> Posted by Anna Kanze, Chief Operating Officer, Grassroots Capital Management, and Danielle Piskadlo, Manager, Investing in Inclusive Finance, CFI
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:
- 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.
- 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.
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 Financial Inclusion Equity Council (FIEC) paper further examines exactly how this can be done. (CFI serves as the secretariat of FIEC.) Here are a few examples:
- Company By-Laws – Equitas made a commitment to dedicate 5 percent of its profits to social programs and wrote that commitment into its bylaws.
- 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.
- 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).
- 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.
For more details and additional findings, read the new FIEC paper, “How to IPO Successfully and Responsibly—Lessons From Indian Financial Inclusion Institutions”.
Have you read?