attribution 3.0 Unported license (CC BY 3.0) http:// creativecom- mons.org/licenses/by/3.0. Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and adapt this work, including for commercial purposes, under the following conditions: Attribution—Cite the work as follows: Rozas, Daniel. 2014. “The Art of the Responsible Exit in Microfinance Equity Sales.” Forum 9. Washington, D.C.: CGAP and Center for Financial Inclusion. License: Creative Commons Attribution CC BY 3.0 Translations—If you create a translation of this work, add the following disclaimer along with the attribution: This trans- lation was not created by CGAP and Center for Financial Inclusion at Accion and should not be considered an official translation. CGAP and Center for Financial Inclusion shall not be liable for any content or error in this translation. All queries on rights and licenses should be addressed to CGAP Publications, The World Bank Group, 1818 H Street NW, MSN P3-300, Washington, DC 20433, USA; e-mail: cgap@world bank.org. Contents SECTION 1. Introduction 1 SECTION 2. Four Decisions 3 2.1 When? 3 2.2 To Whom? 4 2.3 How? 5 2.4 How Much? 7 SECTION 3. Market Development Considerations for Exiting DFIs 9 SECTION 4. Responsible Exits: Looking Ahead 11 APPENDICES APPENDIX A Accion Investments: Selling an Entire Portfolio 12 APPENDIX B Equitas: Separating Governance from Ownership 13 APPENDIX C KfW: Selling Back to the Holding 14 APPENDIX D Arohan: A Distress Sale 15 APPENDIX E Edyficar: An NGO Selling to a Bank 17 APPENDIX F Sathapana: A Multi-Stakeholder Exit 19 APPENDIX G Focus Group on Social vs. Financial Return 21 APPENDIX H List of Interviewees 23 APPENDIX I Sources 24 i ii 1 SECTION Introduction E quity as a funding instrument is particularly important healthy development of the overall market? And what if they to responsible development of financial markets. At its reinvest the proceeds from a sale into younger mission- core, it supports the growth and diversification of mi- focused institutions and underserved markets: is such an exit crofinance institutions (MFIs) and other financial institutions then automatically socially responsible? that serve the poor, and it is especially vital to the expansion of Equity exits are not a new phenomenon in a sector where deposit services. the first funds were created well over a decade ago and a But beyond that, equity holdings can add value when number of sales have already happened (Glisovic, Gonzalez, paired with active governance.1 First, they offer development- Saltuk, and Rozeira de Mariz 2012). They are also expected minded shareholders the opportunity to provide leadership to accelerate. According to MicroRate/Luminis, between to partner MFIs, including guidance to ensure that the overall 2014 and 2016, at least two equity and six hybrid funds worth strategy and specific products and practices are responsible. nearly $600 million are scheduled to mature (Figure 1). Second, they can promote responsible development of the In this context, this paper seeks to explore the concept of a broader market to the extent that they demonstrate the responsible exit along four strategic decisions: (i) the timing viability of responsible MFI business models (including by of the equity sale, (ii) buyer selection, (iii) the governance and sharing relevant information on partner MFIs’ performance use of shareholder agreements to achieve social objectives, with other market actors) and crowd in additional investors and (iv) how social and financial returns are balanced when with goals and funding types that are appropriate for selecting among bids. We also examine how DFIs can use exits microfinance. This point is especially important for development finance institutions (DFIs), which are owned by donor governments and thus are mandated to be catalytic FIGURE 1 and “additional” in promoting private sector development. Most microfinance investment intermediaries (MIIs) and Microfinance Fund Maturity Schedule DFIs have committed explicitly to do right by clients through industry initiatives such as the Smart Campaign and the Hybrid - $ mln Principles for Investors in Inclusive Finance (PIIF), which Equity - $ mln urge and support them to choose partners carefully and inte- 245 218 grate specific responsible finance practices throughout their 87 investment processes. 106 90 54 69 60 As the holdings of MIIs and DFIs mature, the sale of eq- 33 20 24 43 27 8 uity stakes is becoming an increasingly important task and one that requires consideration of additional dimensions of Hybrid - # responsible finance and responsible market development. Equity - # 3 When investors that seek to be socially responsible exit, they face the challenge that they will give up their right to help 1 1 oversee or govern the investee. To what extent can—or 2 2 2 1 1 1 1 1 1 1 1 should—investors seek to ensure that the sale of their stakes in MFIs will result in ongoing responsible behavior by their 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 (former) partners and new owners and even contribute to Source: MicroRate/Luminis  owever, DFIs and MIIs do not always succeed in providing active governance support to partner MFIs. McKee (2012) and recent studies from CFI on 1. H governance and investor and board behavior during sectoral crises document that equity investors often fail to provide adequate guidance and expertise in the board room and other governance processes. 1 to encourage responsible market development given their This paper is not intended to be prescriptive. The practice particular role as publicly funded entities. We interviewed of selling equity in MFIs is still evolving, and the complexi- more than 40 representatives from MIIs, nongovernment or- ties of the transactions make each sale unique. Rather than ganizations (NGOs), DFIs, MFIs, and merger-and-acquisition setting out specific guidelines, we hope to draw on investor (M&A) specialists to capture their experience, perspectives, experiences to highlight key exit-related decisions for MIIs and emerging lessons on equity sale transactions. In addition, and DFIs, and in so doing, we hope to spur a focused debate we conducted six case studies of equity exits, which are de- on how to exit in such a way that the interests of investors, scribed in detail in the appendices. MFIs, and their clients are balanced. BOX 1 Key Findings Exits of equity investments are still relatively recent but about the kind of capital and expertise the MFI most needs lessons on how to ensure ongoing responsible behavior by in its next chapter. partners and the broader market are emerging. There are 3. How? In principle, putting provisions in shareholder several overarching themes that affect the options that in- agreements and setting up alternative mission-oriented gov- vestors are likely to face: market context and stage of devel- ernance structures could help enshrine the MFI’s mission and opment; share of ownership being sold; and the MFI’s own- social commitments to send an important signal to potential ership structure, governance arrangements, and place in its investors when current owners seek a buyer for their shares. life cycle. As a result, there is no single approach to ensure We analyze several examples of this approach. It should be a responsible exit. However, investors need to carefully noted, however, that the legal enforceability of such provi- think about four main strategic decisions: sions varies widely and their relevance may be limited when a 1. When? The desired timing and avenue of exit should controlling stake is being sold. The risk also exists that overly form a key part of an investor’s decision to invest. These restrictive and complex legal provisions could pose unreason- plans and preferences should be discussed with the other able barriers to exit. equity investors and the MFI’s management. That said, rare- 4. How Much? The selling party may have multiple offers to ly did the exit opportunity materialize exactly as planned, choose from, with each bidder offering a different mix of price and ability to adapt and respond flexibly was a feature in and nonprice characteristics. Since cashing out nearly always many exits. For fixed-term funds, exit timing is built into the entails giving up say over the investee’s future social or devel- prospectus, but at least one case study suggests that this opmental mission, we examined more specifically how inves- structure may not be optimal for the specific role of anchor tors described weighing price- versus mission-related features investor. of the potential new owner. The findings suggest that many 2. To Whom? There are advantages and disadvantag- investors currently may be using a two-step process in which es of selling to a microfinance investor versus an investor they first screen buyers for suitability (including mission fit) and outside of the microfinance ecosystem. On the one hand, then make their final selection based on the most attractive it is easier to find a like-minded buyer within the ecosys- price. We also note that high-priced sales to new buyers in the tem, which can mitigate concerns about mission drift or microfinance sector may risk locking an MFI into a strategy that reputation risk. On the other hand, for more mature MFIs, may harm both its clients and the broader market. investors such as local or regional banks might be better Finally, because of their specific mandate, DFIs have a placed to play a strategic role by bringing strong balance special role to play in private-sector development. The way sheets, operational expertise, and local market linkages they exit—when, how, to whom, and for how much—can that the MFIs need to develop further. Exiting DFIs and send important signals to other market players. By integrat- MIIs can be guided by careful and deliberate due dili- ing a market development dimension into these four key de- gence to ascertain the buyer’s intentions and commit- cisions, DFIs have an opportunity to fulfill their mandate to ment to the MFI’s mission, combined with judgment play a broader catalytic role. 2 2 SECTION Four Decisions A s noted in Box 1, there are four key questions equity nance roles, Aavishkaar Goodwell decided to sell half of its investors have to wrestle with when trying to respon- shares and worked with the MFI management to select the sibly exit an MFI: (1) when to sell, (2) who to sell to, most appropriate buyer. Despite the unusual limitations at- (3) with what conditions, and (4) at what price. Several over- tached to Equitas’ stock, the investor had no difficulty in arching themes affect these decisions and the actual options finding willing and suitable buyers. Indeed, the MFI’s ex- that investors have: the context and stage of development of traordinary growth as well as the excitement around the SKS the market (e.g., less-developed markets tend to have more initial public offering (IPO) created attractive conditions.2 circumscribed exit opportunities); the size of the stake being The fund was then able to redeploy its capital in younger sold (“anchor” investors face a different set of choices than in- markets and institutions where it expected to have a greater vestors selling noncontrolling stakes); and the MFI’s stage in impact and better fulfill its double bottom line. its own life cycle, ownership structure, and governance ar- For fixed-term funds and their investees, the “when” rangements. The decision might also create tensions with question can be particularly challenging. For example, the other shareholders and/or the MFI management, making the Indian fixed-term fund Bellwether was an anchor investor in selling process more complicated to manage. Ultimately, the Arohan and had been instrumental in supporting this MFI in final decision requires balancing among competing demands, its early stages of growth (Appendix D). However, when Aro- demonstrating that exiting responsibly is an art of tradeoffs. han was facing a severe liquidity shortage at the height of the Andhra Pradesh microcredit crisis, Bellwether was unable to 2.1 When? provide the capital Arohan needed. With its equity already Plan your exit before you enter. This phrase was repeated fully invested and the fund itself scheduled to mature soon, in so many interviews that it seems almost a mantra for eq- Bellwether had few options. Meanwhile, with Arohan strug- uity investors. In fact, the exit plan can be an integral part of gling for survival and the sector in crisis, conditions for sale their decision to invest. Our findings suggest that a few in- were exceptionally poor. Ultimately Bellwether found a will- vestors are starting to integrate exit criteria into their pre- ing buyer in Intellecash, but this was not the exit it had investment due diligence, including the possible exit strate- planned. gies according to the stage of market development. Some Bellwether’s example highlights the important role of an- investors also suggested discussing exit planning upfront chor investors and their investing strategies. Anchor inves- with pre-existing shareholders, co-investors, and the MFI’s tors generally hold a large (although not necessarily majori- management, and referencing the question of exits in the ty) stake that comes with a governance role that is often shareholders’ agreement or the MFI’s charter. more active than that of other shareholders. Ideally, anchor Upfront plans notwithstanding, exits rarely materialize investors should have sufficiently long investment horizons exactly as planned—the ability to adapt and respond flexibly and deep enough pockets to be able to support their invest- to unexpected circumstances is no less important. When the ees with additional capital when needed, while providing early stage investor Aavishkaar Goodwell invested in Equitas strategic guidance and necessary expertise on the board of in India (Appendix B), the plan was to stay in for at least five directors. However, as Bellwether’s case demonstrates, the years, during which Aavishkaar Goodwell expected to be ac- fixed-term funds’ timing limitations and limited capacity for tively involved in governance and provide technical support. later stage investment may result in negative consequences However, within two years Equitas had grown so fast that it for both the investor and the MFI. Fixed-term funds can play had far outstripped the needs of typical early stage MFIs. an important role in bringing diversified capital into the sec- Aavishkaar Goodwell’s stake had been diluted in the process, tor, especially by crowding in local sources of funding, but and it had to give up its board seat. Unable to put up addi- their structures may not be best suited for the role of anchor tional capital and continue its influential advisory and gover- investor. 2. On 28 July 2010 SKS, India’s largest MFI, became the first Indian MFI to float its shares through an IPO. 3 For anchor investors, the stakes are higher in an exit, es- and the limited number of actors involved mean that a seller pecially with respect to balancing social and financial re- is likely to have longstanding knowledge of the buyer and its turns. Consider the case of the sale of Edyficar in Peru by the reputation. As a result, selling within the microfinance eco- large international NGO CARE International (Appendix E). system simplifies the process of meeting the minimum stan- CARE founded Edyficar as an NGO MFI in 1985 and, over dard for a “responsible” buyer and is less likely to raise sig- the next quarter-century, supported its development, includ- nificant concerns about mission drift or reputation risk. ing transformation into a regulated, deposit-taking institu- A good example of a sale within the microfinance eco- tion. However, following Edyficar’s transformation, CARE system is the purchase of Accion Investments (AINV) by was increasingly unable to provide the requisite technical Bamboo Finance (Appendix A). Both Accion and Bamboo expertise and governance support. Having recognized that it are long-term members of the sector and subscribe to the was becoming an impediment to Edyficar’s development, same responsible finance commitments. The familiarity CARE sought to sell its anchor shareholding position. Unlike goes further still—Bamboo and its former sister organiza- Bellwether, it did not face any fixed exit horizons, yet CARE’s tion, Blue Orchard, had direct investments in many of Ac- decision to sell Edyficar was not easy, especially in light of cion’s MFIs, and one of Bamboo’s senior staff was a director the long and close history of the two institutions. of AINV. As the seller, Accion had little need to evaluate the Edyficar’s sale illustrates the critical role anchor investors buyer’s like-mindedness on the issues that mattered; it play in MFI development. In the course of our research, we knew where Bamboo stood. identified cases where the limited capacity of such anchor Despite the apparent advantages, selling within the eco- investors (including founding NGOs) to provide growth cap- system is not necessarily the best course of action. In some ital and technical expertise may have constrained the part- cases, seeking buyers outside the microfinance ecosystem is ner MFI’s ability to diversify products and scale up. (In some an outright necessity: most MIIs in the market do not have cases, lack of access to growth equity may even force MFIs to sufficient capital to buy large stakes in mature MFIs while finance growth with retained earnings, which in turn can maintaining a diversified portfolio. For mature MFIs, local create pressure to maintain higher profit margins including actors such as domestic commercial banks can make excel- through higher prices for their clients.) lent strategic investors, bringing operational depth, a more diversified product line, and longstanding regulatory rela- 2.2 To Whom? tionships, in addition to capital and access to low-cost depos- No other aspect of an equity sale looms quite as large as its. Such actors are usually found in markets with growing the selection of the buyer. The decision consists of two key economies or relatively well-developed financial sectors— issues: first, ascertaining to what extent the buyer is a like- the same markets where large MFIs are also more likely to minded investor that shares a commitment to the MFI’s stat- develop. As a result, for selling shareholders, finding such ed mission and can be trusted to “stay the course” over time; investors has not generally been difficult. and second, whether the buyer can add value to the MFI in The chief challenge of going outside the microfinance terms of strategic direction, specialized expertise, and ecosystem is the difficulty of assessing buyer like-mindedness. growth capital. To start with, the seller is less likely to be familiar with the For purposes of defining “like-minded investor,” prospec- potential buyer. And such buyers are also less likely to be tive buyers fall into two broad categories: members of the aware of, and have subscribed to, industry standards such as microfinance investment ecosystem (such as current share- the Smart Campaign Client Protection Principles. In our holders, MIIs, DFIs, or large MFIs or their holding compa- interviews, selling investors mention paying close attention nies) and external actors (often local or regional investors, to the following in their due diligence on prospective buyers: including commercial banks and venture capital firms). Within the microfinance ecosystem most investors share • The buyer’s rationale for the purchase and its strategic plans and alignment with the MFI’s own somewhat similar goals and responsible finance commit- strategy ments, and nearly all tend to subscribe to the sector’s basic set of client protection principles and social performance expec- • Willingness to reference mission-related objectives in tations.3 Most importantly, the small size of the ecosystem the shareholder agreement among owners of the MFI4  he Social Performance Task Force (SPTF) brings together more than 1,500 members (MFIs, donors, investors, associations, etc.) to agree on a common 3. T social performance framework and to develop an action plan to move social performance forward. SPTF facilitates a social investors working group that aims to explore good practices related to investment for social as well as financial outcomes and also promote social investment. A shareholders’ agreement is an agreement among the shareholders of a company, and it supplements (or supersedes) the company’s charter. It is com- 4.  mon practice in a company where there are a relatively small number of shareholders and often regulates issues such as voting rights, control and man- agement, dispute resolution, etc. Shareholders’ agreements are not always legally enforceable. 4 • The prospective buyer’s prior activities or investments in micro, small, and medium enterprises BOX 2 (MSME) or low-income finance A Fund to Invest in Mature MFIs • The comfort level of the MFI’s management and, where relevant, the founding NGO/promoter with the For some time, MIIs have exhibited a common invest- potential shareholder ment model: each usually seeks to invest around $3 million to $5 million, most want a board seat, and most have an One example of the challenge of assessing buyers is the eventual exit timeline. This limits the range of investable case of Sathapana, a Cambodian MFI held by several social MFIs to small and mid-sized operations. Institutions that and development investors (Appendix F). The outside-the- grow past that threshold—around $100 million in assets— ecosystem bidder in that case was Maruhan Japan Bank no longer present realistic investment options for these (MJB), an existing commercial bank in Cambodia that was funds. already lending to Sathapana and other MFIs. The bid was The recent launch of the responsAbility Participations financially attractive and brought many strategic advantages. fund is meant to fill this void. Specifically designed to in- However, one concern that arose was that MJB was wholly vest in mature MFIs and small emerging market banks, the fund expects its typical investments to be in the $20 million owned by Maruhan Corporation in Japan, whose business to $25 million range, entitle the fund to a board seat, and includes slot-machine gaming. To address this concern, the be subject to social performance requirements. In other sellers requested a specific legal commitment from the par- words, it meets the “desirable buyer” criteria for many ent company that the scope of its Cambodian operations other funds seeking to sell their stakes in mature MFIs. The would remain limited to the banking sector and would not fund is distinctive in one other dimension—it has an “ever- extend into gaming. green” structure that focuses on delivering dividend yield Another example is the case of CARE’s sale of Edyficar rather than capital gains, which enables it to avoid a spe- (Appendix E). As an NGO focused on fighting poverty around cific exit timeline. the world, CARE faced a considerable challenge in assessing like-mindedness when it sold its majority stake in Edyficar to Banco del Credito del Peru (BCP), a purely commercial bank consumer lending directly or through an affiliate. This fact with no explicit social mission. However, BCP offered Edyfi- might merit additional due diligence on the seller’s part to car the banking expertise and balance sheet strength that assess the bidder’s commitment to responsible finance and CARE could not possibly provide. A key factor that played better understand whether and how this line of business into CARE’s decision was BCP’s claim that it would in fact might affect the character of the MFI. maintain Edyficar’s mission—and do so out of largely com- In summary, when looking for a buyer, it helps to consider mercial motives. BCP had previously tried to build its own whether an existing microfinance investor is likely to come microcredit operation. While it was not successful, the bank forward, since such investors almost by definition pose a took away the lesson that microfinance required an inher- lower risk to the MFI’s mission. However, particularly when ently different approach from its retail banking model. This large equity stakes are involved, such buyers may prove un- experience enhanced the credibility of BCP’s assertion that it suitable or altogether unavailable, and going outside the mi- would not change Edyficar’s mission or operations, especial- crofinance ecosystem can bring other advantages and may ly when BCP underscored its commitment by agreeing to prove a better choice. In such cases, most of those inter- sign year-long contracts with key management. The signals viewed found it likely that a seller with a careful and deliber- proved convincing, and CARE chose BCP from among its op- ate due diligence process could reasonably ascertain the bid- tions. Even now, with three years of hindsight, both CARE der’s intentions. At the same time, the microfinance and Edyficar’s long-time management regard the sale as suc- investment sector also would benefit by broadening the ca- cessful and consistent with the long-term goals of all parties pacity of socially responsible funds to absorb larger-ticket to the transaction. equity transactions (see Box 2). However, not all such sales to buyers outside the sector end as well. Our interviews yielded cases that were described 2.3 How? as less successful, including the 2005 sale of Russian KMB Bank to Italian bank Intesa, which within a few years had While efforts to assess buyer like-mindedness and com- abandoned KMB’s original focus on SME lending, largely mitment to the MFI’s mission are critical, these are not the undoing the efforts of its founding investors. Another only doors through which development-oriented sellers can scenario that could become increasingly common is that of a exit gracefully. What if they could put in place some mecha- commercial bank bidder that engages in substantial nism to constrain buyers from steering the MFI away from 5 its mission even after the sale? The research uncovered growing interest in, and use of, the shareholders’ agreement BOX 3 to codify the MFI’s mission and social commitments. Such Governing from a Minority provisions can send an important signal to potential inves- tors, a warning to those who would prefer not to be thus con- Companies can choose to have multiple classes of com- strained. That said, the legal enforceability of such share- mon stock, usually denoted as Class A and Class B shares holder provisions varies widely from one jurisdiction to with one class having more voting rights than the other. another, and this approach would work only so long as the This can set up a system whereby a relatively small minority majority of investors support these commitments. (And this of shareholders could maintain governing control of the option can become moot in cases where a controlling stake is company. For example, in 2006, when McDonald’s sold its being sold.) Class B shares of Chipotle Mexican Grill it provided its Shareholders’ agreements in the microfinance sector of- holders 10 times the voting power of Class A holders’ while ten have provisions that serve to protect minority sharehold- holding fewer outstanding shares. ers when others are seeking to exit. In fact, the right of first Other examples of such governance include family- refusal (ROFR) was commonly cited during our interviews.5 owned institutions and entities chartered by foundations, where the founders seek to retain significant say in gover- ROFR permits existing investors to acquire shares before a nance, even as they raise equity from public investors. third party buys them. It can enable existing investors to State-owned enterprises, especially where governments send strong signals to potential bidders, keep a tighter con- own minority stakes, are likewise vehicles that provide a trol on who buys the MFI’s shares, and protect its adherence strong governing voice with a limited equity investment. to its mission and social commitments. Minority sharehold- ers can typically use these protective provisions to exit when the proposed transaction significantly alters their planned strategy for the MFI, or more simply, to take advantage of a voting rights to minority shares). Some legal structures6 spe- favorable price. But couldn’t such rights also be exercised to cifically allow minority shareholders to have a significant say protect the social mission of the institution? on certain key issues, including changes to the institution’s Such minority shareholder protections can have down mission, while other structures may allow minority share- sides, however. For one, they set up a structure of dual rights holders to exercise outright control (see Box 3). among the shareholders (those initiating the sale and those These structures need to be approached with care, to en- exercising minority protections) that can lead to tension sure that otherwise suitable potential investors are not put among shareholders. They can also have unintended conse- off by having less say in governance. However, when done quences. For example, when one social investor decided to correctly, alternative governance structures to support a exit from an MFI owned by a mix of social and commercial strong social mission can remain attractive on a strictly com- shareholders, a commercial investor decided to exercise its mercial basis. ROFR prerogative to buy the stake. This threatened to shift Equitas offers one such example (Appendix B). Since a the balance on the board away from the social investors that majority of its board members serve as independent direc- made up the governing majority unless the remaining social tors, shareholders are prevented from having full run of the investors exercised their own ROFR rights to increase their institution’s governance. Furthermore, Equitas’ shareholder stakes (which they did). Some investors mentioned situations agreement sets a return on equity (ROE) ceiling of 25 percent where minority shareholder protections present so great a and earmarks funds for charitable activities. Despite these barrier for the seller as to make an exit impossible altogether. limitations and lack of shareholder control, Equitas has re- Minority shareholder rights are not the only means for mained attractive to purely commercial investors. One pri- keeping an MFI focused on its mission. Other avenues in- vate equity firm, Canaan Partners, which purchased Equitas clude executing long-term contracts with existing manage- shares before the Andhra Pradesh crisis pointed out that it ment or putting in place self-perpetuating governance struc- was drawn by the fact that Equitas’ governance structure, tures that prevent takeover by any one shareholder. There combined with its strong management, helped generate sol- are also examples where investors can exercise post-exit in- id but stable returns over the long term, in clear contrast to fluence (e.g., by adding the requirement that key institutional the potentially higher-return but more volatile model of decisions be made by a super-majority or ascribing majority many of Equitas’ competitors at the time. 5. First refusal rights are common to commercial private equity and venture capital investments and are not unique to microfinance. 6. Such as the Kommanditgesellschaft auf Aktien in Germany. 6 Mechanisms that embed a self-sustaining social mission volunteered that the price was the topmost factor in its deci- in organizational governance structures are among the sion. And yet, delving deeper into other cases, it became ap- least understood elements of social investing. Future analy- parent that the final sale nearly always went to the highest or sis could shed further light on how such techniques can at- second-highest bidder. tract a broader spectrum of capital while maintaining a Since few investors were willing to discuss details of their strong social mission. decisions on price and accepted (and rejected) bids, we The board of directors plays a leading role in changes in attempted an experiment, by presenting a focus group of 33 shareholder composition and governance structures. An exit equity investors with a hypothetical scenario in which they that entails a significant change in board composition is like- were selling an MFI with social objectives (Appendix G). All ly to bring with it important changes in the governance bal- sale prices were purposefully set well above a reasonable ance among directors and that between directors and the return threshold (substantially exceeding average stock- CEO. Naturally, that would include cases where the exiting market returns, for example), and the hypothetical buyers shareholder is selling a controlling stake. But minority share- offered a wide range of social returns: a local commercial holders may also have an outsize influence on the institu- bank that appeared to provide partial support to the MFI’s tion’s governance. Such influence may be exercised by found- social objectives made an offer equivalent to 2.1 price-to- ing investors whose stakes may have diluted over time, or book (P/B), a holding company with a strong social focus perhaps by network NGOs that provide technical assistance offered 1.6 P/B, and a private equity investor with no and institutional support as well as equity. An exit by such documented social mission offered 2.7 P/B. investors may substantially shift the institution’s gover- Stating that they were “going with their mind, rather than nance—a change for which boards should prepare in antici- their heart,” most investors chose the mid-priced offer (67 pation of the exit. percent average annual return) from a local commercial Beyond the board, the perspective of the CEO and the top bank, which held out the benefit of a strong balance sheet leadership team is no less important. Except in cases where and local and regional market depth but only partially sup- management is expected to be replaced, getting its buy-in is critical. If management’s incentives are not aligned with the sale, the result can be problematic to all parties involved BOX 4 (Rhyne, et al. 2009). This was a key consideration for both Edyficar and Sathapana, whose managers had been leading The Perils of High Valuations the organizations for many years. Their buy-in and comfort with the new shareholder was key, and the buyers’ willing- Under normal circumstances investors will choose a ness to extend management contracts as part of the purchase higher price over a lower one, all else being equal. But is agreement played an important role in securing the confi- there such a thing as too high a price? For social investors, the answer should be yes. An dence of both management and the selling shareholders. equity valuation is a reflection of the buyer’s expectations of future profits and gains in enterprise value. If those two 2.4 How Much? factors run significantly below expectations, the buyer may not meet its required return or potentially suffer a loss— The concept of balanced returns is relevant to all MFIs even if the institution itself remains profitable. As a result, and their funders but takes on particular significance for MII when the purchase price is based on expectations of very and DFI equity investors. Unlike creditors, shareholders high profits and/or growth, it can make it difficult for the earn their primary (and sometimes only) financial return company to change course down the road. upon sale. Yet the sale nearly always entails giving up a say Consider the examples of Compartamos and SKS, over the investee’s future social or developmental mission. whose IPOs both commanded high valuations. In the case Thus, the fourth key decision we explored is the price in- of Compartamos this may have affected management’s vestors look for when they sell their shares and how they willingness and ability to reduce interest rates charged to clients. In the case of SKS, the high valuations paid in the choose between competing bids that offer different combi- run up to the IPO may have contributed to what has now nations of financial versus (future) social returns. Despite its proven to be unsustainable growth. In both cases, the ex- critical importance to achieving balanced returns, pricing is ceptionally high valuations either attracted unsuitable buy- one of the areas that few investors proved willing to com- ers or motivated unsustainable behaviors by the institu- ment on in-depth. One of the most common themes voiced tions themselves or by others seeking to capitalize on the by those interviewed for this paper was that price was an im- apparent high profits in the sector. portant, but not the driving element, in deciding which offer Source: O’Donohue, et al. (2010). to accept. Among the cases studied, only one shareholder 7 ported the MFI’s social objectives. Only one out of the four then make their final selection based on the most attractive investor groups chose the lowest-priced, but still highly prof- price. This example stresses the trade-offs investors face in itable offer (46 percent average annual return), even though balancing returns of social and financial performance. most investors acknowledged that the buyer provided the To the extent that DFIs or MIIs seek to maximize their best support for the MFI’s social objectives. Meanwhile, all profit—even after first applying a social performance filter to investors unanimously rejected the highest-priced offer (91 the bids—merits further investigation, since a high-priced percent average annual return) from a short-term investor sale could lock an MFI into pursuing a strategy that could with no interest in the MFI’s social mission. hurt its clients or even pose risks to the broader microfinance If this admittedly primitive experiment indicates actual sector. When an MFI’s shares command too high a price, two investor preferences, then the outcome could be interpreted factors are at play: high growth, high profit margins, or both. to suggest that investor choices may be guided by a two-step High-priced equity can increase risks of market volatility process in which they first screen buyers for suitability and compared to markets with moderately priced equity. 8 3 SECTION Market Development Considerations for Exiting DFIs A s publicly funded institutions, DFIs’ mandate is to might offer stronger proof of the attractiveness of the core provide longer-term, patient capital to the private microfinance business. Likewise, a DFI’s return expectations sector for investments that promote development. can provide an important indication for what other market As a result, their investments are best placed where private actors ought to expect. On the one hand, relatively high re- investors fail to invest sufficiently because of real or perceived turns could help bring in mainstream sources of capital, but risks. But beyond developing individual retail institutions to as noted, when price expectations go beyond a certain range, the point where they can demonstrate the viability of the they also risk attracting future buyers with growth and prof- business and attract private investments, DFIs could aspire itability goals that are hard to reconcile with the nature of to play a broader catalytic role in developing more inclusive microfinance products and clients segments. As the sector’s financial markets. They could make their investment viability is proven, the risk premium should decrease over decisions based on a broader and a more detailed assessment time in most markets. of market needs (El-Zoghbi and Lauer 2013). Often, the most To date there has been only a handful of DFI exits from catalytic priorities for market development are in three MFIs. Several factors explain this. Our research suggests areas: (1) improving information, (2) building the capacity of that while DFIs analyze and discuss their future exit options all market actors, and (3) creating market incentives and an at entry, DFIs’ longer time horizon and incentives may weak- enabling policy environment. DFIs may already engage in en the “exit culture.” In their desire to mitigate reputational these different areas to some extent, depending on the nature risk and/or help ensure steadfast commitment of MFIs to of their funding instruments among other factors. But they their mission, some of these publicly funded institutions face inherent limitations in their ability to be the local, have tended to include a number of restrictions in their neutral, flexible “facilitator” that could support market- shareholder agreements. When they do look to sell, these building across the board over the longer term. In fact, DFIs provisions combined with the overall complexity of the legal likely will contribute more to market development to the documents and procedures have had the effect of slowing extent they can coordinate closely with local “facilitators” down the sales process or putting off interested buyers. In that undertake deep and ongoing market analysis and engage addition, DFIs typically have preferred taking a minority in these three catalytic areas. stake, which can be less attractive to potential bidders (espe- This market development perspective has implications cially if the holding period is long and the stake has been di- for DFIs’ equity investments at both the entry and exit stages luted). While these present serious challenges, our inter- that require further analysis and discussion. For example, views suggest that DFIs are starting to push themselves to entry into a relatively immature or “frontier” market might find ways to exit. itself have a more catalytic effect than putting the same funds One example of DFI exits is with start-ups or “greenfield” into a more established market, as it offers more opportuni- institutions sponsored by international networks or holding ties to demonstrate the viability of base-of-the-pyramid mar- companies (Appendix C). These retail institutions are often ket segments and the MFI business model. Whether the MFI created in frontier markets and are meant to set examples for partner is a startup or an existing institution, the specifics of others to follow, by demonstrating the viability of the how a DFI engages over time, including in governance, can microfinance segments they serve, as well as efficient encourage private investors to “crowd in” or even take the operations and responsible practices.7 After showing several DFI’s place outright. years of sustainability, some DFIs have sold their greenfield The way a DFI exits—when, how, to whom, and for how MFI shares back to the holding company. The result typically much—can send important signals to other market players. changes only the nature of their involvement in the MFIs’ To the extent that the buyer is a local commercial investor or governance, without changing its ultimate ownership since bank, rather than another DFI or DFI-funded entity, this they usually are also a major shareholder in the holdings.  recent IFC and CGAP study shows that in Ghana, the DRC, and Madagascar, the most important effect on market building has come from greenfield 7. A MFI investment in staff training and development while playing a pioneering role in expanding access to financial services. See, Earne, Jansson, Koning, and Flaming (2014). 9 Applying a market development perspective raises questions effects? Would the market impact have been greater if the DFI about this exit strategy: does the DFI continue to add value at had sold its shares to a suitable private investor instead of the the holding company level (as many sponsors seem to believe)? holding company? Should the proceeds be re-invested in other Were lessons about the business model and performance frontier markets? These questions merit further discussion widely shared with the market to ensure demonstration among development finance professionals. 10 4 SECTION Responsible Exits: Looking Ahead T he aim of this paper is to explore the issues of fixed-term funds, and with a governing minority stake for responsible investing during equity sales and most investors including the DFIs. Over time, this model stimulate debate without prescribing practice, has had positive effects in creating strong institutions which we consider premature. However, as exits start to serving the poor. Some shortcomings are also coming into accelerate, we hope that the four key decisions—when, to focus, however. Fixed-term funds do not offer the flexibility whom, how, and how much—will provide a useful that is required in an evolving sector where market framework for development-oriented investors to use in conditions can still be unpredictable. However, some evaluating their exit options. In addition, we see a number investors are showing interest in taking majority stakes. of specific areas that warrant further exploration. Other models that prioritize delivering dividend yield Active governance of MFIs through to exit. Active and rather than capital gains are also gaining traction. Other balanced engagement in MFI governance by social investors is equity investing models merit further analysis since they widely reported to be a weak spot overall (McKee 2012). Most could reduce exit trade-offs. of those interviewed for this paper felt that among the Balanced returns and reasonable growth. The governance areas that need strengthening, boards need to pay microfinance investment sector is currently involved in a more attention to the specific goal of responsible exit and how lively debate about how best to balance the financial to best achieve it. Waiting until exit is imminent to raise the bottom line with one or more social or development question at the board level is unlikely to optimize the outcome objectives. While the concepts of and emerging metrics for the selling investors, the MFI, or the other stakeholders. for “balanced returns” and “reasonable growth” extend Further discussion and exchange of experience is needed on well beyond the specific issues surrounding responsible the role of new ownership models and shareholder agreement exit, the four exit decisions explored in this paper are provisions, along with further analysis of alternative deeply rooted in the double bottom line nature of MFIs governance models that rely on independent or minority and their owners. Each investor has its own goals control to sustain an MFI’s social mission. preferences that it seeks to achieve at exit, and the market Exploring new equity investing models. The first would benefit from improved articulation of those generation of equity investing is carried out mainly by preferences and how best to advance them. 11 A APPENDIX Accion Investments: Selling an Entire Portfolio I n late 2009, the board of Accion Investments (AINV) was agement and board were immediately intrigued. Bamboo pondering its future. The larger investments were begin- was an established global private equity group with years of ning to outgrow the fund, while the less mature invest- experience in microfinance investing. Surely, a sale to a sin- ments required continued financial and governance sup- gle investor would come with fewer complications, and as a port. Recapitalization was possible but not necessarily longstanding actor within the microfinance ecosystem, desirable. Some of the fund’s investors wanted to sell their Bamboo easily met the test of a like-minded investor. As an entire stake. Others were willing to remain but wanted an existing investor in AINV, Bamboo was familiar with its external sale to provide a reality check on how the market portfolio companies making for a simpler due diligence valued the fund’s investments. process and a faster sale. It also helped that in most of these AINV was one of the first equity funds in microfinance, investees, AINV held a relatively small stake, meaning that created when MFIs desperately needed equity and the an exit did not entail a strategic shift in ownership of its commercialization of MFIs was just emerging. By design, MFIs. as the portfolio of AINV grew, it came to include a mix of Still, there were complications. AINV held strategic (i.e., established MFIs in South America, younger ones in Cen- larger) stakes in some portfolio companies, while other in- tral America, and recent start-ups in Africa. vestees required more technical support than Bamboo When the fund’s board tasked its managers to present could provide. The solution was to carve out less mature the available exit options, they named a set of principles MFIs in Africa and sell them jointly to Bamboo and Accion that should be followed: any transactions should leave port- International, thus ensuring ongoing support from Accion folio companies with solid shareholding structures, be fair International’s capacity-building operation. Additionally, and transparent and coordinated with co-investors, and as an anchor shareholder of BancoSol in Bolivia, Accion In- provide fund investors with a profitable return. ternational agreed to buy AINV’s interest in that MFI. The managers identified four options for an exit: floating Given AINV’s close relationship with Accion Interna- the company on a small stock market, recapitalizing the tional and Bamboo’s existing stake in the fund, conflicts of fund, selling it whole to a like-minded investor, or selling interest were inevitable. This was recognized early on, and individual MFIs. Among these, a stock flotation seemed of the fund engaged a legal specialist in conflict of interest to limited value—AINV was relatively small and too globally guide management and the board. This meant taking steps diversified. The diversity of the fund also posed a challenge to clearly differentiate buyers from sellers: those AINV di- to finding a single investor that would be interested in all rectors who held roles at Accion International or Bamboo the company’s assets. A case-by-case sale seemed the most recused themselves from all board decisions related to the likely strategy, allowing management to find the right kind sale. of buyer for each MFI or group of MFIs. However, such an While the final negotiations took place among three par- approach posed its own risks—larger, more mature invest- ties—AINV, Bamboo, and Accion International—the num- ments could sell quickly, leaving the fund with smaller, less ber of stakeholders in the transaction was far greater. MFI profitable companies that would be more costly and take boards and management had to be apprised of the plans, longer to sell. Moreover, microfinance is a small, intercon- and regulators in each of the countries were informed of nected world. The process would not stay quiet for long the potential transaction, which also involved engaging lo- and could lead to difficult questions: how would Accion In- cal legal counsel in each of the relevant countries. ternational (AINV’s sponsor) explain its disengagement Completion of the transaction required 18 months as the from Latin American partners, for example? result of cooperation needed from over a dozen institutions Thus, when an AINV shareholder, Bamboo Finance, ex- and their boards, as well as regulators, outside investors, pressed interest in the entire portfolio in June 2011, man- and other microfinance equity funds. 12 B APPENDIX Equitas: Separating Governance from Ownership I n mid-2010, when Aavishkaar-Goodwell was considering children’s education, as well as a commitment to selling part of its stake in the South Indian MFI Equitas, it employ one corporate social responsibility staff for found itself in a rather peculiar position. Aavishkaar- every 10 branches, whose job would be to conduct Goodwell views itself as an early-stage investor, yet here it medical and skill development camps. was contemplating an exit, just two years into its investment as a founding investor. Equitas had grown so quickly that • Financial return ceiling. Equitas capped its ROE at Goodwell was becoming too small to maintain a significant 25 percent and set a minimum capital adequacy of 20 share in the company. Moreover, Equitas’ development was percent (including off-balance sheet transactions). outpacing the type of close advisory and governance involve- Together, these steps limit the financial returns of invest- ment that Goodwell normally seeks to provide portfolio ing in Equitas (though at a rather competitive level), while companies. keeping in place the financial downside of fixed profit alloca- The other peculiar position for Aavishkaar-Goodwell is tions to charitable activities. Meanwhile, by vesting indepen- that its search for an appropriate investor proved perhaps dent directors—themselves selected on the basis of their pro- simpler than it might have been. After all, this was during the fessional independence—with final say over the company’s height of the microcredit bubble, just months before the SKS affairs, Equitas has made it effectively impossible for inves- IPO. Bids from venture capital funds seeking quick gains in tors to alter those original commitments. what was then seen as a quick path to an IPO were easy to While these embedded commitments create a self- come by. But Equitas was different in many ways. selecting pool of potential investors who are comfortable Like most of its peers in microfinance, Equitas was a with such limits, Aavishkaar worked with the Equitas team nonbank financial company (NBFC). What sets it apart are to select the most appropriate buyer from among the bid- some highly unusual governance and social commitments, ders. Their final choice was Canaan Partners, a traditional which are enshrined in the company’s initial Articles of In- U.S.-based venture capital firm focused entirely on finan- corporation: cial returns. • Majority independent board. The board is com- For Canaan, Equitas was in many respects a departure posed of a majority of independent directors, chaired from the norm—it is the only investment in India in which by an independent and nonexecutive director—all of Canaan does not have a board seat, and it is the only one with whom are well-known and accomplished individuals explicit social commitments and an earnings cap. However, with backgrounds mainly in finance and development. in this structure, as well as in the company’s focus on effi- ciency and quality of execution, Canaan saw the prospects of • No controlling shareholder. During the initial sub- solid, but stable returns over the long term—the very oppo- scription round, no shareholder was allowed to own site of the high-return, but also high-risk deals that were tak- more than 15 percent of the company, and the board ing place in other Indian MFIs at the time. can reject any transactions that would result in a stake Clearly, the unusual self-perpetuating governance and of more than 24 percent. mission focus at Equitas did not limit its ability to tap com- mercial capital, but in fact may have helped maintain the • Explicit social commitments. Equitas enshrined company on the kind of stable footing that many of its com- several substantial commitments to its social mission, petitors had lost during the go-go years of Indian microfi- including donating 5 percent of its profits to pay for nance. 13 C APPENDIX KfW: Selling Back to the Holding W ith an equity portfolio amounting to close to point, while continuing to support the latter with addition- US$950 million, KfW may well be the largest single al capital investments as needed. investor in MFIs and small banks. It has also never The decision to exit is based primarily on assessment of fully exited from any of its positions in retail financial service the subsidiary’s sustainability and ability to maintain and providers, with one notable exception: KfW has already com- further develop institutional capacity, while generating pleted seven exits in ProCredit banks around the world. moderate annual growth of 5–10 percent using retained While an important part of its investment strategy, these earnings. The subsidiary must also demonstrate that it ad- seven transactions are in some ways closer to an internal heres to its mission, acts as a market standard-setter, and institutional reorganization of an ownership stake than a promotes healthy (but not excessive) competition. full exit. KfW has a dual interest in ProCredit: as a direct To avoid the potential for conflict of interest of selling to a investor in many ProCredit subsidiaries around the world, related institution in the form of the holding company (and as well as one of the anchor investors in ProCredit Holding. one in which KfW has a major stake), the valuation and pric- Part one of KfW’s strategy involves investing in new Pro- ing is calculated by an external party, and the premium tends Credit subsidiaries and staying closely involved in the retail to be modest. Even after these sales, KfW continues to pro- institution’s governance—an involvement that demands ex- mote a supportive environment in which the subsidiary (and tensive time from KfW’s staff. In response, part two of other market players) can have lasting positive impact, includ- KfW’s strategy aims to rationalize its resources, by selling ing by developing credit bureaus, deposit insurance schemes, the ProCredit subsidiary back to ProCredit Holding at some and other financial sector infrastructure improvements. 14 D APPENDIX Arohan: A Distress Sale I t was spring 2012, and the Hyderabad-based fund manager growth impossible, but Arohan was forced to severely curtail Caspian faced a dilemma. One of its holdings, Arohan Fi- its lending. By spring 2012, Arohan’s portfolio shrank to less nancial Services in Calcutta, was losing money fast. During than half its peak size. the prior 18 months since the start of the crisis in Andhra Expecting the market to recover, Arohan had retained Pradesh, Arohan had shrunk to a third of its peak size, losing most of its staff and branches. When the market failed to nearly half of its equity. stabilize, Arohan had to face substantial losses. Besides As a manager whose two funds owned a combined 55 per- eroding equity, the losses had two additional impacts on cent stake in Arohan, Caspian felt the problem acutely—the Arohan: first, they further exacerbated its liquidity predica- MFI was continuing on a downward spiral and may not have ment, given that banks were even less willing to lend to a survived without an infusion of new equity. To make matters loss-making institution. Second, the losses eroded the value worse, the dominant position—40 percent of Arohan—was of the enterprise, making the exit from Arohan still more held by Bellwether, Caspian’s oldest fund that was set to ma- difficult sell. Arohan faced an additional hurdle: its share of ture in two years. foreign ownership was already near its legal limit of 75 per- The trouble afflicting Arohan was shared by many small- cent. Any investment would thus have to come from local and mid-sized MFIs throughout India. Since the start of the sources—many of whom were already burned by exposure Andhra Pradesh crisis in late 2010, Indian banks, which at to Indian MFIs. the time, constituted the primary source of the sector’s fund- Many rejected the offer—from private equity funds and ing had either turned off or greatly restricted lending to all from other MFIs. But Arohan’s star was not so easily extin- but the largest and most stable MFIs. guished. Intellecap, the investment firm hired by Caspian, The situation at Arohan was especially acute. On the eve was affiliated with Intellecash, which prior to the crisis had of the crisis, Arohan had embarked on a growth surge aimed served as an incubator for aspiring microfinance start-ups, at doubling its portfolio by March 2011, and it had just providing them with the full suite of tools to start and oper- doubled its branches and staff. With the onslaught of the ate an MFI. Intellecash also managed its own small microfi- crisis, bank funding was frozen; not only was portfolio nance operation in an area adjacent to Arohan. At the time Intellecap was seeking out potential Arohan investors, Intellecash had just embarked on a new acquisi- FIGURE AD-1 tion-based strategy. Here was an organization looking for ex- actly the kind of challenge that Arohan presented, and Cost Basis Rises as Portfolio Shrinks through its strong ties to the Aavishkaar-Goodwell fund, it 21.7 could raise sufficient capital to both buy out Bellwether’s 20.2 Loan Portfolio stake and infuse Arohan with the capital it required. Operating expense Intellecash brought more than just capital to the table. Its experience working with many different MFIs made it in many ways the perfect partner in a merger, while its strong ties to the banking community in India was critical when it came to helping pull Arohan out of its liquidity squeeze. The 10.6 heads of both Arohan and Intellecash both had competen- cies and interests that supported a positive partnership. Fi- nally, the financial engineers at Intellecap were able to struc- ture the transaction in a way that greatly reduced Arohan’s foreign-ownership share, thus greatly improving its pros- 3.4 3.3 1.8 pects for future investment. What looked promising at the outset has not disappoint- March 2010 March 2011 March 2012 ed. In the half-year since the merger, Arohan has returned to profitability and has begun to grow. By all accounts, the man- 15 aging team is functioning well—an item of some importance what if there had been no Intellecash? Did Arohan have any when the merger involves the company’s founder. And most other options? importantly, Arohan seems to have succeeded in escaping its Not many. Its existing investors (Bellwether, The Dell liquidity squeeze. Foundation, and Caspian’s other fund, the India Financial However, given that Arohan had no other interested buy- Inclusion Fund) all wanted Arohan to survive and were will- ers besides Intellecash, it is hard not to conclude that the sale ing to pursue a Plan B—an infusion of limited equity, just and its subsequent success owe much to sheer luck. With its enough to keep the organization afloat, but critically, proba- partnerships in capital markets via Intellecap, and its explic- bly not enough to pull it out of its liquidity squeeze. Under it acquisition-focused strategy backed by the Aavishkaar- this scenario, Bellwether would have maintained (but not Goodwell fund, Intellecash was a unique organization that increased) its stake, essentially buying time and hoping that had positioned itself to play the very role it was now under- the India microfinance sector would recover sufficiently to taking in Arohan’s turnaround. sell Arohan in the next two years. But certainly, there were But by all accounts, the offer from Intellecash was unex- no guarantees, and infusing more equity was simply beyond pected by both Caspian and Arohan. So one has to wonder— the capacity of its existing shareholders. 16 E APPENDIX Edyficar: An NGO Selling to a Bank I n summer 2008, the management of CARE was facing a choice: should it sell its single largest asset, Edyfi- FIGURE AE-1 car? A decade earlier, CARE created Edyficar as part of its pov- Edyficar’s Legal Status Reflects on Average erty fighting program in Peru. Now, it was a thriving enter- Loan Size ($) prise, the third largest MFI in Peru, employing a thousand 1,600 staff, serving 180,000 borrowers, and accounting for over 20 Financiera 1,400 percent of all of CARE’s total assets. That same year, Edyficar transitioned from a microenterprise lender (an EDPYME) to 1,200 EDPYME a Financiera (an NBFI), under the Superintendency of Banks. CARE is an NGO focused on fighting poverty around the 1,000 NGO world. While a large part of that includes financial services 800 for the poor—mostly through the promotion of village sav- ings and loan associations (VSLAs)—full-service banking 600 had never been part of CARE’s domain of activities. Yet that’s where Edyficar was heading, and moreover it would not be 400 long before Edyficar would grow to be larger than its parent. 200 It was also clear that the VSLA model, which targeted far poorer rural residents in countries poorer than Peru, was a - 1998 2000 2002 2004 2006 2008 2010 closer match to CARE’s mission than Edyficar was, whose loans at that point were averaging about $1,000 per client. Those same elements that distanced Edyficar from CARE also meant that CARE was increasingly less able to support In time, it had fielded four serious offers, all from local or the MFI on its journey. Further growth meant more capital regional organizations, including banks and other MFIs. and deeper expertise—something CARE would have been Among these, CARE selected Banco de Credito del Peru hard-pressed to come up with. (BCP) as the winning bidder. BCP offered $96 million for By 2008, its management recognized the difficult decision buying out all of Edyficar’s shareholders, representing a P/B they had to make: they would have to sell Edyficar. After some valuation of 2.5 times. This was high by both global and deliberation, they also recognized that a partial sale would country standards, but considering its profitability (30 per- not work—they had to sell the whole thing. Since its transfor- cent average ROE during 2007–2009), the price was in fact mation to a financiera, the evolutionary path for Edyficar was well below that of its peers, which by JP Morgan estimates leading it ever further away from CARE’s core mission (see should be 3.5 times P/B for that ROE level (CGAP and JP Figure AE-1 for a look at Edyficar’s fast-rising average loan Morgan 2011). amount starting in 2008). Selling a partial stake and retaining Nevertheless, from CARE’s perspective, the price was not significant say in governance would simply serve to slow that the driving factor in its decision. Rather, the main reason was evolutionary process, and would serve neither party well. a qualitative one: BCP’s strategy was to keep Edyficar as it As a global NGO with many stakeholders, CARE took a was. During the due diligence period, BCP was especially re- methodical approach to preparing for the sale, seeking inter- spectful of Edyficar’s management and staff, and it commit- nal consensus, including buy-in from Edyficar’s senior man- ted to keep existing branding, management, and the mission agement. It also maintained close consultation with minority all in place. To demonstrate that commitment, BCP agreed to shareholders, as well as with the Banking Superintendency. sign one-year contracts with Edyficar’s most senior execu- Recognizing its own limited knowledge of the process, CARE tives as part of the transaction. retained Morgan Stanley, which had expertise in both merg- As both CARE and Edifycar understood at the time, BCP’s ers and acquisitions and microfinance, along with a strong perspective was guided by a recognition that microfinance ground presence in Peru. was very different from banking. Some years before, BCP had 17 tried and failed to launch its own microfinance operation. chalking up a 44 percent cumulative annual growth rate That experience and its lessons were encapsulated by some- (CAGR) for the three years since the sale. And while this also thing one of BCP’s directors said during the negotiations: “If reflects an increase in average loan size, that’s in many ways we were to try to do what Edyficar did, we would fail.” less a reflection on Edyficar’s new owner, than on the chang- This is not to say that selling to BCP entailed no change. ing market landscape in Peru, where average MFI loan Both parties understood that back-end operations, IT sys- amounts exceed those of Edyficar. Deposits have also ex- tems, regulatory reporting, and other relevant services would panded enormously, from $30 million at the time of sale to be either merged or leveraged in some way. And as one of the over $500 million now, though this consists almost exclu- leading banks in Peru, BCP could also unlock access to the sively of very large private and institutional accounts, aver- capital markets as well as its own balance sheet. In short, aging $300,000. Savings products for Edyficar’s microfi- BCP would be the partner that could fulfill the potential nance clients have not yet been rolled out. Edyficar had gained by becoming a financiera, and do so Edyficar today is far from the organization that CARE without undermining Edyficar’s internal ethos. founded 15 years ago. It has charted its own path, and BCP These expectations have largely proved correct. Edyficar has proven the right partner to join it for the past three years continues to be led by the same general manager as before, and walk with it into the future. Meanwhile, CARE was able and it continues to focus on microenterprise lending. It has to put the proceeds to work combating poverty both in Peru also continued on its rapid growth path, with the portfolio and around the world. 18 F APPENDIX Sathapana: A Multi-Stakeholder Exit S athapana is in many ways the quintessential MFI story. Founded in 1995 as an NGO focused on providing FIGURE AF-1 health and education services to the poor of Cambodia, it quickly found its way to microfinance. During the early Growing MFI in a Growing Market 2000s, it was supported by GTZ and the World Bank. In 160 8.0% 2003 it had transformed into a commercial enterprise and 140 7.0% established a credit relationship with Triodos Investment Management and Blue Orchard. The original shareholders 120 6.0% included the founding NGO and the staff association. In 2004, it received its first equity investment—from Shore- 100 5.0% Market Share (%) Cap—and in 2006, welcomed FMO and Triodos-Doen8 as 80 4.0% additional equity investors. In 2009, it received a nonbanking deposit license and saw 60 3.0% Assets ($ mln) its first equity sale, when Developing World Markets (DWM) bought ShoreCap’s stake. By 2012, the MFI had assets of $150 40 2.0% million, deposits of $67 million, and a CAGR that averaged 51 20 1.0% percent over the 12 years since 2000. ROE since its first com- mercial investment from ShoreCap averaged 25 percent. 0 0.0% Since about 2008, Sathapana held the position of the 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 fourth largest MFI in the country, with a market share of about 5 percent. However, in many ways, Sathapana stood apart from the field. Its focus had been shifting toward the SME sector, and by 2011, over 25 percent of its portfolio was FIGURE AF-2 in SME loans, averaging $8000—nearly 10 times the sector average. Average Loan Amounts (USD) In 2012 the shareholders approved a new strategic plan 2000 that envisioned transforming Sathapana into a commercial Avg Sathapana Loan 1,779 bank, broadening its products and services, and positioning it Microcredit $1,282 for a potential regional expansion. The plan also entailed a sig- SME $8,001 nificant capital increase, with a further equity infusion envi- 1500 Sathapana sioned within a few years. FMO and Triodos had been hands- on investors: both held board seats, were actively engaged in governance, and supported training programs. However, it 1000 857 had now been six years since their investment, and Sathapana had reached a new level of maturity in terms of performance, footprint in the market, risk management, and governance. 500 Cambodia MFIs They considered the timing appropriate for an exit for these reasons as well as their desire to reduce their Cambodia expo- sure (both also held stakes in other Cambodian MFIs). In light 0 of Sathapana’s new strategy, the time was ripe to bring in a 2001 2003 2005 2007 2009 2011 new strategic shareholder that shared Sathapana’s vision and had the resources and capacity to help implement it.  riodos-Doen Foundation (Triodos Doen) was launched in 1994 by the DOEN Foundation and Triodos Bank. Since December 2013 it has been operating 8. T as Triodos Sustainable Finance Foundation, under the exclusive management of Triodos Investment Management and without active involvement of the DOEN Foundation. 19 When FMO and Triodos decided to sell, they informed action and the buyer.10 The selection criteria for the bidders Sathapana’s other shareholders, senior management, and the focused on three key areas: strategic fit with Sathapana and board of their decision. In these discussions, it became ap- its mission, financial capacity, and a competitive price. parent that the sale would have to be done on a cooperative The auction was competitive, attracting local, regional, basis—FMO and Triodos together held 40 percent of Sath- and international institutions. Ultimately, the sellers selected apana, in other words, a major but noncontrolling stake. Maruhan Japan Bank (MJB), a local commercial bank estab- However, selling a controlling stake could yield significantly lished in 2008 that was already lending to multiple Cambo- more interest and potentially a better price from the type of dian MFIs, including Sathapana. In addition to offering the strategic investor they were seeking. The other sharehold- highest bid, MJB also had a regional growth strategy aligned ers—including DWM, which owned the largest stake (35 per- with Sathapana’s—both saw Cambodia as a home base for cent)—also held tagalong rights, which gave them the right what would ultimately be broader operations in Southeast to sell their shares alongside those of FMO and Triodos. The Asia. Because MJB had only a single branch and no overlap sellers thus had to seek a buyer willing to buy these addi- with Sathapana’s client base, integrating operations was also tional shares. not a significant factor. Plus, MJB was favored by Sathapana’s For the tagalong shareholders, the sale was a significant management, whom the buyer sought to retain by extending opportunity. Although DWM had only recently invested in employment contracts with the CEO and his key staff. Sathapana, it recognized that joining in a strategic sale would However, along with its strong strategic fit, MJB also likely produce a better outcome than retaining its shares. Be- posed a dilemma: in addition to owning banks across the sides providing a higher price, the bid also met DWM’s stra- ASEAN region, MJB’s parent company, Maruhan Corpora- tegic objective to develop deeper links among its partner tion, operates a large number of slot machine-type parlors MFIs and the broader financial systems within which they (Pachinko) across Japan.11 To resolve this dilemma, the sell- operate. For the staff association, comprised mainly of mid- ers asked for special assurance—a request to the parent com- dle- and lower-middle-income Cambodians, this was an un- pany for a specific undertaking that the scope of its Cambo- usual opportunity to monetize their shares, and the share- dian operations would remain limited to the banking sector. holders, through their M&A adviser, sought to make sure the This helped separate the positive aspects of MJB from the staff association was fully informed about the consequences concerns posed by its owner’s gaming business. As social in- of joining the sale or retaining their shares. Finally, for the vestors, the sellers wanted to ensure that Sathapana’s social founding NGO the sale presented an opportunity to mone- and developmental mission would continue following the tize part of its stake, while retaining a voice in post-sale gov- sale. To that end, they led the amendment of the MFI’s char- ernance. ter (to which MJB became a signatory) to clearly spell out its However, the presence of tagalong rights had conse- commitment to provide financial services to the poor. In ad- quences. DWM and its tagalong partners had the flexibility dition, MJB agreed to accommodate the founding NGO’s re- of participating (or not) in the sale, but with fewer obliga- quest to sell only half of its shares while contracting options tions than FMO and Triodos, which had initiated the process to exercise the remainder at a later time. This allowed the and were ultimately responsible for carrying out the deal. NGO to retain its board seat, through which it could help Over the course of the transaction, this mix of different rights maintain Sathapana’s mission focus after the sale. and responsibilities increased the complexity of the process. The offer from MJB also met the expectations of the tag- In view of this complex and intensive process, FMO and along shareholders, all of whom joined the sale. Though Triodos engaged ShoreBank International (SBI)9 as the these tagalong rights divided the shareholders and may have M&A adviser right from the beginning. In addition, Sathapa- complicated the process, they did not change what ultimate- na’s CEO was actively involved, providing input on the initial ly was a positive outcome for all. In the end, MJB acquired list of potential investors who had already demonstrated in- 95.1 percent of Sathapana’s shares, with the remaining 4.9 terest (this included the winning bidder) and facilitated percent retained by the founding NGO. With this, Sathapana close communication with the National Bank of Cambodia, had closed its social investor chapter, setting forth on a new which had to provide regulatory approval for both the trans- path. 9. SBI was a part of the ShoreBank group to which Sathapana’s earlier investor, ShoreCap, had belonged, and thus were also well-acquainted with Sath- apana and the Cambodia market. As of October 2013, SBI is operating as Enclude. The transaction faced greater regulatory scrutiny because the buyer was deemed influential according to Cambodian law, meaning it would own more 10.  than 20 percent of the financial institution. Such investors face greater obligations toward the regulator, which may enjoin influential shareholders to increase the company’s capital until solvency standards are met. While gambling is illegal in Japan, Pachinko is not, in part because it can be also used as a recreational arcade game. Historically, Pachinko has been a 11.  widely accepted activity in the country. 20 G APPENDIX Focus Group on Social vs. Financial Return The following scenario was presented to a group of inves- One of the MFI’s goals is to broaden its loan offerings tors. Participants, all representatives of microfinance equity (currently 93 percent of its portfolio is in microenterprise funds, were divided into four groups and asked to choose loans, 4 percent in housing, and 3 percent in emergency which offer they would accept. Three groups chose the local loans). On the savings side, it has set a goal of depositors sur- commercial bank, even though two of them recognized that passing borrowers in three years and deposits reaching 70 the holding company held out higher social return (one in- percent of loan portfolio. However, it has had trouble keep- vestor described the choice as “going with my mind, not my ing deposit accounts active (40 percent of the deposit ac- heart”). One group chose the holding company, citing mis- counts have negligible balances; two-thirds of deposits come sion alignment as the reason. No investors chose the private from the largest 500 accounts, averaging $20,000 each). The equity investor as a viable option, due to its lack of fit with MFI needs an additional $10 million in equity to continue its the MFI’s mission, though some did mention that it was a growth. painful choice, given that they were giving up substantially Five years ago, the fund you manage invested $3.2 million higher financial returns. in this MFI, which at the time was just two years old (your original 40 percent share has since been diluted to 30 per- Consider the following scenario cent). Since the beginning, you’ve played a leading role in You are a 30 percent shareholder in an MFI that you in- governance and were the driver behind the MFI’s transfor- vested in five years ago. Now, it has a $90 million portfolio and mation into a bank and its push for savings. Another three almost 90,000 borrowers. Two years ago it acquired a banking smaller investors (combined 50 percent stake) have indicat- license, and now has 30,000 deposit accounts at $15 million ed that they would probably sell together with you, thus a total raised. The remaining 70 percent of the MFI’s portfolio is total of 80 percent could be sold (the rest is mostly manage- funded via debt, mostly from foreign sources. For the past five ment shares, some local wealthy investors, and a stake in an years, the MFI has been growing at 30 percent CAGR. employee stock ownership plan). The offers Local commercial bank Holding company Private equity investor Background Background Background The third largest bank in the country, seeking A moderate-size holding company with six Foreign private equity fund active in the to expand its down-market presence. It has MFIs in its portfolio, mostly in the same region. Has made several recent investments previously tried to build its own microfinance region. It has developed an especially strong in consumer finance companies in nearby lending program, which was unsuccessful. savings methodology (five of its MFIs have countries. Most of its investments are resold more savers than borrowers, and portfolios in 3–4 years. mostly funded by deposits). Deposits average The bank would like to keep MFI operations $400–600. Other finance companies have sought separate, integrating only main back office partnerships with large household retailers. functions and MIS. It agrees to sign a one-year The holding company wants to keep the Also offers short-term loans to wage-earners contract with current management. CEO (who holds the holding company in high (payday loans), at prices slightly above MFI regard). It will bring two of its savings experts rates for comparable products. to align the MFI’s savings program to its methodology. Offers management significant options as part of the deal. Management is interested. Continued 21 Local commercial bank Holding company Private equity investor Social Mission Social Mission Social Mission No explicit mission, but regulator (Central Primary mission to expand savings and credit No social mission. Bank) is well-run and includes requirements services to the poor. Focus less on microen- such as standard pricing disclosure and has terprise lending and more on financial inclu- Regulator (Central Bank) is well-run and in- expressed concerns about avoiding market sion, including low-income wage-earners. cludes requirements such as standard pricing overheating. Loan portfolios of other MFIs include up to disclosure and has expressed concerns about 10 percent in housing loans and as high as 25 avoiding market overheating. It’s clear the bank is mostly interested in percent in consumption loans. growing the high-yield MFI portfolio, though larger clients will be able to access the bank’s Has engaged a rating agency to conduct broader offerings. It has a broad ATM net- Smart Certification for one of its MFIs. Plans work and money transfer service, but has very to roll out to others in time. Partners with few deposit accounts below $500. research institutions to evaluate its level and quality of outreach, but largely uninterested in client impact analysis. Price Price Price $13.9 million, or 2.1 P/B. Extends same offer $10.6 million, or 1.6 P/B. Prefers to buy just $17.8 million, or 2.7 P/B. Extends same offer to the other investors, conditional upon your your stake, plus $10 million in fresh shares. to the other investors, conditional upon your sale. Agreed to sign a three-year buy-out option sale. with other investors, who are comfortable with offer. Which one will you accept and why? 22 H APPENDIX List of Interviewees Name Organization Name Organization Sushma Kaushik Aavishkaar Dina Pons Incofin IM Mary Chaffin Accion Anurag Agrawal Intellecap John Fischer Manoj Nambiar IntelleCash Microfinance Net- Anne-Marie Chidzero Africap Microfinance Fund work Company Marcus Fedder Agora Microfinance David Munnich Investisseurs & Partenaires Anne Contreras Arendt & Medernach Matthias Adler KfW Shubhankar Sengupta Arohan Martin Hagen Ximena Escobar de Nogales Bamboo Finance Ira Lieberman LIPAM International, Inc. Xavier Pierluca Kaspar Wansleben Luxembourg Microfinance Development Fund (LMDF) Melchior de Muralt BlueOrchard Geeta Goel Michael & Susan Dell Alok Mittal Canaan Partners Foundation Laté Lawson CARE Doug Young MicroVest Peter Buijs Fernando Campero MIF Vishal Bharat Caspian Advisors Private Limited Stefan Harpe Oikocredit Fernanda Lima Developing World Markets Frank Rubio Brad Swanson Alex Silva Omitrix Ana Maria Zegarra Edifycar Jean-Gabriel Dayre Proparco Edvardas Bumsteinas EIB Elodie Parent Laurie Spengler Enclude (formerly ShoreBank Michael Fiebig responsAbility International) Ian Callaghan Henry Gonzalez Jesse Fripp Mildred Callear SEAF PN Vasudevan Equitas Frank Streppel Triodos Arno de Vette FMO Mark van Doesburgh Triple Jump Els Boerhof Goodwell Investments Luis Guerra Paul DiLeo Grassroots Capital Management Judith Mayer University of Munich Martin Holtmann IFC CJ Juhasz WWB Asset Management 23 I APPENDIX Sources CGAP. 2012. “CGAP Funder Survey.” Washington, D.C.: McKee, Katharine. 2012. “Voting the Double Bottom Line: CGAP. Active Governance by Microfinance Equity Investors.” Earne, Julie, Tor Jansson, Antonique Koning, and Mark Focus Note 79. Washington, D.C.: CGAP. Flamming. 2014. “Greenfield MFIs in Sub-Saharan MicroRate. 2007. “Microfinance Investment Vehicle Africa: A Business Model for Advancing Access to Survey.” Washington, D.C.: MicroRate. Finance.” Forum 8. Washington, D.C.: CGAP and IFC. ———. 2012. “Microfinance Investment Vehicle Survey.” El-Zoghbi, Mayada, and Kate Lauer. 2013. “Facilitating Washington, D.C.: MicroRate. Market Development to Advance Financial Inclusion.” O’Donohue, Nick, et al. 2010. “All Eyes on Microfinance Asset Focus Note 89. Washington, D.C.: CGAP, October. Quality: Microfinance Global Valuation Survey.” Occasion- Glisovic, Jasmina, Henry Gonzalez, Yasemin Saltuk, and al Paper 16. Washington, D.C.: CGAP and J.P. Morgan. Frederic Rozeira de Mariz. 2012. “Volume Growth and Rhyne, Elisabeth, et al. 2009. “Aligning Interests: Address- Value Contraction: Global Microfinance Equity Valua- ing Management and Stakeholder Incentives during tion Survey 2012.” Forum 3. Washington, D.C.: CGAP Microfinance Institution Transformations.” Toronto: and J. P. Morgan. Calmeadow Foundation. Marulanda, Beatriz, Lizabeth Fajury, Mariana Paredes, and Rozas, Daniel. 2011. “Weathering the Storm: Hazards, Frank Gomez. 2010. “Failures in Microfinance: Lessons Beacons, and Life Rafts.” Washington, D.C.: Center for Learned.” Toronto: Calmeadow Foundation. Financial Inclusion at Accion. 24