The following post, which was <a href="http://nextbillion.net/a-tale-of-four-ipos-is-public-investment-in-microfinance-becoming-ok-again/">originally published</a> on NextBillion, shares a conversation between Anna Kanze, COO of Grassroots Capital Management, and Daniel Rozas, Independent Consultant, on initial public offerings (IPOs) in microfinance. Both Anna and Daniel have contributed to a number of <a href="http://fiecouncil.com/">Financial Inclusion Equity Council</a> (FIEC) publications.  Anna was the principal author of the recent FIEC report, “<a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/776-how-to-ipo-successfully-and-responsibly-lessons-from-indian-financial-inclusion-institutions">How to IPO Successfully and Responsibly: Lessons From Indian Financial Inclusion Institutions</a>”. The podcast draws from the report's findings and focuses on the effects of IPOs on Equitas Holdings, Ujjivan Financial Services, SKS Microfinance, and Compartamos.

The IPOs of <a href="http://www.cgap.org/publications/cgap-reflections-compartamos-initial-public-offering" target="_blank" rel="noopener">Compartamos</a> in Mexico and <a href="http://www.cgap.org/publications/indian-microfinance-goes-public-sks-initial-public-offering" target="_blank" rel="noopener">SKS Microfinance</a> in India, in 2007 and 2010 respectively, made a lot of money for investors and turbocharged the sector’s growth. But they also sparked <a href="http://www.mftransparency.org/what-do-ipos-bring-to-microfinance/" target="_blank" rel="noopener">hyper commercialization</a> and <a href="http://finance.yahoo.com/news/ap-impact-lenders-own-probe-080122405.html" target="_blank" rel="noopener">debt crises</a> that rocked the industry, gravely harming its clients and tarnishing its public image.

But last year, two Indian MFIs, Equitas Holdings and Ujjivan Financial Services, had successful IPOs that have garnered a <a href="http://nextbillion.net/behind-the-most-successful-microfinance-ipo-in-indias-history-what-does-gender-lens-investing-have-to-do-with-it/" target="_blank" rel="noopener">much more positive reception</a> in the financial inclusion community – while also bringing in some major funding. We spoke with Daniel Rozas of the <a href="http://www.e-mfp.eu/" target="_blank" rel="noopener">European Microfinance Platform</a> and Anna Kanze of <a href="http://www.grassrootscap.com/" target="_blank" rel="noopener">Grassroots Capital Management</a> about how these four offerings differed, and what these differences could mean for the future of public investment in microfinance. You can listen to the interview in the podcast below, and the excerpts below give a sense of the conversation. And on Monday, Jan. 30, we’ll be discussing these topics in more depth in <a href="http://nextbillion.net/save-the-date-for-nextbillions-1st-ever-twitter-chat-the-subject-ipos-in-microfinance-1000-am-est-on-jan-30/" target="_blank" rel="noopener">NextBillion’s first Twitter chat</a>, featuring Kanze, Rozas and <a href="https://www.mftransparency.org/" target="_blank" rel="noopener">Microfinance Transparency</a> founder Chuck Waterfield – join us at 10:00 AM EST at <a href="https://twitter.com/search?f=tweets&amp;q=%23MFICHAT&amp;src=typd" target="_blank" rel="noopener">#MFICHAT</a>.

According to Kanze and Rozas, the first big difference between the two sets of IPOs was their motivation. As Rozas described it, one of the explicit goals of these early IPOs was based more on public relations and industry-wide strategy than on business need: to demonstrate the attractiveness of microfinance as an investment. “Yes, they needed capital to grow, and yes, they were of the size at which point an IPO was a logical way to get that capital. But in the case of Compartamos, if I remember right, I don’t believe they were actually raising any capital at all. It was just a vehicle for existing investors to exit and sell their shares. In the case of SKS, they were both raising capital and providing an exit for existing investors. And a lot of this was framed in the way of bringing the commercial market to microfinance, and saying this was a major milestone in the development of the sector.” On that count, he said, the IPOs were a success. “If you look at microfinance in Mexico after the Compartamos IPO, it exploded. There were lot of new entrants who came in, a lot of big money started new MFIs.” But unfortunately, along with this new money came new pressure to deliver returns – and not just among SKS and Compartamos.

[soundcloud url="https://api.soundcloud.com/tracks/304341331" params="color=ff5500" width="100%" height="166" iframe="true" /]

The Compartamos IPO led to high interest rates that sparked industry-wide soul searching, with Muhammad Yunus comparing the MFI to loan sharks. “And many of the industry efforts to define appropriate or responsible investing, to define principles for protecting clients – those really arose after that … not immediately, but in the next few years,” Rozas said. And in India, the SKS IPO “pushed it to grow to a level that is really not possible, given its size, without becoming essentially an irresponsible lender.” It also impacted its competitors, creating “a level of competition, especially in Andhra Pradesh, that was unsustainable and led to over-indebtedness. … The IPO drove that reckless growth, and if you look at the statements of the heads of the other major MFIs in Andhra Pradesh, they were all also expecting to have an IPO within one to two years after SKS, and it was a question of who was next. … And I would say that the crisis in Andhra Pradesh, where the government essentially prohibited microfinance, wouldn’t have happened without the SKS IPO, which happened three months before. This was a major factor in that picture, in that juxtaposition of the shareholders in SKS walking away with millions, and some of its poor clients committing suicide. It was the worst possible picture.”

In contrast, Kanze said, Equitas and Ujjivan took a lower-key, socially focused and business-driven approach. They had a mix of social investors and more traditional private equity investors, and “they made it very clear that their social mission was core to their companies’ operations and their corporate culture – I think all their investors knew that going in. … Just comparing Compartamos and SKS to Equitas and Ujjivan, the latter were under two times <a href="http://www.investopedia.com/terms/b/bookvalue.asp" target="_blank" rel="noopener">book value</a>, where Compartamos was close to 13 times book value, and SKS was four times. So that’s to say that the Equitas and Ujjivan prices were a little bit more reasonable, indicating that they wouldn’t be growing uncontrollably, or maybe charging high rates to their customers to create these profits that were unsustainable.”
But Indian regulations also played an interesting role in Equitas and Ujjivan’s approach. First, as Kanze described it, “The regulations had changed after the 2010 crisis, where it wasn’t really possible to charge high interest rates – interest rates were regulated.” What’s more, she said, both Equitas and Ujjivan were prompted to pursue IPOs in the first place because the government limited their ability to go beyond traditional microloans to offer other loan and savings products to their extensive client bases. To get past those limitations, both MFIs had received approval from the Reserve Bank of India to become small finance banks, a new designation that allows them to take deposits from clients, among other benefits. But regulations require small finance banks “to reduce their foreign shareholding below 50 percent. And given that most Indian MFIs already have a lot of private equity investment, they are really unable to do this through domestic private equity alone. So going through the IPO process is one of the only ways to do this.”

According to Rozas, the irony of Equitas/Ujjivan and Compartamos/SKS’ differing approach is that the former two were founded from the beginning as commercial entities with a social mission. “Compartamos and SKS, on the other hand, began as NGOs and transformed into commercial entities afterwards. And in some sense, it actually created both complexities in the IPO itself – both had large amounts of shareholdings held by the original NGO, and in both cases, the oversight of that NGO and where that money went is really unclear.” The IPOs generated hundreds of millions of dollars which went back to the original NGOs and their founders, he said, and it’s not clear what they’ve done with it.

Rozas and Kanze agreed that the impact of the Compartamos/SKS IPOs continues to shape the industry’s approach to public investment – indeed, as Kanze pointed out, the Andhra Pradesh crisis led to the new regulatory framework and credit bureau infrastructure in India that made the Equitas/Ujjivan IPOs possible. But Kanze warned against complacency: “I would caution against relying too much on regulations and credit bureaus. High growth is happening again in India in certain pockets, and I’m sure these IPOs and the positive reaction will probably lead to more IPOs. So it’s important to be vigilant and to continue the focus on the social mission.”

<a href="http://nextbillion.net/authors/james-militzer/" target="_blank" rel="noopener">James Militzer</a> is the senior editor of NextBillion.

Have you read?

<a href="https://cfi-blog.org/2016/12/07/can-social-missions-be-preserved-in-initial-public-offerings/">Can Social Missions Be Preserved in Initial Public Offerings?</a>

<a href="https://cfi-blog.org/2015/03/11/miv-governance-the-case-of-africap/">MIV Governance: The Case of AfriCap</a>

<a href="https://cfi-blog.org/2016/05/04/equitas-ipo-forges-path-for-investing-in-inclusive-finance/">Equitas IPO Forges Path for Investing in Inclusive Finance</a>

A Tale of Four IPOs: Is Public Investment in Microfinance Becoming OK Again?

Financial Inclusion Equity Council

Initial Public Offering

Impact Investing

Blog Post

Initial public offerings (IPOs) are widely viewed as markers of commercial success. However, in the financial inclusion industry, IPOs are sometimes viewed with suspicion, if not alarm. This paper examines the 2016 IPOs of two Indian microlenders – Equitas Holdings and Ujjivan Financial Services – and how “hardwiring” their missions into their operations and corporate culture helped drive their success. The experience of these two companies suggests how a responsible financial services company can position itself to go public while maintaining its social mission.
<h2>Featured Companies</h2>
Equitas Holdings
Founded in 2007 to provide the underserved and disenfranchised people in the Indian State of Tamil Nadu with reasonably and transparently priced microcredit, Equitas diversified after the microfinance crisis in 2010 into affordable housing, small and medium enterprise (SME) and vehicle loans. At the time of its April 2016 IPO, traditional microlending made up slightly more than half of the total portfolio, with over half of assets under management in Tamil Nadu.

In September 2015, Equitas was one of ten companies to receive in-principle approval from the Reserve Bank of India (RBI) for the Small Finance Bank (SFB) license. In order to become an SFB, regulations require that Equitas bring foreign ownership, which comprised 93 per cent of equity before the IPO, below 49 per cent. This requirement was one of the key factors behind the IPO. Once Equitas transitions to a SFB, it will be able to accept deposits, starting with its client base of approximately 3 million.

Ujjivan Financial Services
Founded in 2005, Ujjivan Financial Services’ vision was to make financial services available to the urban working poor in India. At the time, most Indian microfinance was focused on the rural population. Started as a four-person team in a Bangalore garage, at the time of its IPO in April 2016, the company had 8,000 employees, three million borrowers, disbursed loans worth Rs.15,600 crore (approx. USD 2.6 billion), and had operations in every Indian state. Like Equitas, Ujjivan received approval to become a SFB and therefore also needed to reduce foreign shareholding. As of September 2016, Ujjivan was on its way to becoming a SFB with diversified product lines.
<h2>Authors</h2>
Grassroots Capital Management PBC and The Financial Inclusion Equity Council (FIEC), with support from the Center for Financial Inclusion at Accion.

&nbsp;

How to IPO Successfully and Responsibly: Lessons From Indian Financial Inclusion Institutions

India

South Asia

Report

Deborah Drake

Vice President

Danielle Piskadlo

Anna Kanze

James Militzer

Iraq

Jordan

Lebanon

Middle East and North Africa

Syrian Arab Republic

Agent Banking

Responsible Exit

Microfinance Institutions

&gt; Posted by Elissa McCarter-LaBorde, CEO, Vitas Group

<a href="https://www.flickr.com/photos/126278138@N03/17096832777/"><img class="alignright wp-image-23408" style="margin-top: 0;border: 0 solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2017/04/17096832777_b86f614a70_z1.jpg" alt="" width="315" height="178" /></a>Alex Silva and Jeffrey Riecke’s recent blog post entitled “<a href="https://cfi-blog.org/2017/03/17/whats-responsible-about-impact-investing-exits/">What’s 'Responsible' about Impact Investing Exits?</a>” hits squarely on the head a critical issue facing our industry. But it doesn’t go far enough. They ask “What if responsible investors sell their stake to an investor that doesn’t place priority on the social mission?” They argue for investors to take a “pragmatic” course and find “a buyer in the middle,” meaning something in between the “high-priced but questionable offer” and the “capital-starved social investors.” This left me wondering, who exactly is in the middle?

In the past, the NGO founders of what are today profitable microfinance banks were expected to be the keepers of a social mission, if not through ownership then through some form of continuing sponsorship or governance role. Compared to five years ago, today we see term sheets that force NGO shareholders out in the name of successful exits. In fact, even the large open-ended funds, presumably more socially-responsible leaning ones, and the development finance institutions (DFIs) that technically don’t require tighter exits of 5-7 years, are coming with term sheets that require a put option (an option contract giving the owner the right to sell assets at an agreed price) in 5-7 years back to the NGO founder or the company, or that include a drag-along right that forces a majority sale to a future “strategic buyer.” In other words, if the minority investor finds a strategic buyer who wishes to buy a majority stake or to acquire the whole company, the investor can drag other shares along to constitute a majority sale.

This seems to be the outcome of lessons that exits are still incredibly difficult in our industry. With IPOs hard to count on, the equally opaque and far off “strategic buyer” seems the other plausible solution. But just who is this strategic buyer? It is not another microfinance investment vehicle (MIV), DFI, or other player on the spectrum of social responsibility. Few of these want to buy secondary shares. A strategic buyer is a commercial bank, a telecommunications company, a consumer finance company, or other commercial entity that will want to get in on the base of the pyramid market.  Hopefully the managers of these businesses might have sympathetic feelings about the business and appreciate that it is social because it reaches lower-income customers, but at the end of the day, social is not in their lexicon.

Is this a bad thing? I agree with Silva and Riecke that if lower-income customers are served well, then it shouldn’t matter. But in reality, it does often matter because there are tradeoffs. We in the financial inclusion industry are working very hard to demonstrate returns and prove that exits are possible in order to build an impact investing community of buyers and sellers. But it can be at the expense of the investees – the financial service providers. We need more of the focus to be on what these financial service providers need and how to tailor the right kind of capital to fit those needs. Where are the (affordable) investment bankers who can identify buyers and structure appropriate capital at the right stage to match those needs?  Managing a double bottom line is never an even balance when shareholders are sitting at different stages of investment. There are always trade-offs. Riskier market segments, harder to reach geographies, capacity building or expansion that is good for the investee and its customer base, but will reduce book value and returns in the short run, are often at the losing end of those trade-offs. They are casualties when the dominant need is to push the price up.

Who is responsible for the responsible exit? We need shareholders to act responsibly together, to sequence investments in a way that helps the business pursue its goals and leads to the success of the business, not just the success of the impact fund. The fund managers who often sit on boards are not in the right place to do this. There are too many pressures to demonstrate a return for the next fund they are raising. Should the onus be on the anchor investors, many of whom are still DFIs and large institutional investors? The alternative is that “pragmatic” decisions taken by shareholders could force a sale to a commercial buyer when the institution might not be ready or not find such a sale in its best interest at that point in time.

In full disclosure, I am not opposed to commercial investors and ironically, I am finding the purely commercial investors easier to negotiate with, than the socially responsible ones who in theory are “like-minded.”

Vitas Group, established by Global Communities as a for-profit vehicle to advance its work in financial inclusion, operates a network of financial services companies that lend to small enterprises across the Middle East. Over the last decade, Vitas companies have disbursed more than $1.6 billion to 614,000 customers with an annual default rate below one percent in Iraq, Palestine, Lebanon, and Jordan. Vitas employs more than 1,500 young professional staff and has sustained more than 214,000 jobs by lending to small business owners. Despite the volatility that has defined this region, even before ISIS or the Syria conflict emerged, Vitas has continued to earn double digit returns and has been a solid investment for its shareholders, illustrated by the fact that this year Vitas will close its first transactions with two purely commercial, private equity investors in the region.

To my point above, Vitas could not have arrived at this point without the right kind of capital at the right time. With new commercial partners and technological innovations coming into our industry, we have an even greater opportunity to achieve that larger goal of financial inclusion for every citizen. But that makes it all the more important for the development-focused founders, sponsors, investors, and other shareholders to govern well and to work together responsibly to shepherd the process.

<a href="http://www.vitasgroup.com/summary/leadership/#">Elissa McCarter-LaBorde</a> is Chief Executive Officer of Vitas Group and Vice President of Development Finance for Global Communities, where over the last 12 years she has built the technical department that manages Global Communities’ microfinance, SME, and housing finance operations. Ms. LaBorde has 18 years' experience as a microfinance practitioner.

Image credit: <a href="https://www.flickr.com/photos/126278138@N03/17096832777/">Pictures of Money</a>

Have you read?

<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>

<a href="https://cfi-blog.org/2015/03/03/what-impact-investors-could-learn-from-microfinance/">What Impact Investors Could Learn from Microfinance</a>

Who's “Responsible” for Responsible Impact Investing Exits?

<a href="http://bit.ly/2gl8Ojj"><img class="alignright wp-image-22517" style="border: 0 solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2016/12/ipo-covver.png" width="280" height="363" /></a>2016 has been dubbed “the year of IPOs” in India: as of September, there had been 21 initial public offerings (IPOs) worth nearly $3 billion, according to Indian news source Livemint. Among these are two high-profile IPOs for microfinance institutions (MFIs): Equitas Financial Holdings and Ujjivan Financial Services. IPOs are seen as the hallmark of commercial success, but in those industries like financial inclusion that are driven by social missions, inevitable questions arise over whether organizations can preserve their double bottom line priorities when they go public. The cases of these two Indian MFIs offer some answers to this increasingly pertinent question.

But before we get to that, let’s look at why these institutions went public in the first place.

Never waste a good crisis, right? In 2010, when the Andhra Pradesh crisis froze microlending in India, regulators and MFIs rose to the occasion and implemented measures that restored confidence in the microfinance industry and helped cement the social mission of microfinance in India. Most notably:
<ul>
 	<li>Social Standards – In an effort to promote responsible lending, a group of the largest for-profit MFIs in the Indian microfinance sector formed the Microfinance Institutions Network (MFIN). MFIN developed a Code of Conduct by which members commit to client protection, ethics, and transparency, and the group began to “self-police” adherence to responsible lending principles.</li>
</ul>
<ul>
 	<li>Credit Bureaus – The members of MFIN also collaborated with High Mark Credit Information Services to form the first credit bureau to track microfinance borrowing in India. All MFIN members contribute data to the microfinance credit bureau.</li>
</ul>
Five years later, the microfinance industry in India has rebounded, and at the same time the regulatory and investment environment has improved. A new category for MFIs, called Small Finance Banks (SFBs), was created by the Reserve Bank of India (RBI) to allow some of the more advanced Indian MFIs to become more formal financial institutions, provided they maintain their focus on the poor. In 2015, the Reserve Bank of India gave provisional approval to 10 entities to convert into Small Finance Banks within one year. The SFB license requires, among other things, that ownership is at least 51 percent domestic. Two of the institutions looking to convert – Equitas and Ujjivan – needed to restructure their ownership to meet the domestic ownership requirement. They decided the easiest and fastest way to transfer roughly 40 percent of their equity was an initial public offering, which both did in 2016.

Both IPOs were successful. They transferred the required amount of ownership from foreign to domestic shareholders, crowding-in local investors; demonstrated demand by local investors for MFI stock by being oversubscribed; raised necessary operating capital for their respective MFIs; and maintained focus on the social mission by “hardwiring” it into the IPOs.

The last point warrants additional examination and explanation. In fact at the September SOCAP and SEEP conferences, the big question was: How can a company – specifically one in an industry serving vulnerable clients like financial inclusion – hardwire the social mission so that it is preserved in an IPO? A new <a href="http://fiecouncil.com/">Financial Inclusion Equity Council</a> (FIEC) paper further examines exactly how this can be done. (CFI serves as the secretariat of FIEC.) Here are a few examples:
<ul>
 	<li>Company By-Laws – Equitas made a commitment to dedicate 5 percent of its profits to social programs and wrote that commitment into its bylaws.</li>
</ul>
<ul>
 	<li>Shareholder Agreements – Ensuring all investors know what they are buying into can be accomplished via shareholder agreements. For example, Mexican MFI Compartamos inserted a “poison pill” clause into its shareholder agreement stating that if any investor tried to undermine the social mission, the sale would be void.</li>
</ul>
<ul>
 	<li>Company Policies – Aligning management and employees’ interests with both social and financial bottom lines can be enshrined in company policies. For example, positioning management compensation to avoid excessive executive enrichment helps companies focus on more than just profits and dissuades public perception of profiting at the expense of vulnerable clients. Equitas developed a policy that the CEO can’t make more than 40 times more than the lowest paid employee. Additionally, both founders of Equitas and Ujjivan had limited stakes in the companies and encouraged employee ownership through Employee Stock Ownership Programs (ESOPs).</li>
</ul>
<ul>
 	<li>Strong Boards – Of key importance is developing a board that is united and strongly committed to the social mission, has independent members, and is not controlled by a single member or devoted to a single member or investor’s interests.</li>
</ul>
For more details and additional findings, read the new FIEC paper, “<a href="http://bit.ly/2gl8Ojj">How to IPO Successfully and Responsibly—Lessons From Indian Financial Inclusion Institutions</a>”.

Have you read?

<a href="https://cfi-blog.org/2016/07/22/more-in-for-impact-whats-up-in-socially-responsible-investing/">"More in for Impact": What's Up in Socially Responsible Investing?</a>

<a href="https://cfi-blog.org/2015/03/11/miv-governance-the-case-of-africap/">MIV Governance: The Case of AfriCap</a>

<a href="https://cfi-blog.org/2016/05/04/equitas-ipo-forges-path-for-investing-in-inclusive-finance/">Equitas IPO Forges Path for Investing in Inclusive Finance</a>

Can Social Missions Be Preserved in Initial Public Offerings?

India is a global leader in financial inclusion. For over a decade, Accion has worked with and learned from India’s innovators, investors, and policymakers to expand economic opportunity for its people and businesses.