NGO MFI Transformations: 47971 Ownership Issues More and more nonprofit microfinance institutions (NGO MFIs) are transforming into for- profit companies, including regulated financial institutions. Transformations are typically driven by one or more of the following factors: an MFI's need for capital, its desire to BRIEF offer services that may be limited to regulated financial institutions (such as savings), and new legislation or regulation requiring or permitting transformation. Transformations raise a host of issues that NGOs 3. Transferring liabilities. An asset transfer by an and their founders and funders need to address. NGO to the transformed institution may be subject The complicated issues involved in switching from to the NGO's pre-existing debt agreements or an ownerless entity to an entity with owners often other contractual obligations. An NGO MFI that has are not well understood before the transformation outstanding borrowings must review whether these process is initiated. This brief reviews seven areas in liabilities will be assigned to and assumed by the new which those embarking on a transformation should company or stay with the NGO. Although typically research and seek legal counsel's advice. These areas debt may stay with the NGO if the lenders agree, few and others are discussed in depth in Lauer (2008). lenders will want to be in the position in which they can look only to the NGO for repayment after it has 1. Factors that may interfere with an NGO retaining transferred its loan portfolio--the principal source control over the transformed institution. Legal and guarantee of repayment--to another entity. requirements may leave an NGO with less ownership and control than it wants. The law may prescribe 4. NGO-related parties as owners. Many transforming a maximum percentage of ownership. Significant NGOs as well as outside investors have expressed owners (e.g., those owning 10 percent or more of an interest in providing management, employees, the voting shares) may be subject to prior approval by and occasionally board members and trustees with the financial regulator. There may be restrictions on an opportunity to be owners in the transformed foreign ownership of companies. The initial minimum institution. Insiders may purchase shares (either at the capital requirement may be too high for the NGO to general offer price or at a discount) or receive shares meet. In addition, minority shareholders may have without having to pay for the shares themselves in statutory rights to veto or influence voting on specific one of the following ways: the NGO may grant shares issues. to individuals; the NGO may negotiate a grant from a donor to fund the individuals' purchase of shares 2. Restrictions on an NGO's capital contribution in the transformed institution; a third party investing of loan portfolio and other assets. Local law may in the transformed entity may fund the issuance of prohibit an NGO from selling its loan portfolio or shares to the individuals, typically in order to retain exchanging it for shares. Even if the loan portfolio those in key management positions. may be contributed as capital, regulations may not recognize it as "tier 1" capital for capital adequacy The granting by the NGO of shares to individuals raises purposes. And finally, other assets--such as employee ethical and sometimes legal questions as to whether contracts and intangibles--may be difficult to transfer public-purpose donations are providing private gains. or value. Whether management, a board member, or a trustee September 2008 September 2008 is purchasing or being granted shares, entering into agreements did not address a situation in which the such an arrangement presents a clear conflict of grantee would transfer its assets to a company with interest issue that the NGO must address: that is, private owners. Today, most donors support the the individual being awarded shares is on both sides position that the primary purpose of the grant funds All CGAP publications are available on the of the transaction. is to increase the poor's access to financial services CGAP Web site at and that if the funds are used to create a sustainable www.cgap.org. 5. Corporate governance. The main difference institution (i.e., the transformed institution) that is between NGO governance and company governance able to serve more of them by mobilizing savings CGAP 1818 H Street, NW is that a company is controlled by owners who and other capital, then the funds have accomplished MSN P3-300 have an incentive to protect their private financial their purpose. This is not to imply that donors are Washington, DC interests, while an NGO has no owners and depends in favor of uncompensated transfer of assets from 20433 USA on the social motivation of its governing body. The the NGO to private parties; rather, in most donor- Tel: 202-473-9594 Board of Directors has an important role to play approved transformations, the NGO receives shares Fax: 202-522-3744 in determining how the new for-profit institution or other value in exchange for its transfer of assets will grow, be profitable, and manage its risk while to the new institution. Careful attention must be Email: cgap@worldbank.org preserving its vision. The board structure is key paid to the pricing of those shares, to avoid unfair to ensuring the right balance between holding transfer of the NGO's assets, including grant funds, © CGAP, 2008 management accountable and enabling management to private parties. to retain its independence and flexibility. 7. The long term: Ownership and mission. Will Aside from relying on the board, it is possible to anyone ensure that the original mission is pursued have an agreement among shareholders that once the NGO no longer has control over the new includes a statement on the mission of the company entity? Will there be remaining shareholders with and also addresses issues regarding general an equally strong interest in pursuing the original operations. However, shareholder agreements are mission? These are significant and difficult questions, not enforceable in all countries. the answers to which will depend on the composition of shareholders and how that composition is 6. Use of grant funds. In general, grant funding permitted or not permitted to change. for NGO MFIs is meant to benefit poor and low- income people by supporting the development of Resource institutions that offer formal financial services to such people. Until recently, most donors did not Lauer, Kate. 2008. "Transforming NGO MFIs: Critical contemplate the possibility of an NGO transforming Ownership Issues to Consider." Occasional Paper into a for-profit company, so their policies and grant 13. Washington, D.C.: CGAP, May. AUTHOR Kate Lauer