Microfinance is dead. Long live microfinance

In 2011, more things have happened than the historic late season collapse of two baseball teams.  Or the marriage of one of the Kardashian clan (also referred to as the “pre-divorce”).

Yep, in 2011, we discovered that Microfinance sucks.  Destined to end poverty as we know it, small loans to poor women in impoverished circumstance instead have led to the suicide under debt duress of borrowers in Andra Pradesh, India.  Microfinance has led to overindebtedness and not enough changed circumstance.  Microfinance has failed.

It’s an easy storyline to believe if we pay as much attention to it as to the tired chord progressions of a Justin Bieber song.  But listen closely, and you’ll hear the subtle nuances and underlying quality.  Well, OK, the Justin Bieber analogy doesn’t work, as Microfinance is doing substantively better beyond pop analysis than his royal Bieber-ness.

Idealism is directly proportional to one’s distance from the problem.

The primary problem is the same one that affects all bubble mentality — Microfinance was oversold by experts to the world’s microfinance novices.  The novices, far away from the problems, accepted the idealism.

In Edward Chancellor’s excellently written book, Devil Take the Hindmost, he describes stock market bubbles from the Dutch Tulip Bulb through the US Railroads and on toward the internet.  A fantastic read, I won’t spoil it by giving you the bottom line — as soon as you hear the words “this changes everything”, head for the exits.  In the 1820s, the dollars solicited by railroad building hopefuls exceeded the GDP of the country.  In 1999, I heard a VC claim that 100% of product sales would soon occur over the internet.  In 2008, I heard “Microfinance can alleviate poverty.”

Microfinance can’t alleviate poverty.  As my friend Jonathan Lewis has quipped “who wants to live in a town with no schools, no hospitals, no roads, terrible food, but a great bank?”  By overselling the product, we missed the point that it is indeed quite helpful to have a bank in town, customized to the needs of the community.  Particularly when you’re living on $1 a day.  Particularly when that $1 a day is really $0 for two weeks and then $14 all at once.

Do only bad pilots crash?

Airplanes crash for more than one reason.  So does public opinion.  The circumstances behind this summer’s “Microfinance winter” are more complex than merely “Microfinance failed” and too complex for these short words.

The more interesting questions start with “what now?”  What’s next for Microfinance?

The short answer, globally, is growth.  Microfinance in Indonesia, for example, has a faster growth rate than internet traffic worldwide.  Microfinance had one of the most profitable IPOs of the last few years (take that, Silicon Valley).  Microfinance has by some accounts penetrated just 10% of the addressable market.

I have three credit cards in my wallet.  Where would you rather spend your time, selling me a fourth credit card or providing someone else with their first banking services ever?  It is a wide open, high growth market.

Microfinance 2.0

This entire 2.0 nomenclature has gotten out of hand.  I recently heard a radio comment about “The Economy 4.0”.  I suddenly panicked, because I wasn’t sure whether my personal economy was on version 2.0 or 3.1.  I wasn’t sure what I had to do to upgrade, and I worried that if Microsoft was involved it would lead to many of my menu items being moved to inexplicable locations.

Microfinance’s next generation will be better than this generation.  It’s a fast growing industry where regulation still trails.  There is debate about whether profit is good or bad.  The debate will evolve into how best to regulate the profits that will no doubt continue.  Microfinance needs to adopt standard bank and financial reporting.  Microfinance needs credit tracking agencies to reduce borrower over-indebtedness.

This requires the skills of both the “east coast” and the “west coast” of the US.  The “east coast” represents “we should write a paper about it” or “we should standardize it”.  The “west coast” represents “we should go build a company to solve that problem”.  Both halves of our country’s brain (along with the medulla oblongata that is of course the non-coasts.  Again, this analogy breaks down) are needed to move Microfinance to its next generation.

Because, in the end, there are few tools in our arsenal that can both “do good” and “make profit”.  Microfinance is one of those few.  It’s a good one, and it could use more building.

And you.  It could use you.  Bring some intellectual hammer and nails, and roll up your sleeves.

Impact investing = charity

On a phone call today, I accidentally equated Impact Investing to charity.  I said it as hyperbole, at least initially.  As you know, I’m in favor of profits for poverty reduction (and just like Jews for Jesus, this is not an oxymoron).  And then I realized the equation is more equal than I thought.

The bottom line:  Charity returns $0.30 for every dollar, and sustainable impact investing returns perhaps $0.40 for every dollar (time adjusted and depending on some assumptions).

Here’s the (pretty rough) math.  Feel free to quibble, but we’re directionally correct here.

Let’s start with charity.  I give $1 to charity, and I won’t see any of it again.  I will get the warm glow of sending it off to do some good, though.  Oh, and the government pays me back, in the form of tax credits for charity.  The average net US tax rate in the US is 20%, but the gross rate for taxes among wealthy Americans is easily closer to 30%.  So when I’m in a charitable mood, I’m still getting up to $0.30 back for every dollar.  And I get that $0.30 back this year.

For a “sustainable” impact investor, let’s assume the impact fund is targeting a zero percent net return.  That’s “sustainable”.  But it’s also a 12 year illiquid investment.  If I invest all my money now and get all my money back in year 12, that’s great, but there is lost opportunity due to time.  If I consider the alternative uses of those locked up dollars I gave to the impact fund, an average money manager can get me about 8% return per year.  Over 12 years, that’s a 2.5x increase in my money.  With the impact deal, I get 1x, or just 40 cents on each of those future dollars. (Lots of quibbles here, see the comments)

It’s not just about return, though, it’s about impact!  Both charity and impact investing contribute dollars to the good of the world.  The average charity sends 75 cents to the cause, because 25 cents of every dollar is used to administer the charities themselves.  Not bad, really.  75% goes to solve the world’s problem.

The average impact investor has expenses as well, and they are called fees.  Acumen Fund, for example, has fees that are higher than 25 cents of every dollar over the life of their fund.  Less of every dollar goes to the cause from impact investors than from charity.  (Acumen does hope their dollars will grow enough to repay their fees over time.)

So “sustainable” impact investing, targeting sub-market returns, and charity, targeting a 100% loss but subsidized by tax credits, have cash outlays and returns shockingly close to each other.

That’s why I say you have to make money at this impact thing.

(thanks for Brian Weinberg for telling me to write this down, and thanks to all of you for not overly assaulting my rough financial numbers)

Steve Jobs bests Obama, Thomas Edison, and Jack Welch

To put Steve Jobs impact in perspective:

Mourners around the world have been placing memorials at Apple stores. If the President of the United States died, Americans would not place memorials at their local US Post Office.

To call Jobs a modern day Thomas Edison is to do a disservice to Jobs. Owners of iPhones each day use their Apple product more than their lightbulbs. What other technology product is possibly used more than lightbulbs?

It is rare enough to have an entrepreneur retain their CEO position after the company starts doing well — Dell, Gates, and Ellison are among the few. None have been subsequently fired and rehired. And then found success.

Jobs leaves behind the most valuable company in the world by market capitalization. Previous “most valuable companies” have included GM, GE, and Exxon. That’s right, cars, electricity, oil, and iPhones have all been the most valuable product.

More debt is not the answer to Greek’s debt crisis

In the venture capital world, we deal with companies on the verge of bankruptcy all the time. And I must say the answer is hardly ever to add more debt to the company. Yet, this is our solution to the Greek debt crisis.

I’m not a central banker, I’m a VC, and as such I am largely “unencumbered by the facts”.  With this in mind, I have a different solution to the Greek debt crisis — sell equity instead.

The challenge of debt is that it is a fixed payment obligation.  I will give you this money now, and you will pay me back on this schedule — with interest.

Debt also typically has current expenses.  You start paying back today.

These strictures are compounding Greece’s debt problem.  Greece is essentially taking out new loans to pay down old loans.  And since things are getting risky, the new interest rates are higher.  As if Greece were your financially challenged friend paying the interest due on one credit card using another credit card.  The debt keeps compounding.  There is only one outcome to this spiral, and it probably involves your financially challenged friend and dog moving into a large cardboard box.

Equity is a variable obligation.  If things go well in the future, your equity will be worth quite a bit.  Or equity could end up being worth nothing.  Because of this uncertainty, the expected return is higher than debt.  But the good news is that there are no immediate payments due.

Venture Capitalists often use “convertible” equity.  This means it can be paid back in full in the future.  It’s like a loan with no current payments but a bullet or balloon payment at the end.  The “end” is defined by a specific event (an IPO or sale).  Venture Capitalists also use “preferred” equity.  This provides extra features such as control provisions (you can’t do this or that), seniority (you can’t pay any other debt or equity ahead of us), or redemption (you have to pay me back on year 5 if I say so, even if there is no IPO).

Greece could issue sovereign equity, a new concept I just made up (wait, so have smarter people than me).  Since Greece is unlikely to hold an IPO (even I’m not THAT unencumbered by the facts), sovereign equity needs to define when it would pay what amounts.  One idea would be to tie equity returns to future economic performance.  GDP growth above 3% would lead to a payment to the equity of X Euros.  I would have to look at the numbers to see what the thresholds would be, and also for how long the sovereign equity would pay that amount before it was considered retired.  Certainly a long number like 50 years would provide an exciting option for investors.  50 year bonds have recently been in vogue in France and the UK, and Greece will not be in economic hardship forever.

Or sovereign equity could be tied to the already contemplated sale of real estate, corporation, and banking assets held by the Greek government.  Those assets can’t be sold quickly, but a single equity instrument could be.

Or dream up your own economic tie.  With Greece on the ropes, I would imagine all of Europe would be open to your suggestion.  If you’re willing to show up with billions, a good deal is no doubt available (I’m talking to you Goldman Sachs — fancy owning the Parthenon?)

The banks that are currently sweating their loans to the Greek government would now have an alternative.  They don’t want to recognize a 100% loss on defaulted Greek loans, as they have to mark those losses in their financial statements.  With sovereign equity, the banks can convert their dastardly loans to equity.  Instead of a big contraction in their balance sheet, this just moves the owed amount from one section to another.  Still painful, but less so.

The “sovereign equity” proposal I’m dreaming of has many problems — speed of execution being just one.  But then again, problems cloud other once crazy options like letting Greece default on their debt and/or withdraw from the Eurozone.  The undoable is quickly becoming doable.