How Are Equity Exits Like Arranged Marriages?

At last year's European Microfinance Week, Daniel Rozas spoke in a panel entitled "Strengthening Client Protection through Governance: The Role of Boards, Investors, and Senior Management." FinDev Gateway caught up with him to learn more about his thoughts on the key considerations and common pitfalls in shareholder exits from microfinance institutions.

Below is the transcript of the interview:

What are the top three aspects of a good exit strategy for investors?

In terms of the top three aspects, I would think one would really be, is a new shareholder suitable from their vision perspective? Is there an alignment? Do they sort of have the same expectation of the institution that they're buying as the seller that's selling? You know, in fact, there's three parties, right? The seller, the buyer, and the institution itself.  

The second one is, really, does the new shareholder have the capacity to get the institution where they need to go? So usually what's happening is the selling shareholder, maybe it's a fixed-end fund, and they need to exit because a fund is maturing. Maybe they're just constrained, they cannot add additional equity, and it really needs to go to a buyer that's just a bigger institution and has more equity to invest. So that capability is there, and it's not just financial. It's also - do they have the skills and the knowledge to maintain the mission and to go with the vision that they have from the intention?

And then the third part is there's an environmental aspect to the context. So what's the market that they're operating in, and is this really a feasible process? Because you ... cannot expect a market that, for example, has a very repressive regulatory structure that doesn't really facilitate the transfer of shares and transfer of ownership in a way that you would like to do. So you can't forget - not every market is the same.  

Think of the exit like an arranged marriage

So I like to think of exits - a really good example is to think of them like an arranged marriage, right? If you're a shareholder of an institution, you're effectively like a parent of a child. And if you think of marriages in traditional, especially in South Asia and traditional societies, it's the parents that actually choose the bride or the groom. And part of that process is the fit. You know, is this potential bride and groom going to be the right partner for my child? And part of it also in traditional societies is a dowry. So how much is that family paying? And that is quite similar to what's happening in an exit.

So... those shareholders that are really looking for the fit of the new shareholder, the new owner, are going to be the ones more successful. And you know, one that comes to mind is the sale of AMK in 2018 by Incofin, where even to this day, six years later, Incofin sits on the board of AMK and in fact chairs their social performance committee, despite having no shares anymore. So, they've exited as owners, but they're still partners of the institution.  

So I would think that's the top three. There are many others, like, what is the level of management of the institution? How well is the institution positioned? Do they also agree with the exit? Are they actually in favor of it or are they actually resistant? So, these things matter too, but I think top three, I would say, would be those. 

What does a bad exit strategy look like?

I think on the side of the pitfalls, one thing is really not successfully assessing who the new buyer is. As you might in any relationship, you kind of expect the best, and you might not get the best. And it's actually not an easy process. Maybe even to use that same example of an arranged marriage, it's like, hey, the family look might look good, and the groom is great, and all, but actually behind the scenes, it's not what you think you saw. So that's clearly a pitfall.  

And oftentimes, that process winds up being made more difficult by the fact that, look, this offer is very good. The financial offer is very good. So there's a desire to exit, and ... you're able to check the boxes, and everything else looks okay, you just exit. And later, you might look back and say, "Oh, that's not what I wanted." So that's definitely a pitfall.  

Another pitfall - if you talk to investors, they'll mention it all the time - is really not understanding the context of the institution, especially when it comes to the central bank that normally has to approve any major shareholder change of a regulated institution. And, you know, there are plenty of cases where an exit goes on for two, three, four years just because there's no ability to get the approval of the regulator. So that's definitely an issue.  

I think there's a third pitfall, and this is where if you talk to investors, they say, "Hey, think about the exit not at the time that you want to exit, but at the time that you start the investment." Because you really need to plan ahead. You need to make sure the institution is set up, the infrastructure is there, the relationship with the regulator is what it needs to be so that when it is time to exit, you can do this. And you're not going to start hitting roadblocks. And that's definitely part of the process as well.  

Do you think investors have improved their exit strategies?

I think you've seen a shift with investors that now have 10, 15 years experience of equity investing. The very first exits were happening in the late 2000s, early 2010s. And at that time, there were many mistakes made in terms of really focusing on the commercial aspect as a way of showcasing equity investing in microfinance as a legitimate asset class to crowd in other investors, which led to practices that were quite harmful to clients - very rapid fast growth, high profitability, and sort of no guard rails.  

So you see investors much more conscious, taking a much more measured approach, but also they tend to start thinking far ahead. It's very rare for investors to say, "Okay, now I need to exit. What am I going to do now?" Now, they're already planning many years in advance, sometimes at the beginning of the investment, or they have a plan in how they prepare the institution in which they're investing for an exit maybe 10 years later.  

But at the same time, you also need these constant reminders. You also need more lessons learned. This is the nature of investment. It's something you do once with one, right? If you're a debt investor, every two, three years, you're placing a loan, you're placing a loan. So you have a lot of this repetition. You don't have that in equity.  

And also, because markets are different, regulatory systems are different, a lot of it is just building up that wealth of knowledge. And I think it's happening. I think the reality is it's happening, but my guess is, exits five years from now will actually look quite different than what they are today, and I think better, even though today's already are better than what was happening five years earlier.