The micro-finance sector in India over the last decade has witnessed a roller coaster ride that would rival any Bollywood potboiler. As an investor who invested in the sector, I got a ringside view of the euphoria, suspense and drama that accompanied the creation of untold riches in the Rs 50,000 Crore microfinance sector. The sector has shown its resilience emerging unscathed from multiple crisis’s and also spawned dozens of startups in the fintech space.
In the last decade, the number of millionaires and billionaires emerging from the microfinance sector is probably much higher than the E-Commerce sector in India. This is -because unlike the founders and employees of E-Commerce companies in India whose wealth continues to remain only on paper and is fast eroding, microfinance companies have taken the big leap to get listed and some have even converted into full-fledged small finance banks.
2016 saw two microfinance companies coming out with successful IPO’s. Some of the new millionaires minted include Mr. P N Vasudevan whose 2.5% stake in Equitas Microfinance is today worth upward of Rs 150 Crore ( At current market prices). It is also the sector that turned Vineet Rai into one of the most successful impact investors in the world.
Another microfinance millionaire is Samit Ghosh the founder of Ujjivan who saw the stock price of the company he founded double on the bourse in less than 100 days. There are also thousands of top and mid-level managers who cashed out in IPO’s and aftermarket sales. Their names are not public and remain hidden in DRHP’s and company filings with the stock exchanges. The charts below should give you an idea about the wealth creation that has taken place in the sector this year.
The sector also has billionaires who turned into paupers because of the 2010 Andhra Pradesh Microfinance Crisis. Notable among them are Vijay Mahajan of Basix, Padmaja Reddy of Spandana Spoorty and Udai Kumar of Share Microfin.
As an investor in a micro-finance company, I watched my company crash and burn spectacularly over a period of 8 years losing out on millions invested. This post is about the journey and lessons gleaned from this failure.
The Story Begins
It was in early 2007 that one of my close friends and college mates sent me an email saying he was going to start a microfinance company. The year before Mohammed Yunus had won a noble peace prize for starting the Grameen Foundation and the whole microfinance sector was in a state of euphoria.
Venture Capital money was pouring in and every other NGO was starting microfinance operations. We decided to quickly acquire an NBFC license and start operations in the state of Uttar Pradesh. We chose Uttar Pradesh because the financial services market down south, where microfinance first emerged was already saturated.
So by early 2008, the company had begun full-fledged operations, I invested around Rs 1.1 million in the first round and followed this up with another tranche of around Rs 0.5 million in 2010. In return, I got an 8% shareholding in the NBFC. The company had more than 20 different promoters with the highest stake of around 20% being held by the Managing Partner along with his relatives.
The business model of micro-finance was quite simple then, take loans from big banks like NABARD and Private Sector Banks at rates of 14-16% per annum and on-lend them to micro-finance clients at 24%-26%. We were able to pocket margins of 5% after all the loan disbursement expenses were covered. With repayment rates of around 99% because of the group lending model we followed, I felt nothing could go wrong.
Banks were also eager to lend because they had to commit a portion of their funds to RBI mandated priority sectors which included the microfinance sector. So we easily got loans from NABARD and other private banks. The business quickly scaled up and even though we got no returns, the notional value of our shares in the unlisted NBFC almost doubled within the first 3 years. At its peak we had close to 8000 active borrowers and a loan portfolio of Rs 4.5 Crore outstanding.
I was soon dreaming about how I would sell my stocks with returns of 500% on my investment within the next 2-3 years making me a multi-millionaire. But then disaster struck unexpectedly.
The Culprit – Over-lending
In late 2010, there were a couple of suicides by microfinance clients in the state of Andhra Pradesh which quickly snowballed into a full-fledged political crisis with leaders of different political parties jumping into the fray. The main cause of the crisis was multiple lending where individuals had borrowed from multiple microfinance companies and were then unable to make repayments. Some borrowers committed suicide unable to bear harassment from the lenders
Politicians could soon be seen asking borrowers to default on loans in rural AP and soon the sector began to witness large scale default on payments. Microfinance companies that were headquartered in Andhra Pradesh were soon facing bankruptcy.
This had a cascading effect on MFI’s across the country. Banks froze their lending to MFI’s and started recalling their loans. This also sounded the death knell for small MFI’s like ours which were not heavily capitalized. Within a few months, it became difficult to raise funds from banks or investors. We could no longer give fresh loans and lender disciple soon went awry in the absence of fresh loans.
By 2013, we were left with no option but to wind up our field operations. Our loan outstanding portfolio had sunk to a low of Rs 80 Lakh compared to the high of 4.5 Crore it had touched in 2010. Thus ended the saga of our microfinance company in a short span of five years. While the losses I suffered were quite large, the lessons learned are priceless. Here I list them out for the benefit of other entrepreneurs and investors
10 Lessons learned from a Failed Startup In Microfinance
Failure teaches you many lessons, for the sake of brevity I have penned down the ten most important ones.
1. Change is the only Constant
Over the years, the attitude of some of the founders changed completely. The changes were more profound when they got married and became bogged down with family responsibilities. This was totally unexpected and I failed to anticipate how developments in their personal life would affect our company. Soon it became family first and friends ka paisa bhaad me jaye. Well, that’s what life does to you.
When we started the company we were fresh out of college. There was a certain bonhomie among the founders and partners, which was a remanent from our days spent together in the classroom, at canteens and college fests. Sadly this is of no value in a corporation and can often cloud your judgment negatively by inducing biases.
Lesson Learnt: Always have a blueprint for worst-case / best-case scenarios to deal with partners, vendors, employees and the external environmental difficulties. Hope for the best but plan for the worst, that’s life. Starting up with friends is definitely not advised, it is always better to convert a business relationship into a friendship rather than the other way round.
2. Don’t Over-commit – Transfer Commitments into text/paper. Talk is worthless.
Some of the partners had committed to joining the startup within 2 years of it being launched but later went back on their promises because they could not handle the salary cuts. This caused a lot of consternation among the managing partners who felt they were betrayed. I too had committed on expanding the companies operations in the states of Maharashtra and Karnataka but later never followed up on the issue because I had become a little too comfortable in my home base and did not want to take the risk of moving to new geography.
Lesson Learnt: Don’t over-commit or loosely make promises you do not intend to keep. They will often come back to haunt you. This is a major issue in startups and was recently witnessed in the very public duel between NASSCOM veteran Ravi Gururaj and his partner. Also do not fear taking up new challenges because of YOLO.
3. Control Is Key – Never let go
We had many shareholders and only one investor had a shareholding of greater than 10%. This led to the creation of fragmented ownership with no clear promoter. The promoters group was scattered across the country and did not even meet even once under the same roof during the period when the company was operational. This reflects were badly on investors who failed to follow up on our investments and maximize returns. Emails and phone calls have a limited effect, nothing beats getting your hands and feet down on the ground.
Lesson Learnt: Try to keep control of the organization with an individual who is aligned with the vision of the organization and not disparate groups of promoters and investors who are in it only for a good return on their investments.
4. Value Systems Differ Because India Is A Diverse Country.
Not everybody shares your Values, having grown up in an upper-middle-class family I was genuinely surprised when I realized that people don’t appreciate or share your value systems. Values that I then believed were universal are actually in practice quite rare. When there is a mismatch of value systems, it leads to ethical and moral conflicts within the organization.
So always evaluate your founders, customers and employees for value systems and if they do not match your wavelength don’t go ahead with your venture. You are saving yourself some future heartburn. This difference in value systems was one of the prime reasons for the failure of Food Panda and Jabong.com.
Lesson Learnt: Not everybody sees your way, different people are driven by different karma, motivation and logic.
5. Do A Background Check On Partners
One of the partners actually had some missing pieces in his professional career. Nobody knew exactly why he was fired from his previous job. We gave him the benefit of doubt and did not pursue the matter. We eventually ended up regretting it because only later did we find out that he was fired for embezzlement and fraud. Since he did get away with it the first time, he ended up repeating the same behavior in our organization. An oversight that could have been avoided.
Lessons Learnt: Don’t evaluate people and business partners on gut instincts and at face value. Do some digging about their pasts, back your decisions with data.
6. Falling For the Projections
One of the founders used to send us elaborate presentations valuing our shareholding and how it would increase over the years as the company grows. I took them at face value and actually believed the founders would deliver on their promise. This was a mistake because it was clearly a case of biting more than what they could chew. The management clearly lacked the skills to deliver on the projected growth. So never believe the best-case scenario’s projected by your partners. Like N R Narayan Murthy it would be wise to opt for an under-promise and over-delivery model.
Lessons Learnt: Take all presentations and promises with a pinch of salt. Keep your expectations tempered and in tune with reality.
7. Be Assertive – Sweat The Details
In hindsight, we were as a group of promoters very meek and laid back. In fact, we neither got receipts or share certificates for almost three years after we had invested money. Everything was done on the basis of just talk and emails. In fact, it took me almost two years to realize that the managing partners had actually collected more money than what was required to buy the NBFC license and used it to capitalize on the company without informing the investors.
Lessons Learnt :
Investing is a serious business and there is no scope for half-hearted efforts. Don’t be laid back on issues of finance and procedural issues. Always analyze the minute aspects of all financial transactions.
8. Avoid The Self Sacrifice Complex
A lot of time was consumed in listening to how the founders had sacrificed their careers to start the company and how they were suffering because of the pay cuts they had taken. What I failed to tell them then was that it was a choice they made and none of us asked them to become founders.
Ideas are dime a dozen but cash is always king. We gave them hard cash which they reduced to ash. As an investor don’t fall for the self-sacrifice drama. The founders are solely responsible for everything they face in building a great company.
Lesson Learnt: All business ideas at inception are worthless. They acquire value only when you can show the money. Don’t fall for the sob stories by founders, they have been asking for it.
9. Greed – Counting the Chickens before they hatch.
Even before the company had reported any profits, a squabble broke out among shareholders when the two main managing partners became greedy and decided to arbitrarily award themselves ESOP’s which were not commensurate with their performance. Valuations in the sector were soaring and the founders wanted a bigger share of the shareholding. Things got really ugly over time and soon we had full-blown boardroom war.
Eventually, the founders had their way and bullied the rest of the investors to pare down their shareholdings. All this drama ensued even before the company had reported a single Paisa in profits. This created a lot of bad blood and mistrust that soon became the defining point in our relations.
Lesson Learnt: Paisaa Badi Buree Cheez Hai Aur Ache Achon Ko Badal Deta Hai.
10. Do Not Confuse Activity For Accomplishment.
The management team would send us regular updates about whom they met, their new plans for diversification and the new opportunities they get exposed to daily. Sadly most of them never reached any meaningful conclusion and most of it was just hot air in the end. The mistake we did was to get carried away by reports of activity and interpret them as accomplishments much before they had any impact on the top-line or bottom-line of our company.
Lesson Learnt: It is prudent to focus on 2-3 leads or goals than dabbling on dozens of un-related projects. Focus on these 2-3 goals and take them to a successful conclusion.
Eventually, relations soured so badly among investors, that one of the founding partners decided to take his share of money and just resigned from his company leaving all the other investors in the lurch. When the company was eventually sold in 2015, I managed to recover less than 1/4th of the money I invested.
The Bottom Line
Why Did We Fail?
We could put it down to four factors.
- Bad Luck.
- Bad Management.
- External Environmental Factors Turning Negative.
- Inability To Accurately Predict Human Behaviour
The Silver Lining
Every tragedy has a silver lining. In my case, it took the form of a blog called India Microfinance. When we started the company there was no authoritative news website on micro-finance, so I started this blog to keep our partners in the company informed. While our companies folded up the website survived because it had very low annual maintenance costs. (Just Rs 1000 per year)
Today the website gets more than half a million visitors every month and has emerged as a steady source of additional income.