In the last month, we gave out an introduction to banking and other financial institutions. We also looked into a few details of the microfinance institutions (MFIs) and how they are different from the banks.
Today, we shall look at the sources of funding to these MFIs and how they are able to amass adequate funding in order to serve their clientele.
Many financial institutions are owned by wealthy individuals and corporate institutions. They put together the initial or seed capital of the business to kick-start the operation. This initial capital is used to get the license, to acquire offices, hire key personnel and help to start the operation of the business. On many occasions, just one individual could commence the funding until others would join later on. These individuals are called Founders of the organization.
A venture capital is defined as a capital invested in a project in which there is a substantial element of risk, typically a new or expanding business. In other words, a venture capital is financing that investors provide to start-up companies and small businesses that are believed to have long-term growth potential.
Venture capital generally comes from well-off investors, investment banks and any other financial institutions that pool similar partnerships or investments. Do you remember our lesson on development banks and wholesale banks?
Grants and Donations
The minority of the microfinance institutions get their funding from grants and donations. These donations come from foundations, NGOs, charities and some social enterprise organizations that will like to contribute to the development of micro financing in some specific areas. Some private organizations/companies also do it through what is called Corporate Social Responsibilities (CSR).
These grants and donations are called Donated Equity in the books of the recipient MFIs. Others will also treat is as capital grants – grants towards the purchase of fixed assets or specific projects. In this wise, the grants are amortized over the period of the grant.
Borrowing to augment the capital of the business is the normal thing in banking and financial services industry. Banks lend among themselves and lend to other institutions in their brackets other than outsiders.
With this, MFIs do borrow from the banks to expand their loan portfolios and also meet critical fixed assets and operational needs. But the majority of these MFIs only borrow to fund their loan portfolios. This is done after they have exhausted their shareholders’ capital or need a bridging finance. A Bridging finance is used when expected fund is delayed and a quick fund is needed to cover the gap between the shortfall now and the time of receiving the expected fund.
Crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people. Normally this is internet based appeals or proposals for many people to contribute towards a particular cause, for example, raising money to help flood victims or to provide social funding to a poor community. Funding of this sort could come in the form of donations or equity.
Now, there are a number of websites promoting these kinds of funding for businesses and individuals alike. But these strategies of funding call for marketing and selling of the ideas to the wider public.
Private Equity Investment
A private equity is a type of equity and one of the asset classes consisting of equity securities and debt in operating companies that are not publicly traded on a stock exchange. A private equity investment will generally be made by a private equity firm, a venture capital firm or an angel investor. Referring to the points above on Shareholders equity and venture capital, the private equity is from private investment firms that have made an equity towards the business.
An angel investor (also known as a business angel, informal investor, angel funder, private investor, or seed investor) is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity.
While venture capital is a subset of private equity, there are differences between the two. The most notable difference is that venture capital funds raise capital from investors to specifically invest in start-ups and small- and medium-size private companies with strong growth potential. Private equity is generally interested in continuing businesses, not start-ups!
Peer to Peer (P2P) Lending
Peer-to-peer lending, sometimes abbreviated P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders with borrowers. Since peer-to-peer lending companies offering these services generally operate online, they can run with lower overhead and provide the service more cheaply than traditional financial institutions (Wikipedia).
This also looks like the crowdfunding strategy. But there is a great difference. P2P is organised in such a way that, lenders and borrowers are put on a platform. Lenders give out their loans under specific conditions and the borrowers can choose to accept the terms or contact another lender. Alternatively, the platform has a set of agreed interest rates, repayment periods and other conditions.
In the crowdfunding, however, the platform is generally for numerous individuals who could even contribute as little as US$1 towards a cause, and it is not for loan purposes. There is, however, an equity element introduced recently by some of the crowdfunding platforms.
While some people will tell you that money grows on trees, financial experts will say money grows after a careful planning. Before the MFIs go into business, a careful planning is needed. A business plan worth the salt is needed and that must be updated from time to time in order to determine where the institution comes from, where it is now, where it is going and how to get there!