Capitalism vs. Altruism

For SKS, this is a second round of controversy. It is the first Indian company in the microfinance sector to go in for an initial public offer (IPO). It is among the first half-dozen anywhere in the world to list. (Banco Compartamos of Mexico went public in 2007 and drew considerable criticism.) SKS had a very successful IPO in August, being oversubscribed more than 13 times. Ironically around that time, several big issuers — including public sector majors — were waiting for the markets to improve. SKS raised $358 million. It got around $22 per share, the upper end of the price band. It jumped more than 16% on listing and, today, even after plunging when the CEO was fired, is some 30% above the issue price.

According to Nobel-prize-winning economist Muhammad Yunus, who pioneered the microfinance industry in the 1980s by giving small loans to basket weavers in Bangladesh, “Microfinance is mission-driven banking. When you float an IPO you are telling your investors there is a good opportunity to make money off poor people. The message is wrong, the direction is wrong…. Staunch believers of market forces keep saying competition will bring business to people who are now unreached. Over centuries, this has not happened. Competition never brought credit to the poor; it only took it to richer people. That is the route the IPO will take them.”

Taking the For-profit Route

Yunus pioneered the “social business” model where there is no profit involved for the investor or promoter. SKS and its ilk are taking a totally different route. Wrote The New York Times at the height of the SKS IPO controversy: “SKS was set up as what philanthropists call a “social enterprise” — a business based on the concept of doing well by doing good… there is no question that the company’s 41-year-old Indian-American founder Vikram Akula and investors who include prominent Silicon Valley venture capitalists will do very well indeed from the IPO. Akula has already privately sold shares worth almost $13 million, and he still holds stock options potentially worth $55 million. The question is whether the social good will be as amply rewarded.” Headlined The Wall Street Journal: “SKS Microfinance’s IPO Plans Pit Capitalism vs. Altruism.”

There were some disillusioned casualties. A Seattle-based nonprofit, which stood to make a handsome amount by selling its stake in SKS, decided to close shop. “You are encouraging profit maximization while nonprofits are closing down,” Yunus pointed out then. “That shows the real result of this IPO.”

In India, there have been departures, too. M.S. Sriram, Lalita D. Gupte Chair Professor in Microfinance at the Indian Institute of Management Ahmedabad (IIMA), writes in a paper titled “Commercialization of Microfinance in India: A Discussion on the Emperor’s Apparel”: “There were three high profile persons — Gurcharan Das, the author of The Difficulty of Being Good, Anu Aga of Thermax and Narayan Ramachandran of Morgan Stanley — on board [the SKS group] till days before the [IPO] prospectus was filed. Their sudden resignation in March in the run up to the filing of the prospectus raises some questions.”

SKS founder and chairperson Akula, however, has no doubts that his way is best. “The path of the capital markets is the path that will lead to the greatest social impact,” he says. “Otherwise, you are limiting your reach and, in effect, not providing financial services to all those people that you could.” He admits that it did take some time to make the regulators comfortable with the idea of a microfinance institutions (MFI) going public, but that was only because it was a new concept.

The Right Credentials

Akula has all the right credentials. He began working in rural India two decades ago as a community organizer of women’s self-help groups for a nonprofit. He set up SKS Microfinance as a nonprofit in 1997, went to McKinsey & Co in Chicago as a consultant in 2004, and came back to SKS in 2005. He returned a convert; in 2005, he made SKS a for-profit. In 2006, Akula was named by Time magazine as one of world’s 100 most influential people. Also in 2006, he was given the Social Entrepreneur of the Year award at the World Economic Forum meet in Delhi. He is currently writing a book appositely titled A Fistful of Rice: My Unexpected Quest to End Poverty through Profitability.

At SKS, Akula has delivered on the profitability front. The latest quarter ended June 30, 2010, saw profit after tax increase 265% to $15 million compared to the corresponding period the previous year. Gross income increased by 82% to $70.82 million. As of March 31, 2010 (the company’s year-end), SKS had total disbursements of more than $3 billion and 6.8 million women borrowers. This gives it almost three times the growth rate of Muhammad Yunus’ Grameen Bank in Bangladesh.

Akula estimates that poor households in India need close to $50 billion in credit, only 10% to15% of which has been met by all MFIs combined because of lack of access to capital. “The best way to raise large capital is from commercial capital markets and the best way to tap commercial capital markets is to be structured as a profit-oriented institution and do an IPO,” says Akula. “It is precisely where that $50 billion will come from; it is the only place it can come from. That is why we did this IPO.”

Akula is not interacting with the media after the departure of Gurumani. An SKS spokesperson, referring to Gurumani’s comment that he could sue, says that the deposed CEO can go the courts if he likes. “We have done what we have to do, let him do what he has to,” he says. “I cannot comment on his behalf. We have not received any [legal] notice so far.”

Battle for Control

The battle in SKS seems to be about control and money. The company has clarified that there were no issues of financial irregularity in Gurumani’s departure. But the power struggle, as the media has dubbed it, was evident even earlier.

Akula has a very high-profile. Observers speculate that he did not expect the adverse reaction and the global debate over the IPO. The Indian media coverage was actually muted; articles in the Western media raised problems. People within SKS say that Akula allowed Gurumani to take the lead in the IPO as he preferred to stay away from the acrimony. Once the issue was a done deal, however, and the heat was off, he wanted to get back to the helm. The shares were listed on August 16. At a board meeting held in early September, SKS appointed Akula as executive chairman from November 1. (He is currently non-executive.) M.R. Rao, chief operating officer, was elevated to deputy CEO with immediate effect. The writing on the wall for Gurumani was getting clearer by the day.

The only issue, say company insiders, was about the terms of disengagement. Gurumani had already cashed out most of his stock options. The board offered him a handsome amount — upwards of $1 million — to resign gracefully. He wanted more. “He was originally given 900,000 shares when he came on,” says a company spokesperson. “He sold 225,000 shares prior to the IPO. Another 675,000 would have vested in him over a period of four years. After the termination, he doesn’t get a single share. He has no right to his stock options right now. He can’t sell anything.”

Not a Moral Issue

The issue in this and the larger debate about nonprofits turning for-profit is one of context, experts note. In a purely capitalist society, this would have been the way to go; Akula would have been a folk hero. In India, which still has a socialist ethos, there is distaste for money grubbing — and what some might even perceive as greed.

“This is not about morality,” says Ramesh Ramanathan, promoter-director of Janalakshmi, a social enterprise. “It’s not about good and bad. It’s about the nature of markets. Markets are a double-edged sword. The power of the market for innovation, for raising money, for hiring good people, for bringing value to customers… all that positive also comes with baggage. That baggage is greed.”

“When an MFI becomes for-profit, the danger does exist that it might lose its moral and ethical compass,” says Sriram of IIMA. “Everybody succumbs to the lure of the market.” Sriram feels that Gurumani’s departure has nothing to do with this dilemma, although the squabble over the golden handshake is another matter.

Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB), agrees. “It seems to be the consequence of an internal disagreement about the management of the organization between the CEO and the board and perhaps between the CEO and the chairman,” he says. “These things are quite common in organizations, only they are handled a bit carefully so that CEO terminations are relatively rarer. Given that Akula, the founder, is in the driver’s seat, the exit should not hurt SKS too much.”

SKS has “sought to take a profit-oriented approach to microfinance,” he continues. “There is absolutely nothing wrong with that. This is an ongoing debate in the microfinance area. Everyone admits that without the profit motive, it is difficult to have organizations that would engage in the activity in a sustained and efficient manner. On the other hand, a total fixation on the bottom line can easily lead to mission drift.”

Chakrabarti quotes a recent paper published in the Journal of Economic Perspectives titled “Microfinance Meets the Market”: “Globally, the social development model accounts for about 90% of microfinance organizations but 10% of profit-oriented providers are very large and account for over half of the industry assets. The nonprofits lend more to the bottom of the pyramid while the for-profits tend to focus on a slightly higher tier. Also nonprofits are more likely to go for group-lending while for-profits go largely for individual-lending. So, in conclusion, for-profits and nonprofits have somewhat different profiles in the microfinance industry, but both have important roles to play.”

Laws Need Change

Yunus is not so sure. He believes that laws should be changed if they prevent lending to the poor. “If the government is poor-friendly, it should make laws to create banks for the poor and the poorest,” he says. Deval Sanghavi, president and co-founder of Dasra, a venture philanthropy fund, feels that non-banking finance companies (NBFCs) should be allowed to raise external commercial capital. “If the government were truly committed to social change, it should enable 1% loans to come into the country and then lend at 3% to 5%,” Sanghavi says. Rahul Saikia, vice-president, investment banking at Enam Securities, believes the rule that requires banks to have 40% of their portfolio in the “priority sector” should be amended to withdraw priority sector status from MFIs. “That’s what MFIs are surviving on today. If you remove that, only the quality MFIs will survive,” he says.

Such changes would enable MFIs to access lower-cost funds. But it wouldn’t be a substitute for the capital markets. Says Sumir Chadha, managing director of Sequoia Capital India, SKS’ largest investor: “The not-for-profit world in India is filled with well-meaning people, but the challenge is that no one is going to give you enough funds to scale up. Grants just don’t scale to that level.” Additionally “from a banking standpoint, there is no way you can get debt since it’s a percentage of how much equity you have,” adds Ash Lilani, president, Asia market, SVB Capital, another SKS investor.

But Yunus thinks there is enough money in the villages. “Grameen Bank doesn’t have a problem with money. It takes deposits and lends money. The solution is not in going to IPO; the solution is in treating microfinance as banking. That would be the right direction rather than rushing to the big-money people, offering them an opportunity to make money for themselves out of poor people.”

What troubles Sriram of IIMA is the idea that one should not make money while tapping the bottom of the pyramid. “Very much the way we don’t get upset when soaps are sold to the poor, we should not get upset that people are making money from microfinance,” he says. He finds dissonance, however, when this objective is juxtaposed with the lofty mission of eliminating poverty. “There is little evidence to show that microfinance eliminates poverty,” he says, “If that had been the case, Bangladesh should have declared itself poverty-free.”

Janalakshmi’s Ramanathan cites the case of SKS itself. “Vikram Akula constantly communicated a message that it’s a social business. But when push came to shove, the actions were all of a commercial enterprise,” he says. Adds Dasra’s Sanghavi: “The IPO is not unethical or illegal, it’s just disappointing.” Yunus, a sterner critic, says that once MFIs are in the business to make money, no amount is ever enough. “Interest continues to go up because the market will force [MFIs] to go in that direction and you end up becoming a bigger and bigger loan shark.” (Today MFIs charge 28%, higher than the banks but lower than the village moneylender’s 50% plus.)

The Goats and the Sharks

Everyone at SKS has made money, though some more than the others. When Anjamma took her first loan from SKS in 1998, it was for $33 to buy a goat, says the company’s 2009-2010 annual report. Today, several other goats and loans later, she owns a buffalo and a plot of land worth $889.

“First microfinance IPO makes millionaires out of employees,” reports Business Standard. “K. Nirmala, 31, will prepay her home loan shortly, courtesy the stock she held in SKS Microfinance — her employer for 13 years…. Nirmala is not alone. Five days after the company was listed, many of her colleagues are finding themselves in the league of millionaires.”

Gurumani, who had exercised his option to purchase 225,000 shares on March 23, 2010, has made a profit of $1.69 million by selling his shares under a prior agreement, says the paper by IIMA’s Sriram.

At SKS Microfinance, money is going places.