The ‘Conceptual Framework’ to help microfinance investors exit responsibly was launched at a workshop in Utrecht last week.
Exiting “responsibly” from investment in microfinance institutions is particularly important, say Sam Mendelson and Daniel Rozas from the European Microfinance Platform in a “speaker’s corner” article written for "Delano".
So-called ‘impact investment’ has become more and more important in the financial inclusion sector, especially in terms of equity investments to help microfinance institutions (MFIs) grow and ensure quality services to clients in low-income markets, while providing a financial return to a fund’s asset owners. As this trend has developed, so have ‘exits’--sales of equity stakes to a new buyer – and with them, the importance of responsibly selecting a buyer that is suitable for the MFI, its staff, and ultimately its clients.
Investors may exit for a number of factors. A socially-focused investor may view its role as ‘midwifing’ an MFI to sustainability, and interest by commercial investors means that role might be complete. There may be a change in the investment strategy of the seller, or a need for funds to meet capital requirements or make other investments, or a change in the market context, including a need to mitigate risk.
Whatever the reason, exiting ‘responsibly’ is particularly important when the asset being sold involves the provision of key services to vulnerable populations. Yet there is no codified guide, let alone regulation concerning how this should be done. Each investor has its own internal processes and procedures, and for new investors, starting from the proverbial ‘blank page’ risks mistakes with significant consequences.
To help investors with this challenge, the Dutch financial inclusion platform NpM, in partnership with the European Microfinance Platform Investor Action Group, and the Financial Inclusion Equity Council (FIEC), commissioned us last summer to conduct research of industry attitudes and processes surrounding this issue, with the intention of producing a resource that could act as a guide, a tool, to provide some framework to this relatively new challenge. We held a workshop for investors in Utrecht on 25 April to discuss these issues and launch the paper, entitled “Caveat Venditor: Towards a Conceptual Framework for Buyer Selection in Responsible Microfinance Exits”
Building on previous work by CGAP in 2014, this research started with several key questions. What does it mean to exit ‘responsibly’? What (if any) responsibility does the seller have to select a buyer that will maintain the microfinance institution (MFI’s) social mission? And how can social investors manage their fiduciary obligations when deciding to sell to a given buyer?
The research process involved an industry consultation (including a survey, interviews and a workshop during European Microfinance Week in Luxembourg) to consolidate investors’ own emerging principles and procedures in assessing potential buyers, and to use the findings to produce what we have called a ‘conceptual framework for buyer selection’ – a flowchart representation of the steps and criteria inherent in responsible buyer selection in microfinance equity exits. We hope this framework will serve as a resource for investors embarking on an equity sale, and could also help investors to brief external organizations that assist them in exit trajectories (investment banks, advisory firms, etc.); assist new categories of impact investors that have little experience in exits; and serve as a guide to potential buyers to help understand selection criteria and prevent interested (but unsuitable) buyers from wasting time on a futile due diligence process.
Overall, the industry consensus is that the financial offer (how much a buyer is willing to pay) is the dominant criterion in buyer selection. This consensus is ‘Hippocratic’ in nature--what we have called “first, do no harm”--which in this context means excluding only egregiously unsuitable candidates whose purchase, particularly of a majority stake, would imperil the social mission of the MFI. After this, the financial offer dominates in the ultimate selection. This is the dominant practice reported by equity investors throughout this research.
There is another position too, which holds that “first, do no harm” exclusionary criteria fails to recognize the deleterious effect on staff morale if a new investor dilutes the mission of a socially-focused institution; the particular vulnerability of microfinance clients and the need to ensure that they are not only protected from bad practices, but that they are also well-served by the mission-driven institution being sold; and, perhaps most significantly; the implied intention of the asset owners that the social mission of the asset should be maintained.
We believe that this approach, with its positive obligation on the seller(s), is better aligned with pursuing a social mission while delivering a reasonable financial return - which is at the core of the social investment value proposition.
The “Conceptual Framework for Buyer Selection” we have produced brings together the practices of different investors, but also advocates an evaluation process which moves beyond “first, do no harm” towards “best interests”--while incorporating elements of both. It is structured so that questions are organized based on the type of transaction being contemplated: a minority or majority stake being sold, as part of a consortium of shareholders, or by a single investor.
We believe that the responsibility of finding the right buyer lies very much with those doing the selling. And if the sale means handing over control--a majority stake--this creates an even greater burden. As we argue in the conclusion of the paper, “a buyer selection practice which gives primacy to the financial offer and considers social mission and strategic value to the investee - the investee’s best interests - only to reject egregiously unsuitable buyers, fails to keep in mind that the best interests of the MFI and its clients is, for the investors who put funds into the MIV, arguably the primary reason for investing in the financial inclusion sector in the first place.”
We hope that this research will spur discussion and encourage investors to wrestle with the challenges of strengthening the sector’s focus on sustainable and profitable social mission. We hope too that it will inspire further work on an issue which, as equity sales continue to grow, will only increase in importance.