NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

As NextBillion readers are well aware, microfinance has been a steadily growing industry, and since the early 2000s, has almost become a household word. Since Muhmmad Yunus won the Nobel Prize, countless organizations have begun to invest in and embrace microfinance, both in the profit and non-for-profit sectors. Kiva alone has issued hundreds of millions of dollars in loans, as has the Yunus-founded Grameen Bank, which recently opened up a branch in the United States (Grameen America). The success of microfinance has led to innumerable foundations and organizations from the Gates Foundation to the Clinton Global Initative to begin experimenting with microfinance and the impact it can provide. However, despite this success, there is one striking shortfall: Microloans fail to consistently provide the full impact they were set forth to provide. They fall short, in most cases, of truly creating sustainabile businesses, creating jobs, and substantially increasing household income.

Traditional microfinance is a method of loaning very small amounts of money to poor people who have no other option for raising capital so they can create micro-enterprises and increase their income. In spite of their lack of a formal education and limited access to basic infrastructure and resources, there has been an industry-wide repayment rate of over 95 percent, with interest rates typically exceeding 15-20 percent. In spite of microfinance’s success in providing access to capital to the base of the pyramid, most MFIs are structured and capitalized to only take an entrepreneur so far. The vast majority of entrepreneurs served by MFI loans still lack the ability to scale their business, add real value in the supply chain, and steadily increase their profitability. Micro-businesses frequently take out several rounds of loans, creating a cycle, not true sustainability. The same micro-entrepreneurs may take out loans from other MFIs to repay initial loans, or even take out loans for personal use, pay it back, and then take out another loan again in the future. While microloans make capital available, they fall short in providing true growth.

At the Micro Equity Development Fund, we believe the answer that not only provides additional capital and a more long-term approach, but also greater benefits for investors as well, lies with micro-equity. Micro-equity seeks to overcome these obstacles by giving larger sums of capital without fixed payment amounts in return for giving investors a small equity stake in the micro-business. The micro-entrepreneur thus has more time to use the capital and truly grow the business. By introducing micro-equity, micro-entrepreneurs and microenterprises now have new opportunities to access additional capital and more time to grow their businesses without strict repayment dates and at times exorbitant interest rates.

The dual opportunity upon which the micro-equity seeks to capitalize is the introduction of a new, robust and flexible source of capital that will fuel further growth in microenterprises currently funded via microloans and help them grow into small-to-medium sized companies. On the investor side, this would provide another channel to add safe, socially responsible investment opportunities to investors’ portfolios.

There are many reasons behind the absence of these middle-sized employers in developing countries, primarily a lack of investment capital, but also the absence of publicly available resources such as the equivalent of the U.S. Small Business Administration, a domestic private venture capital industry, or university-based business incubators, and peer-to-peer business networks. This is the demand side of micro-equity. On the supply side, there is an equally important opportunity to be capitalized upon by investors.

From a logistical standpoint, implementing this new model could be less complex than one would expect. MFIs can easily adapt to micro-equity, and can continue to use their existing infrastructure with minor changes in terms of teaching basic accounting. The cost to them will be offset by “maintenance” fees, or by sharing in the profits investors receive in return for their oversight. Since these should be viewed as long-term investments, they have the potential to provide greater overall returns for MFIs, especially as profits increase and these businesses grow.

Micro-equity will seek to empower micro-enterprises by providing them the tools and capital they need (through MFIs) to grow their businesses. Although this model is intended to deliver a return on investment to partner MFIs and individual investors, the investment is socially-oriented.

This new investment vehicle will also attract new investors. The emerging trend is to integrate socially-conscious business practices with the efficiency and sustainability of the private sector to create enterprises that equitably balance their focus on delivering both a social and financial return. Therefore, micro-equity will be appealing to an evolved hybrid investor who is socially-minded, but also believes that generating returns on invested capital using this method can only enhance the opportunities to alleviate poverty. If the model is successful in spawning the development and driving growth of medium-sized enterprises, this will also likely improve the overall business climate in emerging markets, creating a multiplier effect for their economic growth and additional investment opportunities – and most importantly job creation.

Lastly, a system of checks and balances is important to ensure protection of both the investors and the micro-business. In order to protect the investor, micro-equity investments will be given in tranches and often tied to assets, which can be collateralized, such as machines and equipment which can be recovered in the event of default.

To protect the micro-entrepreneur, investors can never own more than a small percentage of the micro-business, and in the event of liquidation, the micro-entrepreneur has first opportunity to repurchase the equity at a “fair price” based on our valuation parameters. It is important that the micro-entrepreneurs have the freedom to grow as they see fit, so we will also limit outside influence to ensure that businesses can grow at the direction of their owners. By limiting investors’ influence, micro-equity can assist and not undermine the social benefits and growth in developing societies.

The impact should be quickly observed. Micro-equity will bring a substantial amount of new capital to entrepreneurs in emerging markets and at the base of the pyramid, allowing them to more easily scale their businesses and become more profitable. Our venture, Micro Equity Development Fund (MEDF), is preparing to pilot our model and introduce micro-equity abroad.

Mark Wien is a co-founder of the Micro Equity Development Fund, a for-profit, social initiative focused on connecting investors with investment opportunities in microfinance, particularly micro-equity. He can be reached at Mark.Wien@theMEDF.com.