What do IPOs bring to microfinance?
A question that gets presented repeatedly to me is stated something like this: “Are you against profit in microfinance? We need profit to grow, so why are you negative about IPOs?” To answer that question, I’ll need to first talk about my views on profit, and then I’ll relate those to the issue of IPOs.
Profit, yes, but how much profit?
I’ve not ever been against “sustainability” (as we used to call “profit”). I spent 15 years of my life working on the Microfin financial projections software that the majority of the industry uses to make their business plans and determine how to be profitable. Both of the well-known IPOs – Compartamos and SKS – used my Microfin software in earlier stages of their institutional planning.
In my 27 years in microfinance, I have never once said that aiming for profitability is not a justifiable goal – just the contrary. But most of those 27 years were in the “olden days”, when we were lucky to break even. My concerns over the past ten years are that we have no serious discussion on the question of “How much profit is too much profit?” You can see much more of my thoughts on that point here.
My position is that earning a “responsible” level of profit is acceptable, and that we need to be extremely careful and fully committed to responsible decision making when we are lending money to the very poor at the bottom of the economic pyramid (and mostly women), prices are non-transparent and difficult to understand, and we are working in quite imperfect markets that vastly benefit the seller over the buyer.
Pure business theory would say that these are the prime conditions for quick profits. Early entrants reap the benefits, and others then enter the market to try and also reap quick wealth. Supply grows, and supply eventually meets demand, forcing prices and profits to an equilibrium level. But reaping the “Fortune at the Bottom of the Pyramid” is not the original vision of we who started innovating in microfinance. Many of us are arguing that responsible microfinance requires responsible decisions by management, not decisions centered on profit maximization. A CEO-friend of mine said, “I’m not against profit, I’m against profiteering.”
What are the benefits – and risks – of IPOs?
So profit isn’t bad, within limits, but do we therefore need IPOs? IPOs are argued to be necessary to increase scale. That’s perhaps true if you’re a huge manufacturing company needing to build more factories, but IPOs are not needed for growth to occur in microfinance. The amount of money we need is not that large, and the funds can, and are, mobilized from private equity investors. And anyone paying attention would see ample evidence that we don’t have much of a supply shortage problem in many countries. Rather, we have a repeated occurrence of over-indebtedness, with growing percentages of the client base juggling multiple loans.
So if not really needed for prudent growth and for providing credit to those not already having access, what other motivations are there for IPOs? I think it is rather apparent that the other primary motivation is the potentially huge return going to the original investors. When all goes as planned, the IPO allows the original investors to cash out some of their initial investment as new investors buy up the shares. The Compartamos IPO was a 100% secondary sale of shares to allow original investors to “cash out”. No new equity was raised for Compartamos. Instead, US$400 million in cash went into the pockets of the initial investors, who also received another US$1.6 billion in wealth for the shares they continued to hold to sell later.
Was the IPO necessary to help Compartamos grow? I see no evidence. To the contrary, they could have grown through financial leverage (which they have completely ignored, because they had far more equity through profit than they could use). They could have grown through inviting in new private equity, as there were many standing in line wanting to do so, but they accepted not a single new investor in their seven years as a privately held for-profit.
The SKS IPO was more “balanced” as I point out in this presentation here, but I believe the same arguments can be made – the SKS IPO was not necessary for growth, the Indian market was experiencing serious over-indebtedness problems, and the original investors were pursuing an IPO in order to extract large financial gains.
Public For-Profits vs Private For-Profits
My last concern on the issues of IPOs is that an institution choosing to fund itself through private equity can control who sits at the table. It can invite in investors that agree on core values and turn others away. It can set standards on the maximum amount of profit the business will choose to generate. It can set prices to target those profit levels, rather than follow the path of “charging what the market will bear and maximizing profits.”
The rules turn upside down when a business converts into a public for-profit. In some countries, it is a legal obligation for the managers to maximize profit for the shareholders. Even if not so, any person, with whatever values or goals, can purchase your shares when they are sold openly. Shareholders have a voice and vote at meetings and can overrule the desires of management.
The publicly traded institution seriously risks losing the ability to maintain any commitment to core values centered on responsible pricing and responsible profits. If the opportunity is there to get very rich off of loaning money to the poor, how does a publicly traded company say, “We proudly choose not to act that way”? That is my main concern with IPOs.