Microfinance · Social Business

Why Equity Matters to Microfinance

In a previous post on for-profit microfinance, I summarized some of the benefits that I see for the poor in the trend for microfinance institutions (MFIs) to become for-profit entities rather than the traditional non-profit entity model. One of the key aspects of a for-profit entity is the ability to sell ownership shares to investors to raise capital.

I caught up (via email) with Geoff Woolley, a very experienced venture capitalist (Dominion Ventures, European Venture Partners, MACC Private Equity and more) and an early pioneer in microfinance equity. Geoff currently chairs the Capital Markets Committee on the board of Unitus, an innovative global microfinance accelerator. He was very involved in setting up the Unitus Equity Fund … one of the first private-money-only private equity funds exclusively focused on investing in start-up MFIs.

Dave: Geoff, first, what is your background related to investing equity capital in companies?

Geoff: I have been a venture capitalist all my professional career and founded both a US and European private equity firm. Through myself and my firms, I have invested in hundreds of growth companies … both start ups and expansion stage companies.

Dave: What experience have you had in making equity investments in MFIs?

Geoff: Investing direct equity rather than making grants or giving loans to MFI’s is relatively new. My experience has been over the last few years with assisting in structuring the financing of the Unitus partners. With the new Unitus Equity Fund, we work exactly as most private equity firms. My “non profit job” and my regular job are almost alike except with Unitus I know my efforts help thousands of poor women and their families in a small way.

Dave: It seems like there is still a lot of confusion about why MFIs need equity investments. Why not just give them donations/grants or give them loans?

Geoff: The key word is sustainability. Essentially, if an MFI does not learn to become profitable, most donors will grow tired over time of supporting their financial needs. The best way to think about MFI’s are as small start up banks. If a wealthy bank founder provided all initial capital and continues to support the bank without taking equity or a loan note, potential new lenders or investors would not be able to assess the banks profitability or sustainability. This “free capital” would never appear on financial statements. By treating an MFI like most start up companies, lenders and new investors will more easily understand the MFI and its progress. With MFI’s, profitability is a measure of effectiveness rather than strictly making money. Capitalism and social purpose are well aligned.

Dave: How do MFIs grow their equity base?

Geoff: The same way as banks do. They raise more equity (by issuing and selling shares) or reinvest profits from their operations. In MFI’s that are licensed to collect savings from clients, these saving accounts help increase the MFI’s capital base which enables it to borrow less from outside lenders.

Dave: There is talk about some MFIs reaching the limit of how much they can borrow. What are those limits and how does equity impact lifting those limits?

Geoff: Reaching borrowing limits could relate to either market saturation or an inadequate capital base. In most microfinance markets, the need of the poor for capital is far from saturated. I hope someday to see the “problem” of oversupply of capital for the poor since it means poverty will be reduced significantly. Most MFI’s reach limits based upon their equity or capital base. Both banking regulators and an MFI’s lenders set limits in terms of the amount of debt that a MFI can have outstanding in proportion to the amount of equity they have built up on their balance sheet. For example, if an MFI wanted to borrow $5,000,000 from a state bank to make its small $100 loans, the lending bank might require $20 of equity for every $100 of loan it will provide to the MFI. This would be a 5-to-1 capital base requirement and the MFI would need $1,000,000 in equity or capital to borrow the requested $5,000,000. With many MFI’s expanding their number of borrowers by more than 100% per year, more borrowing and proportionate equity is required.

Dave: What are some of the additional benefits to MFIs of having equity infusions?
Geoff: The most important positive factor for a MFI is independence and being the masters of their own destiny. Management can plan for the future without outside factors such a grants being cut or reduced. Being able to plan and understand your resources is key to the success of any growth companies including MFIs.

Dave: Are there any downsides to MFIs in taking outside equity capital?

Geoff: Even in the US, we practice a “modified” capitalist economy where regulators, investors, voters and many other constituents impact and constrain the market system. Similar “guardrails” are required in microfinance to ensure it keeps its focus on the unbanked sector. Social guidelines and priorities need to be prioritized against pure profit decisions. For example, the cost to transact a $100 loan versus a $500 loan is the nearly the same. Therefore, a MFI could become more profitable if it moved to making $500 loans to increase profits. In such a case, the social benefit of making loans to the poorest women should be prioritized before maximizing profits. For instance, these social safeguards are outlined and documented in Unitus Equity Fund’s equity investments to ensure MFI management keeps their focus on the targeted unbanked poor. A balanced approach of social good and sustainable operations is key to the Unitus mission.

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