ET: The Poor as Puppets: January 31, 2011

Within two years of that proud declaration,there was little community-based or mutual benefit about Share Microfin.As on March 31,2007,promoters,associates and employees,led by Kumar,owned 98%,having bought all the shares held by the poor women,which were housed in mutual benefit trusts,or MBTs (The story on Page 1 explains their working).

About the time the promoters finished taking control of the company also marked a breakout point for the business.Between 2006-07 and 2009-10,revenues of Share Microfin increased from Rs 62.9 crore to Rs 475.3 crorea compounded annual growth rate (CAGR) of 96%.Net profit increased from Rs 1 crore to 108.7 crorea CAGR of 372%.In other words,the poor women bore the risk during the building phase of the business.But it was the promoters who reaped the rewards from the business taking off.

The wholesale transfer of shares from MBTs to the promoters raises several questions of corporate governance.At what price were the shares of MBTs sold to the promoters Who did the valuation Who represented the MBTs Was the consent of the poor women taken;if so,how Did the women get the money;if so,in what share
Kumar did not respond to phone calls,emails,faxes and text messages,sent over a period of two months.Since Share Microfin is not a listed company,the only public documents pertaining to it are its corporate filings with the ministry of corporate affairs.None of these questions are answered in those filings.

The only shreds of informationunconfirmedrelating to this transfer comes from the March 2010 paper by MS Sriram,an adjunct professor at IIM-A.Srirams paper was the first public attempt to pierce the veil surrounding MBTs.

According to the paper,before Share Microfin the NBFC was formed,there used to be an NGO called Share.Poor women held savings in the NGO,which were converted into share capital in the NBFC,in 1999.On transformation,99% of the paid-up capital of $1.2 million was contributed by over 26,000 poor women clients via the conversion of their compulsory savings into shares, says the paper.This was done to meet the minimum equity requirement of Rs 2 crore for an NBFC.The poor women were paid 10% dividend a year for three years.

According to Sriram,in 2005,Shares promoters and employees bought out the women by paying a premium of 50%,or $1.8 million.In 2007,Dubai-based investor Legatum Capital acquired majority holding in Share Microfin for $25 million.Sriram says 18% of the stake was bought from Share Microfin employees,who had bought it from the poor women two years back.Rough calculations show the employees would have made a minimum 100% return in two years.

Even if the promoters decided to bring in a private investor to increase capital,which would enable the company to lend more,couldnt the private investor have bought the shares from the MBTs (read,poor women) Why make the MBTs sell the shares to promoters,associates and employees,who,in turn,sell to the private investor at a 100% windfall,if not more Kumar has some explaining to do.

SPANDANA WENT FROM BEING 93% owned by 20,000 poor women in March 2004 to 86% owned by promoters in March 2006.By March 2007,the mutual benefit trust (MBT),the shareholding vehicle for the poor women,had no stake in Spandana.The promotersPadmaja Reddy and her husband,Vijaya Siva Rami Reddyheld a 93% stake.

Padmaja Reddy says the promoters never wanted Spandana to be a community-owned company.They took the MBT route only to enable Spandana to convert itself from an NGO to an NBFC.This is unlike Share or SKS,which made community ownership a stated objective.It (the MBT) had a limited objective, says Reddy,who is also the companys managing director.

According to Reddy,during the time ownership was with the MBT,the promoters started talking to two private investors,Lok Capital and JM Financial Trustee,for an equity infusion so that the company grew faster.But they (the private investors) did not want MBT ownership in the company, says Reddy.So,the promoters took a loan to buy out the MBT.

A company spokeswoman says the Spandana MBT was paid a 10-20 % premium,thereby making a handsome profit.In other words,if the par value of the shares was Rs 10,the MBT got Rs 11-12 per share.On its investment of Rs 2 crore,the minimum equity required to become an NBFC,the MBT received about Rs 2.2-2.4 crore.Given that the MBT held 93%,Spandana was valuedin the words of the spokeswoman,by a reputed chartered accountant firm at about Rs 2.5 crore.

In 2006-07,less than 18 months after the first lot of shares were transferred from the MBT,Padmaja Reddy,her husband and one Koteswaramma Yenumual sold 138,000 shares to Lok Capital and JM Financial.This was part of the 1.2 million shares given to the two new shareholders for about Rs 50 crore.Based on this transaction,the value of the 2.15 million shares held by Spandana MBT was Rs 88 croreabout 35 times what the promoters paid the MBT 18 months ago.

As in Share Microfin,the transformation from a communityowned company to a promoter-owned company happened when Spandana was on the cusp of extraordinary growth (See adjacent graphic).The benefits of this bypassed the poor women.

Subsequently,in March 2010,Spandana sold 1.5 million shares to Valiant Mauritius Partners FDI at Rs 647 a share.At that price,the initial holding of the poor women of 2.15 million shares would be valued at Rs 1,400 croreagainst the Rs 2.2-2.4 crore they received five years ago.

Its relative, says Reddy.What would have been the value had the MBT held on to the shares Valuations of microfinance companies have taken a severe beating in the wake of the Andhra Pradesh crisis.Our current net worth is Rs 600 crore,but our portfolio at risk is greater than that.If we dont get our money back,it could erode our net worth.

Also,the Rs 2.2-2.4 crore received by the MBT was not distributed among the 20,000 poor women.As in the case of SKS,Spandana says it was meant to benefit the larger community,not individual borrowers.The money is being used by the MBT to set up two hospitals in Hyderabad for its members.Reddy says it was a conscious decision not to distribute the sale proceeds among members.Borrowers who did not get the money would have complained, she says.

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Unlike Spandana and Share Microfin,where the promoters have bought shares from the MBTs in a manner that appears to benefit them over the poor women,this has not happened in SKS Microfinance.But there are issues on how its five SKS MBTs were managed.

The first Indian MFI to be listed took a conversion route similar to Spandanas.When SKS NGO decided to convert itself into an NBFC,it decided to take the MBT route.In the name of the poor,promoter Vikram Akula raised $410,000 (Rs 2.05 crore) from philanthropists and friends to meet the Rs 2 crore equity requirement for an NBFC.The donors were American Indian Foundation (AIF),individuals and philanthropists.Emails to AIF Foundations CEO Sanjay Sinho and Ethan Veneklasen,a senior official,were not answered.

SKS NGO distributed the $410,000 to 28,000 SKS borrowers,all women and mostly poor.The women were organised under five MBTs,one for each SKS loan centres at that time.In December 2003,the five MBTs invested in SKS Microfinance shares,holding 99.5% in it.

As the business grew,the company needed more capital.So,beginning March 2006,SKS Microfinance started issuing new shares to external investors like private equity (PE) fund Sequoia Capital and venture capitalist Vinod Khosla.Equity expansions meant a dilution in MBTs stake.To preserve their control,in March 2006,SKS NGO gave Rs 4.55 crore more to the 28,000 MBT members to buy additional shares in SKS Microfinance.

Before SKS Microfinances IPO,the MBTs held 14.7% in it,making them the third-largest shareholder.In the IPO,in August 2010,the MBTs sold 4% and received Rs 198 crore.But the 28,000 MBT members did not receive that money.It will go to SKS NGO,which last year worked on grants of Rs 5 crore in areas of livelihoods,health and education.

When the initial trust deed was drawn,the intention was to distribute the value created among the poor women, says a finance professional involved in drafting the SKS MBT deed.Another person involved in mobilising the poor women under the MBTs confirms this.

Akula says the trust deed spells out the procedures for the use of funds.As per the objectives of the trust,the money will be used for community projects initiated by SKS NGO,a sister non-profit outfit;any surplus remaining would be available for distribution to trust members.The trust does not benefit individuals,but serves the communities of SKS borrowers through programmes in social and economic development, says Akula.

The finance professional has a different reading.MBTs are registered under the Indian Trusts Act, he says.All the money should be first credited to the individual accounts of the beneficiaries (the poor women).Only after this,if the beneficiaries collectively agree to transfer the money,the trustees can give money to non-beneficiaries.

In the run up to the IPO,there was a dilution in the powers of the women borrowers.Till November 2009,on paper at least,the poor women had a say.Each MBT had five trusteesa chairperson,two SKS appointees and two women members.So,in all,the five MBTs had 10 women members as trustees.

This structure was done away with in November 2009.In its place,a new entity,SKS Trust Advisors Pvt Ltd (STAPL),was made the trustee for all 5 MBTs.STAPL would have two to seven independent board members,with no connection to SKS or SKS NGO.Their independent nature was meant to ensure a fair deal for the community.

In less than six months,the independent nature of the board was under question.The first board of STAPL,formed in November 2009,was an eminent one.Its three members were Anu Aga,former chairperson of Thermax,Narayanan Ramachandran,then with Morgan Stanley,and Gurcharan Das,former head of P&G India and author.Immediately,after the first board meeting,Aga and Ramachandran quit.Das left subsequently to join SKS NGO.

Aga says her exit was not acrimonious.In the meeting,it was unanimously decided that all decisions regarding the disbursement of surplus would be taken by the board, she says.However,immediately after the meeting,Aga says Akula informed her that the money would be routed to SKS NGO.I did not see a role for myself when it was already decided where to use the money, says Aga.

In July 2010,the board comprised of Ankur Sarin,faculty at the IIM-A,and Akula,who owns 99.9% of STAPL.In one of the board meetings then,it was decided to allocate the IPO proceeds of the MBTs to SKS NGO.At this point of time,there was no elected community representation in the SKS MBTs.Under the new structure,100 members had to be elected to the general body of every MBT by November 2010.

Akula has since left the board of STAPL.Now,besides Sarin,there is Farzana Haque,global head (large accounts SBU) at Tata Consultancy Services.Akula says there will not be any conflict of interest,as an independent board of STAPL will vet the projects to be taken by SKS NGO;he does not have a role to play in that decision-making and also does not have a role in SKS NGO.

Its a complex management structure,one the poor women barely understand.ET tracked down two of the 10 women who were on the trustee boards to villages in Andhra.Their names or villages are not being disclosed to protect their identity.One woman could not place SKS MBTs at all.The other woman,after much prompting,managed to place SKS,but nothing more.

Akula says the legal framework is explained to women before making them members,though there are difficulties.Says Akula: We tried in many ways to explain the concepts in the trust deed such as shares,debentures and bonds.We used everything from literal translations to metaphors.But these concepts are difficult to understand for anyone,let alone uneducated poor women.

When asked whether the women were told about the choices and hierarchy of surplus distribution,the company spokesperson declined comment.The important thing is if it is an informed consent, says IIM-A professor Sriram.

A person who was involved in the formation of the SKS MBTs says the trusts were not taken seriously.A meeting of the board is to be held every quarter, the person says.In the first two-and-a-half years,not a single meeting was held.And during this period,the company issued shares to outsiders.

Akula says the meetings of the trust boards were held.On Friday,we emailed SKS officials for the minutes of the meetings.On Saturday,a day before we went to press,SKS offered to show us the minutes of the meetings,pending clearance from their legal team.The next day,however,the company said their legal team had advised them that the minutes could be shown to us only in the office of the legal representatives of the trusts.This was not a feasible option for us.

Over the past year,SKS has been video-recording its member meetings where the legal framework is explained to the women.On Saturday,the company promised to show us a recording of one such meeting.On Sunday,90 minutes before the designated time of viewing,it said it could show these to us only in the office of its legal representatives.

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EVEN as microfinance institutions (MFIs) battle a raging controversy over their lending practices to the poor in Andhra Pradesh,new revelations suggest poor shareholders have been deprived of wealth that should have rightfully been theirs. An ET investigation shows 45,000 women who were shareholders in the countrys top three microfinance companies have missed out on the benefits of wealth creationsome due to transactions engineered by promoters, some due to the structure used to house shares owned by the poor.

The promoters of Spandana Sphoorty and Share Microfin,for example,paid 6 crore to buy out poor shareholders.At their peak valuation,these shares would later have been worth at least 1,900 crore.The women shareholders were paid a pittance and somebody else benefited from it, says Sanjay Sinha,Managing Director of MCril,which does credit rating of MFIs.

In the early part of the decade,the promoters of SKS Microfinance,Spandana and Share made at least 45,000 of their women borrowers owners of their respective businesses.Except,these women,most of whom were poor and uneducated,were titular owners.For all practical purposes,control and decisionmaking lay with the promoters;the women were mere rubber stamps,and they neither had knowledge nor a voice.

Our investigationdone over two months,and based on public and private data,and conversations with key players and insidersshows many decisions tak en by the promoters did not maximise the interests of these women.Jarringly several decisions in which the poor women and promoters are counter-par ties have delivered a windfall to the latter MS Sriram, an adjunct professor at the Indian Institute of Management Ahmedabad,was the first to throw critical light on this issue.His March 2010 paper titled Commercialisation of Microfi nance in India: A Discussion on the Em perors Apparel,traced the useand abuseof an ingenious shareholding ve hicle called mutual benefit trust (MBT that was central to this lopsided promot er-poor women relationship.

The story goes back to around 1999 when MFIs were doing micro-lending as charitable organisations or NGOs.The promoters saw increasing business potential,but their non-corporate identity discouraged growth.Commercial investors were not interested in buying equity because profits cannot be taken out of an NGO.Banks were not keen to lend money because an NGOs assets cannot be attached easily.So,MFIs decided to morph into for-profit entities.

Of all the options before them,the most suited to their objectives was to become a non-banking finance company (NBFC).But there was one problem: the minimum capital requirement was Rs 2 crore.The promoters,most of whom came from a developmental background,did not have that sum.

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THOSE days,I was working with SKS through a fellowship amount,and I did not have Rs 2 crore to invest,”says Vikram Akula,founder and Chairman of SKS.

They could have roped in external investors,but that would have meant giving up equity-and sharing the value the business would create.They couldn’t raise free money in their name,but they could in the name of the poor borrowers they were lending to.

Around 2002-03,MFIs raised money from several sources.SKS mobilised grants from friends,family and philanthropic institutions.Spandana dipped into its NGO’s coffers.

They distributed the grants to the poor women,and made them use that money to buy shares of their company.”Sometimes,they even asked the poor women to contribute (Share),”says Sriram.At least 45,000 poor women,mostly from Andhra Pradesh,became the first shareholders of these three MFIs,accounting for a minimum capital of Rs 6 crore.

The promoters did not want to manage so many shareholders and they wanted to retain control.So,they organised their women shareholders under MBTs,where borrowers were grouped like a mutual fund.The MBT would,in turn,invest the money collected from the poor women in the NBFC.Instead of 20,000 shareholders,each MFI had to deal with one: the MBT.

“Originally,the idea was to give ownership to the community and give them a share of the value created,”says a finance professional who conceived this ingenious shareholding vehicle for the sector.”Everything changed when the promoters saw exponential growth.”

In two years,between 2004-05 and 2006-07,Share Microfin went from 99% owned by poor women to 98% owned by promoters,employees and individuals.Similarly, Spandana went from 93% owned by women in March 2004 to 93% owned by promoters in March 2007.Control coincided with the business taking off,with revenues and profits doubling every year.

The promoters or the MFI started selling shares to private equity (PE) funds at a multiple of the price they paid the women.Take Spandana.When the MBT exited,by March 2007,it received Rs 2.2-2.4 crore for its 2.15 million shares.About 18 months later,the value of that holding,based on the price paid by two external investors,was Rs 88 crore.In March 2010,it was Rs 1,400 crore.”Promoters have freely violated all corporate governance norms,”says Manoj Sharma,Director,Microsave,a Lucknow-based microfinance research and consultancy firm.

“My intention was never to make money from buying the shares from the MBT,”says Promoter and Managing Director Padmaja Reddy.She says the two external investors,Lok Capital and JM Financial,said they would invest only if the MBTs were not there.”They feared backroom driving by the promoters,”she says.Phone calls,emails,faxes and text messages to Share Microfin promoter M Udaia Kumar went unanswered.

At SKS,the shareholding wasn’t turned on its head;the poor women are still shareholders,through five MBTs.But there are governance issues brought on by the powers the MBT structure confers on promoter Vikram Akula.

After the IPO,the SKS MBTs received Rs 198 crore by selling their shares.This money,as per the objectives of the trust,will be used for community projects initiated by SKS NGO;the residual surplus would have been available for distribution to trust members.”MBTs are designed for the beneficiaries under the Indian Trusts Act.Any accrual in the MBT has to belong to the beneficiaries,”says V Nagarajan,a chartered accountant who is considered the architect of the MBT shareholding structure for microfinance companies,without making a reference to a particular company.

The board of trustees,in July 2010,decided to give the entire amount to SKS NGO.When this decision was taken,the board of trustees had two members,one of whom was Akula,and there was no community representation.

Akula says the women’s consent was taken for every decision.”Our representatives read out key provisions of the deed at member meetings and explained the contents,using local idioms and metaphors,”he says.”Then,a voice vote was taken.Thereafter,their written confirmations were obtained.”Asked whether the women were told about the choices and hierarchy of surplus distribution,the company spokesperson declined comment.”The important thing is if it is an informed consent,”says Iim-A professor Sriram.

The women mostly had no clue what was happening.ET met two women who were among the 10 community board members on SKS MBTs in the old trustee structure.They recalled the company,but not the trusts,or the meetings held and the decisions taken.

Despite that information and understanding gap,SKS and other MFIs went ahead and made the women-poor,uneducated and uninformedowners in the business.”The MBT structure is being heavily misused,”says Sinha of M-Cril.”It is good in theory,but not in practice.”The dealings of SKS,Spandana and Share with the poor women,detailed on Page 16,show that the women were the owners,but the promoters called the shots.

(With inputs from M Rajshekhar)