Valuation of microfinance institutions case study: the activists for social alternatives

Abstract

This project attempts to build a valuation model for Microfinance Institutions by studying the existing valuation techniques for Financial Institutions and analysing how these techniques apply in the case of Microfinance Institutions (MFIs). We will determine what the value drivers for MFIs are. The study tries to reflect the evolution of Microfinance Industry from pro-poor charitable trusts with donor funding to a profitable institution attracting commercial capital. Venture Capitalists, looking at equity investments and willing to take the risks of early-stage investments in emerging social markets, have evinced interest in the micro finance sector. Given the financial needs of the micro finance sector and its huge growth potential, such investors have a key role to play in the sector's future growth. However, microfinance being emerging market, valuation is distorted because of information asymmetry. Equity valuation of micro finance is more difficult due to some of the key issues being: Transformation from not-for-profit to for-profit business models. MFIs project a double bottom line, where social impact is an equally important measure as profitability. MFIs have much shorter track record of institutional micro finance. Lack of comparative data on values. Little investment history These factors create hurdles in the process of finding the equity value of an Institution and also in using valuation methodologies that apply in the case of other businesses. In this report, I have tried to discuss the usage of valuation techniques for MFIs by driving comparisons to Financial institutions such as banks, which is a mature sector and shares many similarities with micro finance sectors. Further, lack 'of regulations in this sector puts a question on reliability of valuation that is primarily driven by financial data as there are no specific reporting and accounting standards. There are various other Managerial, Institutional, Environmental, Regulatory parameters that affect the profitability of the institution. For eg: In assessing and rating SHGs, NABARD looks at factors such as the age of the SHG, the regularity with which meetings are held, the democratic pattern of meetings and the regularity of savings and internal lending. Further, these parameters can vary in their influence based on the lifecyc1e stage of the microfinance institution. Investors would greatly benefit if these impact assessment can be modeled as part of valuation methodologies to arrive at true valuation of the company. In this report, I have made an attempt to determine these parameters and attach weights to them to arrive at impact assessment. I have developed a valuation Matrix that would incorporate these weights on the key financial numbers of the company to arrive at true valuation. This report is only an early attempt to build a framework as above. It is still immature and needs a lot of work before it can be used in a standardized manner. The endeavour has been to provide findings that are convincing and useful to contribute to a wide understanding of challenges of equity valuation of micro finance Institutions. I have relied on data collected from primary and secondary sources.