Written by Kate Lauer, lawyer and a policy advisory consultant to Consultative Group to Assist the Poor (CGAP), published in June 2008 as Number 13 of Occasional Papers, a publication of CGAP, 28 pages, available at http://www.cgap.org/gm/document-1.9.4213/OccasionalPaper_13.pdf
This paper examines nonprofit microfinance institutions (NGO MFIs) that plan to transform into a regulated for-profit company, while focusing on the issue of ownership establishment and the challenges it presents. The issues discussed in what the author calls a “guidance paper for those who plan to carry out a transformation” may be summarized as follows; legal restrictions to NGO’s ownership of the transformed institution, limits concerning the transformation of assets and liabilities, limitations regarding NGO’s grant funding, and issuance of shares in the transformed institution. (page 1)
After redefining “transformation” solely as the “transfer by an ownerless NGO of all or a part of its microfinance business to a for-profit company” (page 2) Lauer explains the possible motives for transformation. Accordingly, majority of the transformations are triggered by legislative change; 7 of 11 transformations completed in 2007, were mandated by new legislation (page 17). Another popular motive is the desire to provide new services to clients, including savings and transfering services.
Lauer argues that in most transformations, the NGO has retained, or wanted to retain, control over the transformed institution. She then explains the legal restrictions that may have interfered with the NGO’s initial intent of being the controlling shareholder. There are six restrictions listed, including the maximum ownership limitation set by the operating country’s legislature that limits the percentage of shares an individual or an entity may own in a regulated financial institution.
Since establishing ownership of the transformed institution involves a capital contribution, often comprised of the NGO’s loan portfolio and other assets, issues may rise if the transfer of the loan portfolio and other assets is restricted by law. Lauer further argues that a loan portfolio may not be used to satisfy the initial capital requirment since in many countries, local law does not permit the transfer of a loan portfolio in exchange for shares (page 6). Related is the issue of transferring liabilities. Lauer advises that an NGO MFI with outstanding borrowings should review whether these liabilities will be assigned to and assumed by the new company or stay with the NGO.
Lauer emphasizes the difference between the governance of an NGO and a company by stating that “a company is controlled by owners who have an incentive to protect their private financial interests,while an NGO has no owners and depends on the social motivation of its governing body.” (page 10) She further argues that with the transformation, the NGO has to adjust to new measurements of accountability and accomodate new shareholder’s interests.
To conclude, Lauer offers insight on how to protect the NGO’s original mission once the transformation occurs. She calls on NGOs to familiriaze themselves with legal and financial considerations that may affect the NGO’s selection of outside investors: “There has been significant upside to some transformations because they are permitted to offer additional services, access commercial capital, and work toward better governance. Some of this upside can be traced specifically to the introduction of outside owners, who may bring financial expertise, important connections to providers of capital, and the potential to contribute to effective governance. There are also risks, including in particular the possibility of mission drift,” meaning a departure from core values. (page 16)
The cases provided by Lauer are; Bolivian Prodem transforming into Prodem FFP in 1999, in Mexico the 2001 transformation of Asociacion Programa in Mexico Compartamos into Compartomas, a limited liability finance company, Compartomas. As an example for client ownership, Lauer gives the case of Indian SHARE transforming into SHARE Microfin Limited. In 2000, “99 % of SHARE’s paid-up capital of USD 1.2 million was contributed by over 26,000 poor women clients via the conversion of their compulsory savings into shares.” (page 11)
By Ipek Kuran, Research Assistant
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