The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

When you think about responsible investing, what comes to mind? Finding investment prospects that can deliver social returns? Perhaps diligent monitoring, with an eye to effective governance? How about when you sell an investment? How can investors remain committed to balanced social and financial goals when passing the baton to someone else?

This last question is the focus of a joint project by the Center for Financial Inclusion and CGAP. With several microfinance equity funds approaching maturity, the issue of equity sales is becoming more relevant, and as part of the project, the team has been interviewing many equity investors to understand how they perceive the question of what, exactly, is a responsible exit? A paper detailing the findings of these interviews, The Art of the Responsible Exit in Microfinance Equity Sales, will be released in the coming weeks.

In the course of these interviews, many respondents used the analogy of children growing up. As early-stage or founding investors, they reach a certain point where they have fulfilled their “parental” mission and are no longer best-positioned to provide the MFI what it needs, be it capital, expertise, or market access. From the investor’s perspective, the analogy works. But selling an MFI is less an act of entrusting your child’s future to his or her own good sense, along with whatever wisdom you’ve been able to impart – you are handing the MFI over to somebody else.

Indeed, the better analogy might be that of an arranged marriage: you hire a matchmaker (M&A specialist) to help find a suitor (buyer); you meet with the suitor to find out who he is and what he has done in the past (due diligence); maybe if you’re a responsible parent (investor), you ask your daughter (MFI management) for her opinion. All along, you are nagged by one important question – is this a suitable match for my daughter?

Unsurprisingly, buyer selection is a major part of social investors’ focus during the process and is seen as the most important way to assure continued attention to the double bottom line. However, investors have a few additional options at their disposal to insure that buyers will stick to their promises and will not lead the MFI away from its primary mission. The most common among these is simply selling a minority stake, relying on other like-minded investors to provide continuity of governance. In one case, a seller included one year employment contracts for key MFI management as part of the sale agreement, thus assuring at least temporary continuity in MFI operations. Several investors incorporated specific commitments to the MFI’s social mission and to client protection principles in the shareholder agreement, thus binding the buyer to some degree. Yet another investor was seeking to structure a minority stake with veto power over key institutional decisions, as a means of retaining post-sale control.

Each of these is an interesting exercise in insuring at least some level of continuity or control, even if the suitor turns out to be a dud. However, one institution figured out a way to bypass the process altogether. From the start, it was built on an unusual evergreen governance structure that assured that this commercial enterprise would stick to its social mission. Its initial charter insured that no single investor would have a controlling stake, and gave its board – composed of majority independent directors – veto power over any acquisition that would give a single investor a controlling stake. In effect, the structure gives a purchasing investor a share of the company’s assets and earnings, while leaving governance largely outside investor hands. And thus far, this MFI has been highly successful. In effect, the institution rendered the arranged marriage – or any marriage – unnecessary, by choosing to remain single and independent.

Which MFI is this, and how exactly does its governance structure function? And what are the other relevant lessons to investors seeking to sell their equity responsibly? Stay tuned for The Art of the Responsible Exit in Microfinance Equity Sales.

Have you read?

A $204 Million Leap for Financial Inclusion

Six To-Dos Now for Responsible Investors

A Journey to Understanding Risk as a New Board Director in “Governing Banks: MFI Edition”

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

In 2003, the Council of Microfinance Equity Funds (CMEF) was formed by a handful of equity investors in microfinance with the goal of sharing, developing, and disseminating industry best practices in equity investing.

I recently had the pleasure of catching up with Jim Kaddaras, who was Vice President of Special Projects at Accion from 2001-2003. He was instrumental in launching the CMEF in 2003, and also led the charge on the creation of Accion Investments. Jim is now a Partner at Developing World Markets, and is still a Council member.

Q: What did the landscape of microfinance equity investing look like in 2003?  

Jim Kaddaras: It wasn’t much of a landscape – it was more of a scatter shot.

Accion owned stakes in some of their Latin American affiliates and Accion Investments was just launching in 2003. Procredit was a player (they were called IPC back then and their banks had separate names). FINCA had some equity investments and ShoreBank had a smattering of equity holdings.

ProFund had been around since 1995 as the first investment company focused on microfinance equity but it was winding up when the Council started. Africap was just starting, based on the ProFund model. Various other Council members, plus the development finance institutions (DFIs) and several non-profit networks, held a handful of equity investments.

Q: What was the goal of the Council when it was formed?

JK: We felt that by gathering people who had been making equity investments in a one-off way, we could help to develop and disseminate best practices in the field.

Q: Who were the Council members in the early days?  

JK: I believe the founding members were Accion, Oikocredit, Doen Foundation, ProFund, ShoreBank, and Triodos. Other early members were Africap, Andromeda Fund, Calvert Foundation, Citigroup, DID, Deutsche Bank, Open Society Institute, Opportunity, SARONA, SIDI.

Calmeadow in Toronto was also present at the creation. Its founder, Martin Connell, was a Canadian businessman who wanted to do something social and funded a lot of early studies and research.

Q: Where was the first Council meeting? What topics were discussed?

JK: An early meeting was hosted by Oikocredit at their office in Amersfoort, in the Netherlands. The first couple of meetings were focused on getting organized as a Council, discussing who else should be invited to join the Council, and building consensus around the idea of having members pay dues, which was a very controversial topic at the time.

In those early meetings we also focused on setting out the lay of the land as it currently stood so everyone was starting from the same vantage point. And we discussed what type of research and writing the Council should focus on.

Council members represented much smaller organizations back then and we faced issues of how, given our limited capacity, we would cover the world and provide help to MFIs far away. We discussed ways to provide more effective governance in an efficient manner and debated the use of head office staff vs. trusted local directors to serve on boards. We explored the potential for sharing directors among investors in joint investments, and discussed how best to execute this concept of “piggy-backing” off of like-minded investors.

Q: What were some of the early CMEF publications?

JK: The first Council publication was the Characteristics of Equity Investments in Microfinance, which I co-authored with Beth Rhyne. This report looked at where equity investments were in microfinance by region and country, and so tried to quantify and describe the investment landscape in microfinance. The report also examined the role investors were playing at the time – were they active on boards or passive?

The report also focused on effective corporate governance. It focused on how boards should be organized, which committees were important and why, and how to strike the proper balance in terms of a relationship between governance and management—that is, how to ensure that the power wasn’t tilted too much in one direction or the other so the board was in charge of overall strategy and direction, and management was in charge of executing that strategy and managing day-to-day operations.

Q: What were some of the controversial topics when the Council started?

JK: The Council was made up of pretty like-minded investors so there weren’t too many controversial topics among members. But one of the big issues we discussed was what to do when you didn’t have like-minded investors on the board.

All of the Council members at the time were convinced that there should be a double-bottom line and everyone investing was trying to build the field, so making money was not the leading concern. Over time, it was recognized that to build the field, we had to draw other investors in, and to do that, we had to be able to offer a reasonable return. It seems now that some investors feel the social mission can be subordinated to financial returns, but that didn’t exist back then.

We, as equity investors, were also concerned about the role of NGOs in institutions that had transformed from an NGO into a for-profit entity. Often, the non-profit entity would get most of the shares of the for-profit entity in exchange for the microfinance operations it had previously housed, and we struggled with the issue of an NGO keeping up with the capital needs of a growing MFI. Sometimes the original NGO can act as a brake on the growth of the institution, and this is especially true when a strong founder is involved. It can be hard for the founder to let go of his or her “child.” It isn’t always easy from an investor perspective for the founders to be involved. Sometimes the NGO ends up with diluted shares as a minority stakeholder but there can still be complications (i.e. the NGO requires special rights associated with its shares). An NGO refusing to let go can drag the MFI down.

Now, much more diverse shareholdings make it more challenging to have like-minded investors on the board. It used to be like a family sitting at the table and now, sometimes there are strangers.

Q: Looking forward, what do you think will be important issues for the Council to tackle in the future?

JK: The Council has done the industry a great service in terms of supporting pioneer investors and drawing new investors into the field. Now, the Council’s most valuable contribution will be in continuing to promote the best practices in corporate governance, and in striking the optimal balance between the social mission and financial returns.

It will be important for the Council to help shape where MFIs end up at the end of the day. Is the future of MFIs to become part of the mainstream banking system, or will they continue to operate separately as specialized institutions?

The Council should also focus on keeping the social mission of the MFI. How can we ensure this social mission remains – or is our job as social equity investors in microfinance essentially now done and we should move on to other things?

Have you read?

A $204 Million Leap for Financial Inclusion

Six To-Dos Now for Responsible Investors

A Journey to Understanding Risk as a New Board Director in “Governing Banks: MFI Edition”