Daniel Rozas

Sam Mendelson

Blog Post

The following post was <a href="https://nextbillion.net/caveat-venditor-a-new-model-for-buyer-selection-in-responsible-microfinance-equity-exits/">originally published</a> on NextBillion.

<img class="wp-image-25527 alignleft" style="border: 0 solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2018/05/architecture-door-entrance-277552.jpg" alt="" width="615" height="461" />For most, socially responsible investing means just that – investing in a manner that not only generates financial returns but also produces positive social value. But what does it mean for an investor to be “responsible” when selling their holdings? How does one stay responsible at the very moment when one ceases to be an investor?

This is a basic challenge facing investors seeking to “exit,” i.e. sell their equity stakes to a new buyer. The issue isn’t entirely new. It first emerged in the mid-2010s, when several microfinance investment vehicles (MIVs) were starting to reach the end of their 10-year terms and were seeking to divest their assets. This issue was first addressed in the financial inclusion sector by a <a href="http://documents.worldbank.org/curated/en/914731468154465262/pdf/805400NWP0CGAP00Box385295B00PUBLIC0.pdf" target="_blank" rel="noopener">2014 paper</a> commissioned by CGAP and CFI, which first defined many of the key questions that socially responsible investors need to address when selling their equity stakes.

With another four years of multiple exits under the sector’s belt, <a href="http://www.inclusivefinanceplatform.nl/home" target="_blank" rel="noopener">NpM, Netherlands Platform for Inclusive Finance</a>, along with the <a href="https://fiecouncil.com/" target="_blank" rel="noopener">Financial Inclusion Equity Council</a> (FIEC) and the <a href="http://www.e-mfp.eu/" target="_blank" rel="noopener">European Microfinance Platform (e-MFP)</a> asked us to take a closer look at one particularly tricky part of the exit process – selecting a buyer that is suitable for the microfinance institution (MFI), its staff and ultimately its clients. The result is <a href="http://www.e-mfp.eu/sites/default/files/resources/2018/04/Buyer%20Selection%20in%20Responsible%20Microfinance%20Exits.pdf" target="_blank" rel="noopener">Caveat Venditor: Towards a Conceptual Framework for Buyer Selection in Responsible Microfinance Exits </a>– a new paper that goes beyond raising questions, and seeks to provide a template to help investors navigate the complex terrain of “responsible exits.”

The research – an investor survey, several in-depth interviews and a workshop during <a href="http://www.european-microfinance-week.eu/2017/" target="_blank" rel="noopener">European Microfinance Week</a> – found a mix of approaches applied by different investors. But these nevertheless shared many common elements aimed at making sure that the buyer will honor and pursue the social mission of the institution being sold. We consolidated these elements into a “Conceptual Framework for Buyer Selection” – a flowchart representation (plus explanatory notes) of the steps and criteria inherent in responsible buyer selection in microfinance equity exits.

<img class="aligncenter wp-image-25535" src="https://centerforfinancialinclusionblog.files.wordpress.com/2018/05/table.png" alt="" width="615" height="797" />

Overall, the consensus among investors was that social responsibility in the context of an exit largely means excluding those potential buyers who are deemed unsuitable and then applying the financial offer (how much a buyer is willing to pay) to select among those remaining. But that exclusionary process is driven by exceptionalism, i.e. buyers have to be obviously unsuitable to be eliminated from consideration, and such exclusions tend to be rare, based on factors like unclear ownership of the buyer, inability to trace the source of the buyer’s funds or suspicion of the buyer’s motives. And because such cases are rare, what this means in practice is that the financial offer is the dominant factor in the decision, much as in the world of purely commercial investors. We refer to this by a term borrowed from medicine, the First, Do No Harm principle.

However, there was an important dissenting view among some investors, which holds that the Do No Harm exclusionary criteria are insufficient for a social investor. After all, a commitment to a social mission is a positive one; it must do good, and not simply avoid doing harm. In effect, this view seeks to invert the process, first deciding whether the financial offer meets the selling investor’s predefined financial objectives, then considering its value to the institution’s social mission. That value need not be strictly mission-driven, nor is there any expectation that the ideal buyers are socially motivated NGOs. Rather, the question is of organizational fit. Extending the <a href="https://medical-dictionary.thefreedictionary.com/best+interest+standard" target="_blank" rel="noopener">medical analogy</a> somewhat, we call this the Best Interests approach. We believe that this model, with its positive obligation on the seller(s), is better aligned with pursuing a social mission while delivering a reasonable financial return – which is at the core of the social investment value proposition.

The framework consolidates the practices of different investors we spoke to but also advocates an evaluation process that moves beyond Do No Harm toward Best Interests while incorporating elements of both. It is structured so that questions are organized based on the type of transaction being contemplated: a minority or majority stake being sold, as part of a consortium of shareholders, or by a single investor.

The framework is not designed to be – nor could it be – one-size-fits-all: Each exit is dependent on the investee’s mission and the context in which it operates, as well as the seller’s own objectives. The framework should be thought of as providing a rubric that each seller can expand upon themselves. It can be thought of as a three-stage process:
<ol>
 	<li>Are there exclusionary factors that mean the potential buyer is manifestly unsuitable; and, if not, is there any reason to believe that regulatory approval for the purchase would be difficult or unlikely?</li>
 	<li>If not, is the initial, indicative financial offer within a predefined range that is acceptable to the seller(s) based on the overall double-bottom line objectives of the fund?</li>
 	<li>If so, how does the proposed buyer, and its strategic objectives for the MFI, align with the social mission and the other best interests of the MFI?</li>
</ol>
We believe that the responsibility of finding the right buyer lies very much with those doing the selling. And if the sale means handing over control – a majority stake – this creates an even greater burden. As we argue in the conclusion, “A buyer selection practice which gives primacy to the financial offer and considers social mission and strategic value to the investee – the investee’s best interests – only to reject egregiously unsuitable buyers, fails to keep in mind that the best interests of the MFI and its clients are, for the investors who put funds into the MIV, arguably the primary reason for investing in the financial inclusion sector in the first place.”

We hope this framework will serve as a resource for investors embarking on an equity sale. We hope it could also: help investors to brief external organizations that assist them in exit trajectories (investment banks, advisory firms, etc.); assist new categories of impact investors that have little experience in exits; and serve as a guide to potential buyers to help understand selection criteria and prevent interested (but unsuitable) buyers from wasting time on a futile due diligence process. We hope too that it will inspire further work on an issue which, as equity sales continue to grow, will only increase in importance.

<a href="https://nextbillion.net/authors/daniel-rozas/" target="_blank" rel="noopener">Daniel Rozas</a> and <a href="https://nextbillion.net/authors/sam-mendelson/" target="_blank" rel="noopener">Sam Mendelson</a> are co-authors of the joint NpM/e-MFP/FIEC research project on buyer selection in responsible exits.

Photos courtesy of <a href="https://www.pexels.com/photo/architecture-door-entrance-exit-277552/" target="_blank" rel="noopener">Pexels</a> and Braden Hopkins via <a href="https://unsplash.com/photos/4WJcte5CByc" target="_blank" rel="noopener">Unsplash</a> 

Have you read?

<a href="https://cfi-blog.org/2018/03/12/solving-the-puzzle-of-responsible-exits-in-impact-investing/">Solving the Puzzle of Responsible Exits in Impact Investments</a>

<a href="https://cfi-blog.org/2017/03/17/whats-responsible-about-impact-investing-exits/">What’s “Responsible” about Impact Investing Exits?</a>

<a href="https://cfi-blog.org/2013/03/20/four-challenges-for-impact-investing/" target="_blank" rel="noopener">Four Challenges for Impact Investing</a>

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Caveat Venditor: A New Model for Buyer Selection in Responsible Microfinance Equity Exits

Caveat Venditor focuses on one particularly tricky part of the exit process – selecting a buyer that is suitable for the microfinance institution, its staff and ultimately its clients.

Report

Caveat Venditor: Towards a Conceptual Framework for Buyer Selection in Responsible Microfinance Exits goes beyond raising questions, and seeks to provide a template to help investors navigate the complex terrain of “responsible exits.” The paper is co-authored by Daniel Rozas and Sam Mendelson and is part of a joint research project on buyer selection in responsible exits of <a href="http://www.inclusivefinanceplatform.nl/home">NpM, Netherlands Platform for Inclusive Finance</a>, along with the Financial Inclusion Equity Council (FIEC) and the <a href="http://www.e-mfp.eu/">European Microfinance Platform</a> (e-MFP). Caveat Venditor focuses on one particularly tricky part of the exit process – selecting a buyer that is suitable for the microfinance institution (MFI), its staff and ultimately its clients.

With the growing maturity of the microfinance industry, 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) – and, increasingly, the broader category of financial service providers (FSPs) and other companies working in financial inclusion – in which they have invested.

Leveraging an industry consultation process, Daniel and Sam have consolidated investors’ own emerging principles and procedures in assessing potential buyers, and used the findings to produce a Conceptual Framework for Buyer Selection in financial inclusion equity exits. This framework serves as a resource for investors embarking on an equity sale, providing them with a concrete, industry-recognized framework to evaluate an exit. Additionally, it can:
<ul>
 	<li>Guide investor discussions with external organizations that assist them in exit trajectories (investment banks, advisory firms, etc.);</li>
 	<li>Assist new categories of impact investors that have little experience in exits; and</li>
 	<li>Serve as a guide to potential buyers to help understand selection criteria and prevent interested (but unsuitable) buyers from spending time on a futile due diligence process.</li>
</ul>
During the course of the research, a majority practice and opinion emerged (what we call the First, Do No Harm consensus), alongside dissenting voices that argue for an inversion (what we call, continuing the medical analogy, the Best Interests approach) of some of the processes and presumptions of this majority perspective. As a result, we have moved beyond just reporting what existing industry practice is, to incorporate in the output of this paper - the Conceptual Framework for Buyer Section – not only what is commonplace, but also what industry practice could – and perhaps should – look like.

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Caveat Venditor: Towards a Conceptual Framework for Buyer Selection in Responsible Microfinance Exits

The words “offshore” and “tax-haven” are often taboo rhetoric within the investment space. In this paper, the Financial Inclusion Equity Council (FIEC), with support from CFI, explores why and how equity impact investors use offshore vehicles. Our findings reveal that offshore vehicles offer key operational, legal, tax and reputational advantages and are a key part of the impact investment landscape.

Through interviews with Financial Inclusion Equity Council (FIEC) members, we sought to better understand the scope of offshore usage in financial inclusion and the factors at play when impact investors select a fund domicile. Convenience, transparency and reputational advantages are among the strongest drivers for choosing to offshore. However, divergent views exist among FIEC members regarding the tax implications of offshore vehicles.
<h3>Major Findings</h3>
<ul>
 	<li>Impact investors have legitimate reasons for using offshore financial centers (OFCs)—and tax status is not the driving factor. The main factors for choosing OFCs include:
<ul>
 	<li>Administrative Efficiency: OFCs have the legal, financial and administrative infrastructure in place to facilitate investment.</li>
 	<li>Human Capital: Accordingly, OFCs have specialized staff on hand to manage investments, such as lawyers, accountants and auditors.</li>
 	<li>Reputation: OFCs are reputable vehicles in international investing, which helps to validate their use for financial inclusion.</li>
 	<li>Convenience: OFCs may serve as a neutral base for multiple investors. Favorable time zones, shared language and currency also add to their accessibility.</li>
</ul>
</li>
 	<li>Two divergent perspectives exist between North American and European investors regarding the tax implications of OFCs. The North American perspective prioritizes tax minimization for shareholders/investors, while the European perspective prioritizes paying their fair share of taxes to the offshore country.</li>
</ul>
Challenge your assumptions about offshore funds and learn more about how these financial instruments contribute to financial inclusion.


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Offshore Financial Centers for Financial Inclusion

&gt; Posted by Daniel Rozas, Independent Microfinance Consultant

The following post was <a href="http://www.phnompenhpost.com/analysis-and-op-ed/interest-rate-cap-will-hurt-rural-families">originally published</a> in The Phnom Penh Post.

On March 13, the National Bank of Cambodia announced a major new policy. Starting April 1, all microfinance institutions operating in Cambodia will be required to lend at interest rates no higher than 18 percent per year. This is a deeply misguided regulation that will undo over a decade’s worth of successful financial policies.

At the dawn of this century, Cambodia’s financial sector was largely nonexistent. There were no ATMs, few bank branches, and equally few customers. In rural areas, there were no banks at all, and moneylenders held a monopoly on lending.

How times have changed!

Today’s village household has far greater control over its finances and is deeply connected to Cambodia’s growing economy. A farmer can borrow from a microfinance lender to buy seeds and fertilizer and set aside savings to help pay for his kids’ school fees. He can finance a solar panel to charge the phone that lets the family stay in touch with older children in the city, who themselves can send money home to the parents cheaply and reliably. None of this even requires the three-hour trip to town – a loan officer from a microfinance institution visits the village each week, while the village shopkeeper doubles as a microfinance agent who can send and receive payments. This picture is repeated in house after house, village after village, from the outskirts of Phnom Penh to the remotest corners of Cambodia. Today, in rural areas alone, half a million clients hold savings at microfinance institutions, and over a million borrow from them.

The new regulation puts all that under threat.

Interest rate caps are a type of price control. Like all price controls, they have a predictable effect – if something can’t be sold at a profit, it won’t be sold at all. If there’s any doubt, just take a look at the empty store shelves in Venezuela, where price controls have created a major food shortage. After all, even the most socially-oriented business has to cover its costs.

The results in Cambodia won’t be empty shelves, but it will mean fewer and more costly financial services for the very people the law is intended to help – the rural poor. To understand why, consider two loans: one for $500 and one for $5,000.

To read the rest, visit <a href="http://www.phnompenhpost.com/analysis-and-op-ed/interest-rate-cap-will-hurt-rural-families">The Phnom Penh Post</a>.

Daniel Rozas is an independent microfinance consultant based in Brussels.

Have you read?

<a href="https://cfi-blog.org/2017/02/23/new-interactive-website-exploring-the-client-protection-journey-in-cambodia-and-morocco/">New Interactive Website: Exploring the Client Protection in Cambodia and Morocco</a>

<a href="https://cfi-blog.org/2015/10/20/getting-to-scale-with-housing-finance-innovation-in-cambodia/">Getting to Scale with Housing Finance Innovation in Cambodia</a>

<a href="https://cfi-blog.org/2016/03/30/interest-rate-caps-in-nigeria-may-not-be-good-for-clients/">Interest Rate Caps in Nigeria May Not Be Good for Clients</a>

Interest Rate Cap Will Hurt Rural Families

David Lascelles

This year's report, entitled Facing Reality, refers to the fundamental structural changes that are taking place in the industry, including the diversity of providers, the struggle to achieve sustainable growth, overindebtedness concerns, and more.

The Centre for the Study of Financial Innovation's (CSFI) latest Microfinance Banana Skins report, Facing Reality, charts the risk perceptions of more than 300 practitioners and close observers of the microfinance scene in 70 countries. Two-thirds ranked overindebtedness as their top concern – a persistent issue given that it was also the top concern in the Banana Skins 2012 Survey.

The survey also reveals strong concern about the ability of microfinance providers to meet the strategic challenges facing the industry in areas such as client management, new products and technological change.

Although the extent to which micro-borrowers face repayment difficulties is not known, many respondents said the problem was growing and that it posed both a financial and a reputational risk to the industry.

Respondents' comments showed that overindebtedness is seen as a symptom of deeper weaknesses in the industry, for example in micro-lenders' governance and management, internal controls, and awareness of clients’ financial needs and capacities. Seven of the top 10 risks identified by the survey relate to the ability of microfinance institutions (MFIs) to manage a sound and growing business.

One of the main drivers of overindebtedness is seen to be competition (No. 3) which is alleged to be driving down lending and ethical standards in the micro-loan business. Although the risk of political interference in the industry is easing (down from No. 5 to No. 7), reflecting the cooling of controversy about the industry in countries such as India, respondents warned that it could rebound.

The other major area of concern flagged by the survey lies in strategic planning. With strategic risk at a high No. 6 position, respondents said that insufficient thought was being given by the industry to its future at a time when major changes were taking place in its market, through new entrants, technological innovation and calls for new products.

Many potential risk areas such as client relationships, products and technology management were seen as having little urgency, particularly by the industry itself. The Banana Skins report says this suggests that these risks are being underestimated "which is itself a risk". It adds that these are among the realities "which need to be faced" if the industry is to get to grips with its future.

Microfinance Banana Skins 2014 was prepared by CSFI, an independent London think tank, and was funded by the Citi Foundation and the Center for Financial Inclusion at Accion. The 80-page report provides a commentary on each of the 19 risks that are identified in the survey, and breaks down responses by type and region, providing detailed views of the concerns by geography and different classes of respondent.

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Daniel Rozas

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