Exclusive: SKS Microfinance journey to IPO – An inside story
- Monday, May 17, 2010, 17:20
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By Vikash Kumar & Daniel Rozas *
Microfinance Focus , May 12, 2010 : SKS Microfinance, India’s biggest lender to the poor, is soon to become the nation’s first microfinance company to list on the Stock Exchange. In the past 10 years, it has evolved from an NGO to a public limited company and has set many benchmarks for the industry to follow. Microfinance Focus presents a comprehensive look at this journey, tracing it from the company’s roots in the late 90s through the final months leading up to the IPO.
Editor’s note: this article is based on published sources, including the SKS Draft Red Herring Prospectus, as well as numerous exclusive interviews with individuals closely familiar with different aspects of SKS, many of whom spoke only on condition of anonymity. Depending on the nature of the confidentiality requested, some sources may not cited at all. However, we have included only such information that could be independently verified.
The Foundation
Started in 1997 as a public society in the form of an NGO, Swayam Krishi Sangam (also known as SKS Society or SKS NGO) went on to transform itself into the largest MFI in India and the fastest growing MFI in the world, as of September 2009 reaching 5.3 million poor women, or some 20% of all MFI clients in India.
After several years of operation as an NGO, SKS Society found itself constrained by the not-for-profit business model. In response to the growing demand of microfinance, SKS Society created a private company, SKS Microfinance Private Limited in 2003, which became a Non-Banking Financial Company (NBFC) in 2005. Finally, in May 2009, the Company was converted into a public limited company.
table 1
This transition from an NGO to a public limited company allowed SKS to achieve and sustain a level of growth that is unprecedented in the history of microfinance, both in India and anywhere else. In the 3½ year period from March 2006 to September 2009, SKS recorded cumulative annual growth of around 250% across multiple categories (Table 1). Meanwhile, its profit margins continued to increase, with return on equity growing from 5.1% in FY2007 to 18.3% in FY2009.
The Business Model
Since at least 2003, SKS has been focused almost exclusively on developing a model that could scale rapidly. As a result, the company has long used outreach – the number of poor people reached and the number of loans granted – as the key measure of its success. It has achieved this by constantly overcoming constraints to scaling that are present in microfinance. To insure a sufficient supply of capital, it was the first Indian MFI to raise purely commercial equity; to build capacity, it has adapted scalable processes from the business world and applied them in the microfinance context; and to reduce costs, it has extensively invested in technology.
Given the high-touch nature of microfinance, SKS staff growth has paralleled that of its portfolio. On its own, such growth presents significant difficulties, but SKS has also been continuously dealing with significant employee turnover – an average of 25% – such that, after combining this with the rapid growth, the result is that any given time, some 75% of the staff has been with SKS for less than 12 months. While official numbers are not available, one individual with knowledge of the situation reported that the challenge posed by large numbers of new staff is an issue not just in the field, but also at the headquarters. Nevertheless, productivity remains high – each of its loan officers is responsible for an average of some 450 active borrowers (or 550 clients).
SKS has also invested heavily in standardizing its operations, basing them on an extensive MIS. In fact, it was among the first Indian MFIs to invest heavily in technology as a means of supporting growth and driving productivity. Thus, it might not be surprising that among its early investors, one finds many luminaries from the IT world: Vinod Khosla, co-founder of Sun Microsystems; Sequoia Capital, an investor that counts Cisco, Apple and Google among its early-stage investments; and Unitus, a microfinance investor based in Seattle (the home of Microsoft) whose board and executive staff is filled with former IT executives.
This standardization thus far has implied an almost exclusive focus on traditional group-based microcredit loans – just two of these loan products accounts for 98.5% of SKS portfolio. At the same time, the company has engaged in tie-ups with insurance companies, most successfully with Bajaj Allianz with which it sold 2.4 million life insurance policies. More recently, SKS has been piloting partnerships with Nokia, Airtel, and Metro. However, to-date, these tie-ups have not been a major income source: while microcredit operations account for 89% of revenue, insurance commissions and related fees account for only 5%. The remainder comes from interest on bank deposits.
When it comes to financing its rapid growth, SKS has been one of the first MFIs to actively engage the commercial finance market, especially in the private equity space. The frequency of these capital raises was also unprecedented in the microfinance sector, with five distinct capital raises since 2006 and each successive deal larger than the first. However, at the present, SKS has reached a stage where further private equity raises have become a limiting factor, pushing it to seek funding from the larger public markets, by way of the IPO.
The Trust
The SKS Mutual Benefit Trusts (MBTs) have been a core component of SKS since it began its transformation to a for-profit entity. In essence, the MBTs are the link between SKS Society (the NGO) and SKS Microfinance (the NBFC). In 2003, these five private for-profit trusts were formed by SKS Society with the objective of promoting and enhancing the social and economic welfare of their members. At their inception, these trusts consisted of 500 sangams (SKS village-level groups) in Andhra Pradesh, representing about 16,600 women. In March 2010, the Trust deeds of the MBTs were revised to include 220,000 sangams that are currently part of the SKS network, that will eventually represent some 6.8 million women.
MBTs as investors
To capitalize the MBTs, Vikram Akula raised donations which then became the source of the Rs. 2 crores (US$500,000) that the MBTs invested in SKS Microfinance in 2003 to become effectively the sole (99.5%) owners of the new company. In August 2005, having raised its first round of equity from social investors, such as Unitus, Vinod Khosla, SIDBI, and the Reddy Foundation, SKS Microfinance bought the NGO’s microfinance portfolio for Rs. 5.5 crore ($780,000), paying 3.5x over book value. The proceeds were then transferred to the MBTs, which used it to take an additional equity stake of Rs. 4.5 crores ($1.0 million) in SKS Microfinance.
The third and final transaction took place in 2008-9, when Vikram Akula raised another Rs. 1.5 crores ($350,000) from a few US philanthropists. However, the result was an extraordinary transaction, whereby in January 2008 the MBTs were allocated shares valued at 27.3 crores ($6.1 million), while paying only 1.5 crores. The remaining cost of the shares was paid only in December 2009 – nearly two years after allocation and only some four months before the filing of the draft red herring prospectus – when Silicon Valley Bank issued a loan to the MBTs, backed by a guarantee from Vinod Khosla, for the remaining 25.8 crores ($5.7 million). Presumably, the loan was issued with the expectation that it will be repaid following the IPO with the proceeds from the partial sale of the MBT stake.
Table 2
Through these three transactions, the MBTs were able to become the second-largest SKS investor (Table 2), with a 16.1% stake (pre-IPO) valued at Rs. 660 crores ($144 million) – all for an investment of only Rs. 2 crore originally donated back in 2003 and 1.5 crore in 2008. Most of the rest essentially came from the other SKS equity investors who were effectively agreeing to indirectly fund the MBTs via voluntary dilution of their own stakes. The 2008 transaction is especially notable, since the investors in January 2008 (among them Sequoia Capital – a strictly commercial fund), appear not to have objected to the essentially unfunded allocation to the MBTs at a time when they themselves were paying 71 Rs/share. By the time the MBTs actually paid-up these shares at the original price set two years prior, they were already worth 637 Rs/share, or nine times the price paid by the MBTs.
Because this is a transaction of some complexity, a simple analogy might be helpful: consider five friends who decide to pool their money and invest in a mutual fund. One of them doesn’t have enough money to contribute, but the others invite him to join anyway, so long as he pays them back in the end. Four friends contribute Rs 1000, and the fifth invests only Rs 50, for a total of Rs 4050. After two years, the fund has grown nearly 10 times, and the friends cash out, dividing Rs 40,000 into even shares of Rs 8,000. Out if this, the one friend pays the Rs 950 to the other four. The analogy is not identical, but it is essentially what took place with the 2008 equity raise, with the MBTs playing the role of the moneyless friend.
MBTs and SKS Society: an organic link
The upcoming sale of 19% of the MBT stake, which would net Rs 128 crore ($28 million) based on the most recent valuation (final pricing will not be known until the IPO is completed), will constitute a major infusion of capital for the MBTs. Although it has not been publicly disclosed, according to several knowledgeable sources, these proceeds will be directed to the SKS Society. In this way, the circle begun in 2003, when the MBTs for created by the NGO, will be completed.
This is would be a large sum for any NGO, but in the case of SKS Society, a relatively small organization with annual budget around Rs 1.1 crore ($240,000), it represents a sea-change. Indeed, a few knowledgeable individuals have suggested that Vikram Akula is seeking to make SKS Society his next project, in some ways mirroring Bill Gates’ transition to his own eponymous foundation. However, in Mr. Akula’s case, the change is in many ways a return to the early days of Swayam Krishi Sangam, though with more funds and far greater prominence.
In fact, the Society has been preparing to take its place among leading Indian NGOs since spring 2009. At that time, it brought in several independent directors with considerable global reputations in the development sector and no prior affiliation with SKS, including Orlanda Ruthven, a long-time development consultant, and Frances Sinha, co-founder of EDA Rural Systems. SKS Society is trying to position itself as a broad-based development organization, focusing on economic development, health, and especially childhood education in the communities where SKS Microfinance is active, somewhat along the lines of Bangladesh-based BRAC.
One person actively promoting the focus on education is Gurcharan Das, the well-known author and former board member of SKS Microfinance and trustee of the MBTs. Early this year, Mr. Das resigned both these positions to dedicate his time to the SKS Society’s education programs, becoming chairman of the Society’s board in May 2010. “There is so little time in life so one should do few things and should do them well and should do things which are your passion and this is my passion,” said Mr. Das, adding that he seeks to have “a million poor children educated in the SKS school program.” That is an ambitious goal, given that the NGO’s existing education program reaches only 550 children.
Governance of the MBTs
Mr. Das is not the only trustee to have resigned from the MBTs. Two additional persons, Anu Aga of Thermax and Narayan Ramachandran of Morgan Stanley, who, along with Gurcharan Das had all joined as trustees of the MBTs in November 2009, resigned only a few months later. There had in fact been significant differences in views – according to Gurcharan Das and another individual familiar with the situation, the disagreement had centered over the best means to direct the Rs. 650 crore capital base of the MBTs.
The other two trustees argued that providing such a large sum to an organization with only modest operations to-date was not the most effective way to serve the interests of the MBT beneficiaries, arguing that a Ford Foundation model of funding different organizations with existing infrastructure and expertise would ultimately bring greater benefit. Others, including Vikram Akula and the late Sitaram Rao, insisted that a model patterned along the lines of BRAC in Bangladesh would better take advantage of the existing network built by SKS. The second argument prevailed, and the two trustees resigned.
Prior to their resignation and that of Mr. Das, this board did adopt one notable decision. It voted to express its gratitude on behalf of the MBTs for the work of the former CEO of SKS, the late Sitaram Rao, in the form of a gift of SKS stock worth Rs 6 crore ($1.3 million) made to his mother.
Following the resignation of these three trustees, SKS Trust Advisors Private Limited (STAPL) was designated the sole trustee of each SKS MBT. The directors of STAPL currently comprise Vikram Akula and Dr. Ankur Sarin, professor at IIM-Ahmadabad and director of SKS Society, although for Mr. Akula this is expected to be only an interim appointment, until replacement board members are found. The new MBT governance structure also includes representation from the beneficiary member groups.
In fact, from the beginning, the MBTs provided for representation from the sangams via two members of the community who held positions as trustees on the 5-person MBT board. This proved better in theory than practice, since the educational background and experience of these representatives limited their influence in board decisions. Instead, the board elected to hold informal meetings with large groups of SKS clients as forums to discuss the activities of SKS Society and the MBTs. The focus of the meetings was more to communicate the Society’s activities and plans rather than seek explicit input from the women for specific decisions. This structure was formalized with the updated trust deed as of March 2010, where the sangams of each of the five MBTs can appoint up to 100 individuals to represent their interests.
Management Shareholding & Compensation
Besides being the first MFI IPO in India, SKS has another unusual distinction – its management is not among the promoters. Indeed, neither Chairman and Founder Vikram Akula nor CEO Suresh Gurumani own any significant direct stakes in SKS. As a result, this has led the company to take the unprecedented step for Indian IPOs: having its private equity investors, including Sequoia – a venture capital company – serve as promoters for the purpose of the IPO.
Notwithstanding his lack of direct shareholding, in the lead-up to the IPO, Mr. Akula owned significant options granted as compensation in 2007 and 2008, which if exercised, would have comprised about 5.3% of pre-IPO capital, with a net value of Rs. 168 crore ($36.4 million). In February 2010, Mr. Akula sold 26% of his options, realizing a profit of Rs. 55 crore ($11.9 million), while voluntarily locking in the remainder for a period of three years. As it happens, this transaction largely mirrors those of the promoters, each of whom is selling a 20-30% of their stake and locking in the rest, as mandated by SEBI rules.
In Mr. Gurumani’s case, his stock options were granted when he joined the company in December 2008, and currently have an net value of Rs. 30 crore ($6.6 million). Like Vikram Akula, Mr. Gurumani has also opted for selling 25% of his options, realizing a net profit of Rs. 7.6 crore ($1.6 million) and locking in the remainder.
In fact, while the stock option plans (both ESOP and ESPS) have been primarily designated for the two executives, Akula and Gurumani, who were allocated 50% of the options issued under these plans, SKS has also used options as employee compensation. With the other members of the executive team, M.R. Rao and S. Dilli Raj, receiving a further 8%, the remaining 42% was allocated based on a combination of tenure (minimum 2 years) and level of responsibility, covering in all some 25% of SKS staff.
Executives and staff were not the only recipients of stock options. Beginning in 2008, five independent directors of SKS have also been allocated options, with a current net value of Rs. 6.5 crores ($1.4 million). None of these options have been exercised to-date.
The Soul Searching
The announcement of the SKS IPO has brought back many of the divisions precipitated by the 2007 IPO of Compartamos in Mexico. The modern-day founding fathers of the industry – Prof. Mohammad Yunus, Sam Daley-Harris and others – have again raised concerns about how such commercialization undermines the mission of microfinance, emphatically rejecting what they regard as growing “profiteering.” Mr. Yunus minces no words: “when you put an IPO, you are promising your investors that there is a lot of money to be made and this is a wrong message.” Mr. Daley-Harris is more circumspect and doesn’t eschew working with capital markets: recalling a $180 million securitization by BRAC in 2006, he emphasizes that, in the end, the key is to remember the mission. However, he is skeptical of the SKS IPO: “How much of the SKS IPO will be going into the loan portfolio? It seems like it’s a lie.”
Yet the non-profit or social-business models of BRAC and Grameen Bank are not easily found in India. Why this is so isn’t entirely a question of choice – the legal frameworks in Bangladesh and India are also important determining factors. For example, Grameen Bank in Bangladesh is funded primarily by deposits raised from its own borrowers and non-members, whereas Indian MFIs are prohibited by law from collecting deposits. For them, funding must come from outside by necessity. Given the magnitude of demand – by one widely-cited measure, as much as Rs. 2.1 lakh crore ($40 billion) for micro-credit – the only sufficient external sources to provide that are the commercial capital markets. And the larger the MFI, the more broad-based the source of funding – in a recent Business Outlook India article, Vijay Mahajan, founder and chairman of Hyderabad-based MFI Basix, claims that “an IPO is inevitable for any NBFC-MFI that has reached Rs. 3,000 crore (US$650 million) in its loan portfolio.”
Aside from scale alone, there is also the question of growth. Bangladesh is the most widely-served microfinance market in the world, with some 16% of its population counted as microfinance clients. It has also had the benefit of having 30 years to get to this stage. Given the far larger numbers of poor in India, rapid growth is not just an MFI promoter’s dream – it is a necessity if one is to reach the countless villages across the country that are yet to see a single MFI. And SKS sets the benchmark for growth – where Grameen Bank took 30 years to reach 6 million clients, SKS took only 6.
Whether hyper-growth or profit are antithetical to remembering the mission is a different question, and one that is not yet settled. In an impassioned essay in Microfinance Focus, P.N. Vasudevan, founder and CEO of Equitas – the fastest-growing MFI in India last year – argues that being for-profit in no way contradicts the client-focused mission, inviting any critic “to spend a day with us and then declare that not-for-profit format is the only way of being mission focused and I promise to quit my organization.”
Only time will tell which side is right.
== == ===
*with Contributions from Microfinance Focus team members: Asma Azmi (Associate Editor) and Jesselyn N G
Vikash Kumar : Editor-in-Chief | Microfinance Focus
Daniel Rozas : Sr. Analyst| Microfinance Focus
Send your comments/suggestion at news@microfinancefocus.com
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Unfortunately, this seems far too much like the capitalistic excesses of the 2007 Compartamos IPO in Mexico. Why do MFIs and social entrepreneurs so desperately seek to model the examples of Wall Street, Lehman Brothers, Goldman Sachs, and Citibank? It seems some microlenders have a tendency toward becoming loan sharks, simply camouflaged in sheep’s clothing, but inwardly dangerous wolves. Let’s be honest here: When n NGO dedicated to empowering the poor starts giving its founders and top officials chunks of cash and stock valued at $6-$12 million, their work is no longer about pro-poor strategies, but pro-self-interest. Microcredit was born for the purpose of getting capital to the unbankable, not generating huge growth or rewarding board members. Unfortunately, SKS appears to be heading toward the mantra “Too big to fail.” It apparently won’t have the skill sets and managerial talent to be effective, even as its own growth strategy begins to devour itself. Yet another illustration of how the global microcredit movement seems to be compromising its core values, even as the social entrepreneurial spirit becomes smothered by greed and power for those at the top.
There is no discussion of the high rates of interest upwards of 25% annually that are charged by SKS and other microfinance companies. Nor is there mention of the fact that due to this high rate of interest and the basic economic unsustainability of the clients there is a tendency to default which is averted by rescheduling of loans. However, such rescheduling cannot go on forever and so there is a danger of all microfinance companies buckling under after some time as mass defaults begin in more or less the same way as the sub-prime loan crisis. That is why Akula is trying to exit from the company model through the IPO route and going in for a more traditional NGO model.
Small ticket personal loans were also touted as the means to unlock the consumer potential of middle class India. Many of the organizations that were offering those loans have closed those businesses. Eventually, people are back to borrowing against gold – the traditional way money lenders lent to those whom banks wouldn’t lend. While microfinance is good in ideology, I just hope that the pressure and greed to grow do not derail these organizations and land the underserved back to the doors of the money lenders.
Some reasons pro IPO: 1. Size matters. Social banking needs size in order to reap benefits from economies of scale. ICT is a crucial part of it – and costly. Smaller entities have higher cost and are more bound to fail. 2. If you are running successfully a growing enterprise you should be rewarded for that. Key staff must be retained and rewarded. The board, judged by public opinion, has to decide what is adequate considering the community in which it is acting. 3. Interest rates hardly matter as we all know from so many researches. What matters is ACCESS to credit that so many millions normally don’t have. Please compare 25% annually to 10% daily as charged by loan sharks (or more than 3650% p.a. wihtout compound interest).
Vikash & Daniel,
We enjoyed the succinct write-up and how the company, SKS, is structured so I wonder how smaller MicroCredit organizations like ours with over 1500 members and growing can tap into this philantropic capitalizm which seems to be occuring?
Mr. Falk’s comments were also interesting to us as well since, as a very small organization, our setup of CnC Cafe’ is a brick&mortar business as well as eCommerce MicroCredit organization.
Our cost of loans is under 3% of outstanding and why we charge our members of the Cafe’ 21% on any MicroCredit loan.
Smaller does not mean higher costs if technology is used and we have demonstrated this as well on our current Facebook page platform we use to facilitate the lending process thru our raffle concept:
http://bit.ly/9SDU5w
Our staff are family and we have 0% turnover as they are committed to helping the community and providing the “ACCESS to credit” which you clearly pointed out is key.
All CnCpartners needs is a larger pool of funds to reach the 20,000 people we intend to tap by 2015 in our small community of Bamban, Tarlac, Philippines.
No IPO but using technology to change lives is proving very rewarding so far:)
~Clint & Cristy @cncpartners
MFI’s must be mission driven and they must charge a reasonable rate of interest (not charge an outrageous rate as in Mexico, just because they can), but that does not necessarily mean that one cannot operate on commercial principles and be profitable … Being poor or struggling for funds will not allow an MFI to pursue its mission and grow; complaining that small loan amts is not profitable is not a legitimate complaint.
SKS is a an excellent case in point, and their focus was group lending and yet they were able to make money … how, indeed?
MFIs better wake up and heed SKS’s formula if they are serious about scaling their operations and growing … strong process & process management discipline, making technology investments, and operating on commercial principles .
p.s. Bill Gates is able to make a difference on the international development scene because and only because he has the money, the mullah.
So people, pls get over the fact that making money is unethical (sure the shareholders at an NGO should not outrageously line their pockets), or being profitable is something to be eschewed …
We can only make a dent in poverty alleviation if MFIs are able to scale their operations, not otherwise; And to scale one needs funds, and to attract funds one needs to be profitable and to be profitable one must operate efficiently … you get the gist, I hope.
Thanks Vikas, Its very interesting and encouraging..
Regards
Anoop Singh Sengar
Country Manager at 3i Infotech Ltd
Great work Vikash, amazing that you have made insights to lot of information and articulation at different levels….keep it up
SIVARAMAKRISHNAN K V
Head Channel sales at GRADATIM
Dietar, Moneylenders charge 10% a month in crunch situations but I have not heard of a daily 10% interest charge anywhere. However, the point is that given the basic expenditure to income deficit of poor families they find the repayment of even subsidised loans from the government at an annual 5 to 10% a difficult proposition. That they do pay the higher rates to the moneylenders and now the MFIs means that they remain in poverty and do not grow out of it because of these loans. SKS does not publish its cost of funds and the amount of rescheduling of loans that is going on. Once it is listed in the bourses its accounts will become more transparent and it will be possible to know how exactly it is earning profits by catering to people who cant earn profits themselves.
I completely agree with Mr warner woodworth.MFI were initiated as non banking , pro poor loan facilitator entity . It is not for making profit. It should be re-distributed as loan waiver policy minus admin cost. Yes we do agree that to spread the loan need , backup capital is required , but should be recalculated on rescheduling cost + other expenses so that minimum load is there.Going to Private,public and later IPO differs the vision of the society formed. Later they will not called as Social Entreprenuers but Profit Making Entreprenuers taking the route of social Philanthropy.
Regards
Pawan Kumar Singh , Founder Purvanchal Vikas Foundation.
Great insights and excellent job articulating entire theme and sequence of events.
Very insightful article and interesting comments. My few points:
1. Not every MFIs needs to become an SKS or Grameen bank. True, attracting private equity is near impossible without scale but if scale is the bottomline, then something is wrong with the fundamental principles. The objective of an MFI could be targeting a certain number of clients in a certain geographical area and passing on benefits to those clients, as growth sets in, rather than aiming to be listed on the stock exchange. Too idealist a proposition but if no one will question the basic approach, then its just a rat- race to be the next biggest MFI, and anything to do with anything for the poor is just an incidental by-product.
2. Wonder if there could be a way to find out what those women members of MBTs have gained out of these very complicated and cleverly fabricated transactions (maybe they have….sorry for my naivete then ! ). Sure, Mr. Akula & Co. are masterminds and deserve the best possible compensation, but what have those women members gained from it all? Interest-free loans? Doubt it ! Education for their children – we will see if Mr. Gurucharan Das can deliver this.
3. And after all the MFIs, social businesses, Philanthropic capital and everything that remotely claims to empower the poor, 100 million more Indians are now living in poverty. See link below
http://in.reuters.com/article/topNews/idINIndia-47791820100419?rpc=60
Vikas,
Very Much informative Article. Thanks….
one point to be noted…
Catamaran Fund invested (n r muthy) in SKS Microfinance and acquires 1.3 % stake before it’s IPO
The news that a MFI finally can go for an IPO is great as the need of the hour is that the poor or the needy persons should be served at all possible level, this can only be achieved if we have MFI’s like SKS Microfinance which is leading the group to the next level of leverage i.e. public funds, we all want to give to poor but have little faith in the system, lets give the company a chance to prove us wrong.
SKS is definitely a game changer. In the last couple of years it has become very clear across the globe, that microfinance is a highly potent tool to wipe out poverty. All this brouhaha about SKS IPO was expected. Pessimists are questioning the profit motive of the biz, but hey, if i get rich while helping pull the poor out of poverty……it’s a divine thing….
My guess is SKS IPO will attract only high quality investors – both retail and institutional. And with the backing of the
likes of Mr. Narayan Murthy, this biz could be the next trendsetter and showcase for Indian industry. Vikram Akula has
already proved enough and i bet there’s much more of his brilliance to shine on. There’s far more potential and scale in
this business. Otherwise why would the bright Vikram, quit McKinsey to practice “fortune at the bottom of the Pyramid”
Great article but your ‘analogy’ is misleading to the point of being almost outrageous. The fact is that the MBTs started with 99.5% ownership and were reduced to something less than 16%. You seem to be trying to spin that into a story of incredible generosity by the new outside investors who arranged to give the MBTs time and a loan to ‘buy’ their new stake.
The fact is that there would be no SKS microfinance if the MBTs had not agreed to dilute ownership.
A much better analogy would be that after years of experimentation and hard work a struggling artist produced a couple masterpieces that his 4 friends recognize as something that will be worth millions. Those friends then say: “we can help you cash in on those millions,” how about we each put up $20 to get the $100 we will need to setup this company. We each have $20, but you struggling artist don’t have cash handy. So we’ll give you a loan and you can pay us back after the IPO.
The IPO takes place and voila… the original owner of the art now owns 20% of the proceeds and his “generous” friends now own 80%.
Jay See — I think you miss a key point in your analysis. It’s of course true that the MBTs were critical to the SKS transformation process, but it’s no less true that without outside investors, SKS would still be an operation several factors smaller than it is now. The masterpiece in your analogy may have been created by the artist, but 1) it was but a very rough sketch when the investors came around, and 2) realizing the masterpiece required unusually expensive materials that he could never have afforded. Without his 4 friends and their money, the masterpiece would still be a rough sketch by a struggling artist.
Thanks Daniel for your quick and constructive reply. You make some good points but the more I look into this the less convinced I am.
You put your finger on the key issue, i.e. how important and essential was the new private equity finance by Sequoia and others? I think we can agree that it have been very important and certainly important enough to deserve a significant ownership stake in the new public company. But from press accounts I see that some late investors such as “Catamaran” basically tripled their money from January this year to the IPO http://bit.ly/cSjBdj . We can presume that other early private equity investors also walked away with very hefty returns.
Reasonable people will disagree on what is a fair share for these pre-IPO venture capital investors. But comparing to other IPOs I would judge this as very generous to the venture capitalists and I still find it very difficult to argue that this was ‘generous’ to the MBTs because in my mind they (along with Akula) are the real founders of this company.
Recall that SKS Society began as a non-profit seeded by donor capital. Those were equity grants to the organization. Through the various transactions that you document the MBTs became the almost exclusive owners of SKS microfinance. In a sense then at this point this is a ‘client owned’ company since the MBTs are, by legal design, for the benefit of SKS clients. These owners in effect licensed their highly successful technology and sold their entire loan portfolio to SKS microfinance.
At that point SKS could have expanded in any manner of ways. Raising private equity capital was the path chosen and likely was the fastest path to expansion. But other paths could have been followed. For instance, the Mutual trusts could have worked to attract much more philanthropic capital to retain a much larger ownership stake (as you point out all they needed was Rs. 2 crore for the stake they got, they could have easily raised multiples of that amount). As you point out these shares nine times in value in a very short period of time. For a donor interested in benefiting poor SKS clienteles and communities this would have been a fabulous social return on investment. Obviously you can push that strategy only so far since SKS the firm needed not just the cash equity of investors but also their expertise.
But my point is that there were ways to transform SKS the firm that was 99.5% owned by the MBTs into the much larger and successful SKS microfinance that emerged a few years later without such a deep dilution of ownership. Some level of dilution of ownership in exchange for the cash and expertise of new investors is of course worthwhile. I personally am leaning to think that a dilution as deep as occurred was a very high price for the “original owners” to pay. Look at other IPOs around the world (say Google) and it’s very rare to see original owners give up so much so fast.
Maybe you can try to convince me that things are different at SKS, that the management and technology that the new investors are really worth the 80+ percent of the value of the new SKS. But I don’t think I’ll ever agree to the characterization that these early outside investors — who walked away with fabulous returns on investment –did what they did out of any special sense of generosity toward the 6.8 million women represented in those trusts.
I’m not at all against this transformation or the IPO, I’m just saying that it is not too hard to imagine alternate scenarios where SKS microfinance would have emerged just as successful but with a somewhat different ownership structure.
Once again, thanks for a very informative article.
Some food for thought for making value judgement on the SKS IPO
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The status of MF and MFI
Can Micro Finance be equated logically with other Finance despite the word ‘ finance ‘ is suffixed after ‘Micro?’ or can we equate ethically MFI with other industries in general and other financial institutions in particular taking cognizance of their respective vision , mission and market profile? Do these players (MFI & other FIs) enjoy the same level playing ground for their activities?
The power of romanticized MF and powerless process of productive investment
Every institution or industry has right to seek capital through IPO for their growth and has responsibility to honor their commitment to the investor or equity holders from their earnings, The spectacular performance of SKS IPO indicates how the romanticized Micro finance is able to attract the socially conscious investors on one hand and mobilize significant quantum of funds from the growth potential of the largely untapped capital market…Here return to capital assumes importance .to all the participants. In this context, will there be any difference in the ‘process of investment and earning‘( productive investment/ income generation / profit realization) right from the ultimate user of equity capital in the given market niche for MFI ( mostly informal sector with the SHG/poor clients ) and for others FIs(mostly in the formal sector with non poor clients)?
Regulation
Taking cognizance of the lessons from the functioning of the Regional Rural Banks in Indian rural financial landscape, started in 1975 ceremoniously with the mission for the exclusive inclusion of rural poor in the battle against poverty and subsequently drifting to urban non poor also and ultimately merging with sponsoring banks unceremoniously in the formal sector, a question begs ‘is the ‘regulatory and supervisory mechanism’ adequate enough to ensure prevention of MFI’s mission drift – development to commercial – in the non formal sector?
Validity of the product as a panacea for the poor
In the context of Indian Prime Minster’s concern, anguished during IEA conference recently held in Bhuneswar, that the ‘decline in poverty has not been as fast as one would have wished and it remains a major challenge before the country because of the poor are still too poor’, Is this situation, in poverty sector prevailing a) in spite of aggressive micro financing (micro credit only) by various financial institutions including MFIs with mandatory target from supply side or b) because of multiple financing , multiple borrowing with the poor credit absorbing infrastructural facilities, near micro credit saturation market ,over indebtedness , in the demand side?
As a corollary to the above one, two more questions
a)Whether ‘micro credit alone’ being the only portfolio of the MFI seeking IPO is adequate to do the ‘magic’ in the poverty sector ? Can we establish a causal relationship between the micro credit and income generation or poverty reduction without any assumption? ( The related issue ‘ questioning the validity on the impact of micro credit’ in MF arena, has become a hot topic’ in many postings in CGAP blog )
Shift from micro credit to micro insurance
b) It is an acknowledged fact that Micro finance is a package of financial services including micro savings, micro credit , micro insurance , transfer services and other services required for the poor.If the MFI design their portfolio management for micro insurance also with or without micro credit and eventually facilitating making a substantial dent in poverty canvas, will their approach for IPO justified without any criticism?
In fine can we expect the initial successful Financial market inclusion of MFI (SKS) would also lead to more ultimate successful micro financial inclusion of the poorest ?
While the ‘end ‘result in MF game (poverty reduction) assume more important and the means such as IPO, ROI,VIP/celebrity Investing, are all subjective and secondary ones. let us therefore wait and watch the ‘end ‘ performance of SKS as MFI in the battle against poverty. during post IPO venture period in the given regulatory environ.
Are we going back to the days when nationalisation of private commercial banks to open up their resources to the needy and poor was justified on the grounds that the large deposits mobilised was not being used to provide credit opportunities to the sector who formed majority of the low cost savings clients to the banks?
This time around the logic could be that the huge clientele of MFIs are almost trapped – they borrow cycle after cycle till they reach the point that their current incomes are just enough to service the loans – the loan cycles are short enough to ensure that incremental income from the uses of these loans are adequate to make the poor borrowers to service their loans – leading to a debt trap situation.
Because the returns on the livelihoods of these poor will be just enough to service the loans and not enough to create their own capital – would prompt the Government to step in with a concern that national savings rate presently at around 38% of GDP would be threatened? It would be too optimistic to expect that all the profits getting into private sector would be used for nation building investments.
People talk of micro insurance being taken to the poor by the MFIs? Of whose products? The same companies who baited the middle class with excellent market related growth and were taking off the table upfront 35% of the investments in ULIPs in the first two years? They were only passing on the risks to the people who are less capable of bearing them and making their own business opportunities in the process? Will these insurance companies really serve the interests of the poor? They once again see another market opportunity in micro finance.
Then the economic issues can take a political turn.