Lok Capital makes profit with social impact
Civil Society News, New Delhi
In times when private equity investments haven’t been faring too well, Lok Capital is out there raising money for its third fund, having made some good decisions and performed nicely in the past 10 years with its first two funds.
Set up to invest in companies that don’t just make money but are also drivers of inclusion and socially oriented in their goals, Lok Capital chose microfinance in the first round and did well. The exception was Basix, which unfortunately got caught in the Andhra quicksand.
Lok Capital is now looking at micro, small and medium enterprises where the demand is consistently big, as was the case with MFIs a decade ago. The fund is also looking at healthcare, agriculture and affordable housing.
Civil Society spoke to Vishal Mehta, one of the co-founders along with Rajiv Lall and Donald Peck, on what Lok Capital’s investments are looking like:
You invested early on in microfinance companies. What has been the experience?
Actually, just yesterday (10 July) we completed our final exit on the fund. It was a $22 million fund. We made 10 investments and we had our 10th exit yesterday. It was a 10-year fund so technically it expires in December 2016. We have made two times cash on cash in rupee terms, which is basically 15 percent net return year on year. So it was about (makes quick calculation) Rs 100 crore and we made it Rs 200 crore. It is a small size but it’s very good returns for that vintage.
Do all these returns go to the people who put in the money or…?
The way we are structured is quite unique. You want good business leaders, people who are doing it for more than money. Profit maximisation is not the only goal and that’s what we felt we should be in our structure.
So there is the sponsor, or general partner in the lingo of a fund, which is the Lok Foundation. It is a non-profit. The Lok Foundation is the 100 percent owner of Lok Advisory Services, the company which manages the fund.
The profits are calculated after giving the investors the principal and ‘hurdle’ back. The ‘hurdle’ is the minimum return the investors want before they are willing to share the profit with the JV. The 'hurdle' in the first fund was five percent. Of the profits, 80 percent has gone to the investors. Of the remaining 20 percent, 10 has gone to the foundation and 10 to the company, of which the foundation is the 100 percent owner.
What did you look for when you first identified Ujjivan?
I learnt very quickly because I had good mentors like Rajiv Lall and Donald Peck. Donald had been investing in India. He is a co-founder, engaged from day one.
Microfinance is not rocket science. You have to do it right, and do it efficiently, and you will make money. The demand is fairly large and people do have the intention to pay you back because they value the service. Yes, we clearly got our people right and one validation of that is very recently the RBI giving five of its 10 small finance bank licences to microfinance institutions in which we invested. That is a very good hit rate. Ujjivan, Janalakshmi, Utkar, Suryadey and Equitas.
Janalakshmi we had exited long time back. But Janalakshmi was our first investment and I remember doing that deal. Rajiv and I had gone to finalise it with Ramesh [Ramanathan]. Rajiv was so clear. He said, I am doing this first deal for Lok, the last thing I want to get wrong is people. I have huge respect for what Ramesh has done. We paid pretty good valuation for that deal. We wanted to make sure that in people terms we got it right, even if we didn’t make much money.
Look at the pressure. You set out to create impact. But if you start funding some of the guys you should not be funding, you might create negative impact. It’s not like I made a bet and lost money. So for us what matters is who are these people, what are their motivations, are they doing it for the same reasons as we at Lok Capital are? These are very subjective calls. There is no formula. You get better as a team in selecting the right people.
But you exited nicely from all your investments, barring perhaps one.
There was one write-off. In Basix, which was promoted by Vijay Mahajan and a stellar company. It is completely unfortunate that it got caught in the Andhra crisis.
But it wasn’t bad as an original call.
No, it wasn’t. Vijay Mahajan is the father of microfinance in India. I mean, we were very happy to do that deal. It is just extremely sad how it happened and what the eventual outcome was.
Now, you make money and that’s good. What about the impact part of it? How have you assessed that?
On impact I would say we started with a very loose definition. We knew our intent. There were two or three things we looked at. Microfinance, to be honest, was very easy. You are serving a segment completely underserved by banks. You’ve done this consistently, these people keep coming back to you and you earn much higher rates of interest because they value the product. As long as you do it responsibly, there is huge impact.
We haven’t as a fund figured out a way to do deeper impact analysis of how lives of people have changed. That’s a very difficult and expensive impact assessment.
But we looked at microfinance in terms of affordable, consistent financial services done in a responsible way. That’s how we looked at the impact. It is much more complex in health and education and agriculture to innovate and to give more and better products.
I mean, we started funding microfinance at an average interest rate of 40 percent. It has come down to 25 percent now. There are many more products available.
Do you think you had a role to play in that by being an investor in microfinance companies and allowing them to gain new efficiencies?
I would think so, especially when you understand that the RBI goes through a very deep and thorough analysis of who should be given a banking licence. The kind of diligence they have done on people and systems!
How deep is your association with companies you invest in?
Out of the 10-member team I run right now there are only two people who are pure investment background folks. Eight of us have done operational things in life, which is very unusual for our fund. I think that stems from our model of getting engaged.
The reality is that not every promoter is looking for your engagement. It is a very, very intense relationship game. People have to see value in you and so you have to invest in that relationship to build trust over time. Our engagement has largely been in the areas of human resource — building teams. The fact is I was getting much better CVs than these companies were getting on their own. But we also run a fellowship programme where we deploy smart people for one year in these companies and we share the cost of that jointly.
The other main area has been technology — how you think about systems. Governance is a misused term but in this case I will use it. Post the Andhra crisis, then the Malegam Committee and now licences… governance is very important. How are you looking at the boards and the auditors of these companies? How are you preparing them to become institutions rather than just small individual-run companies? Initially, it did not show us a lot of outcome. Now that some of these companies have been selected we believe we were investing in the right governance structures as well. We have always had somebody — this is largely about expansion — who could help the companies plan the next stage, move to new geographies. How do you go to MP from UP, how do you go to Rajasthan...
Would you like to give an example, like Ujjivan?
I have many examples. We were not one of the early investors in Ujjivan. We came in the second or third round of funding. In Ujjivan I would say our work has been in three areas. One, when the Malegam Committee’s regulations became applicable, which basically meant there is a pricing cap now, the only way companies will remain sustainable is by bringing down their operating costs. We worked with the company to figure out very detailed branch-level economics. I mean it literally — do not keep five stationery items in a branch.
We have worked recently with them very closely on this banking transformation, which is in process. They had confidence and trust in us. But, more specifically, Ujjivan has probably employed more Lok fellows than any other company. I think we have had three or four Lok fellows there.
You give funding, perspective and then you get into ground-level issues which they may not have the wherewithal to address.
At Lok Foundation we ran a big literacy campaign for Ujjivan customers where we made two short films on how customers should be wary of ghost lending — you borrow for someone else and then it gets you into a debt trap. The campaign was translated into 15 regional languages. With Ujjivan we had a pretty strong track record. So you are right — perspective, governance and then minute aspects of the operation.
Your second fund, where has that gone?
About 82 percent has gone into financial services, it’s a $65 million fund. And the remaining 18 percent has gone into health, agriculture and education. When we were raising the second fund we said we want to diversify, we wanted to from day one but at that time we didn’t want to spread ourselves too thin. Our investors wanted us to focus because we had a lot of things to prove. They wanted to keep it simple.
Within financial services we had already said this will be MSME finance, affordable housing finance apart from microfinance. We had not anticipated small finance banks because we weren’t sure those regulations would come or not. So that was the diversification fund.
When you look at MSME finance does that get touched by education and health or are those two separate?
I think they are still separate.
So then in MSME what are you looking at really?
Basically, we are looking at non-banking finance companies. For almost the same fundamental reasons why banks were not able to reach microfinance customers, banks are also not able to reach small businesses. I am talking about loans from Rs 50,000 to Rs 7-8 lakh.
What kind of businesses are these?
Small hotels in small towns, power looms, dairy farmers who want to buy five new animals — all of that.
What is the kind of healthcare company you would invest in?
We set three priorities: affordability, access and quality. We are trying to do this with the right people and we have done two deals so far. There is one eye care company called Drishti that we seeded. It is run by an IT entrepreneur who clearly had his heart in the right place. By the way, Nandan Nilekani just invested in that company last week. We are trying to prove there is a model in eye care in small towns in Karnataka; you don’t have to go to Bengaluru, you can stay in Devanahalli and we will give you good quality and a wide range of affordability from Rs 1,500 to Rs 15,000.
This is optometry plus ophthalmology?
That’s right. Eighty percent of this is cataract. It covers 98 percent of what can go wrong with an eye. We want to start addressing some of the more specific things in the next phase. We already have three hospitals and three spokes or smaller hospitals.
The other deal is in what I call remedial care but the concept is that after an accident or stroke the hospital is done with you but you are not functioning. This company in Madurai does an average of 30 days’ remedial care where you and an attendant from the family comes — it’s largely about diet, physical therapy, but trying to get you back on your feet in an affordable way. The idea is to expand this. This company is about two or three years old and promoted by Arvind from the Arvind eye care family.