NGOs and Transformation: Must You REALLY Transform CAN You Really Transform What Price to Pay May 26

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(No Transcript)
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Consultative Group to Assist the Poor
NGOs and Transformation Must You REALLY
Transform? CAN You Really Transform? What Price
to Pay?May 26, 2005, BucharestTimothy Lyman
ModeratorMary Chaffin, Aleksandar Kremenovic
Ludmila Teterikova Panelists
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Background

• NGO microlending organizations across the region
  feel pressure to transform into a commercial
  legal form
• Why?
• Some donors and investors say they cant support
  NGOs
• Some commentators say NGOs have inherently weak
  governance
• Some regulators remain skeptical about the idea
  of NGOs engaged in commercially sustainable
  microlending
• But transformations of this sort are expensive
  and legally very complicated sometimes even
  impossible without a law change

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Overview of the workshop

• The moderators contribution
• Terminology What is an NGO transformation?
• The basic structural and legal problem of NGO
  transformations
• The legal mechanics two common models (with
  infinite local variations)
• Why do it?
• What might stop you?

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Overview of the workshop (cont.)

• The panelists contributions
• Mary Chaffin Companion in Kyrgyzstan an
  already completed transformation What were the
  true costs?
• Ludmila Teterikova FORA in Russia a
  transformation in process How does one structure
  an NGO-to-licensed institution transformation
  in an unreformed legal system?
• Aleksandar Kremenovic MikroFin in Bosnia a
  transformation waiting to happen How should one
  prepare before the transformation is legally
  feasible?

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Terminology What is an NGO transformation?

• People mean different things when they use this
  term so clarify first how the term is being
  used
• 3 common NGO-to-commercial entity
  transformations
• International NGO forms a local commercial
  company and transfers a loan portfolio to it
• Local NGO transfers its loan portfolio to a
  commercial company
• Local NGO transfers its loan portfolio to a
  commercial company that is then licensed (e.g.,
  as a commercial bank)

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The basic structural and legal problem of NGO
transformations

• NGOs, by definition, are ownerless, whereas
  commercial legal entities have owners with an
  economic stake in them (e.g., shareholders of a
  joint stock company or members of an LLC)
• Who should the owners of the post-transformation
  commercial legal entity be?
• The mechanics of the particular transformation
  determine the answer (but local law may limit the
  possibilities)

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The legal mechanics two common models (with
infinite local variations)

• Portfolio exchange model
• NGO (foreign or local) exchanges its portfolio
  for shares in a commercial company (and probably
  brings in new investors as co-shareholders at the
  same time)
• Portfolio sale model
• NGO (foreign or local) sells its portfolio to a
  commercial company (and probably then invests
  some or all sale proceeds in shares of the
  commercial legal entity)

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Likely consequences of the portfolio exchange
model

• The NGO ends up a shareholder of the commercial
  company (typically along with the other investors
  who also bought shares with cash)
• The NGO faces the question what to do now
• Continue lending (possibly in competition with
  the commercial company)
• Simply exist as a holding vehicle for shares in
  the commercial company (but what to do with
  dividends?)
• Dissolve (but what happens to the shares in the
  commercial company?)

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Likely consequences of the portfolio sale model

• The NGO does not necessarily end up a shareholder
  of the commercial company (unless it buys shares
  with some or all of the cash it got from the
  portfolio sale)
• More likely to raise serious tax issues than a
  portfolio exchange (but this is very
  situation-specific in both cases)
• The NGO still faces the question what to do now
• Continue lending (possibly in competition with
  the commercial company)
• Simply exist as a holding vehicle for shares in
  the commercial company (but what to do with
  dividends and any remaining cash it got from the
  portfolio sale?)
• Dissolve (but what happens to the shares in the
  commercial company and any remaining cash it got
  from the portfolio sale?)

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Why do it? (a few reasons often mentioned)

• Gain access to a new means of raising funds for
  growth (outside shareholders)
• Directors elected by shareholders are supposed to
  be better at governing serious financial
  institutions (because shareholders have an
  economic interest)
• May be legally required to receive a desired
  regulatory status and offer new services (e.g.,
  commercial bank)
• Its chic and everybody else is doing it (STOP -
  bad reason!)

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What might stop you? (some possible factors)

• Type of NGO in question may not be legally
  allowed to participate in a commercial company
  (particularly if this is all it does!) or may not
  be considered a suitable shareholder (e.g., of
  a bank)
• Supposed governance gains depend on bringing in
  outside (private) shareholders and maybe you
  dont want to share control with them
• Costly and who wants to pay for this
  (especially possible hidden costs such as tax
  on portfolio transfer)?

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Analyzing some conflicting claims

• You must transform because donor funds are
  drying up and you need access to new sources of
  funding

• But in many countries NGOs can legally borrow to
  onlend (without the costs of a transformation)
• And many NGO MFIs have a lot of unleveraged
  equity (from grants), so theyre in a good
  position to borrow
• Recommendation analyze costs and make sure the
  investors are there for the equity you hope to
  sell before deciding to transform!

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Analyzing some (more) conflicting claims

• Commercial legal entities are better governed
  than ownerless NGOs

• Some are, and sometimes its because the
  directors are elected by economically interested
  shareholders
• But economically interested shareholders are no
  guarantee of good governance (compare Harvard, an
  ownerless NGO, and Enron, a now bankrupt
  commercial energy giant which has been governed
  better?)
• Also, remember NGOs are usually prominent
  shareholders of post-transformation commercial
  MFIs!

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Analyzing some (more) conflicting claims

• Commercial legal entities can be licensed, so
  an NGO-to-commercial legal entity transformation
  is the key to licensing

• True, few legal systems permit licensing of NGOs
  particularly if the license is to collect
  deposits from the public
• But most banking laws have strict shareholder
  suitability restrictions (to make sure the
  shareholders can put in more money if the
  institution risks insolvency)
• Many times NGOs are not considered suitable
  shareholders (or are limited in their allowable
  shareholdings)

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Analyzing some (more) conflicting claims

• Its possible in your country because it
  happened elsewhere

• Not necessarily!
• Legal systems vary tremendously (even within this
  region)
• Even similar provisions of law and regulation may
  be interpreted very differently in different
  countries
• Each transformation presents unique facts that
  may affect the legal and practical feasibility

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Analyzing some (more) conflicting claims

• Commercial legal entities suffer mission drift
  and abandon their poorer clients

• Not necessarily!
• In fact some evidence suggests market forces may
  have a greater impact than legal status (NGO
  versus commercial company) in determining who
  transformed MFIs target for their products and
  services

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Why are transformations so confusing?
Transform? It seems you must, yet Im not sure
you can!
Is there a contradiction here?
Any questions or concerns?
Lets turn to some people who are learning from
experience our panelists . . .
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The panelists

• Mary Chaffin Kompanion in Kyrgyzstan
• Ludmila Teterikova FORA in Russia
• Aleksandar Kremenovic MikroFin in Bosnia

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Mary Chaffin Kompanion in Kyrgyzstan

• An already completed transformation
• What were the true costs?

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Ludmila Teterikova FORA in Russia

• A transformation in process
• How does one structure an NGO-to-licensed
  institution transformation in an unreformed
  legal system?

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Aleksandar Kremenovic MikroFin in Bosnia

• A transformation waiting to happen
• How should one prepare before the transformation
  is legally feasible?

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Discussion Your Turn
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Building Financial Systems for the Poor THANK
YOU !!!