Funding ventures that cater to the bottom of the pyramid

It is a fund that was set up to finance enterprises that cater to the bottom or the base of the pyramid. It is a little over a decade since it was set up and Lok Capital is all set to expand its horizons.

In the first fund of $22 million, Lok concentrated on the microfinance industry and with its second fund, of $65 million, which recently closed, Lok plans to include other sectors such as healthcare (primary and tertiary), education (both remedial and content), full service financial institutions, mobile payments, remittances and small business lending.

‘Larger mandate'

“The second fund we wanted to raise with a larger mandate,” says Mr Venky Natarajan, Managing Partner, Lok Advisory Services Pvt Ltd, which manages the two funds of Lok.

When Lok started raising the second fund, micro-credit was at its peak in terms of profitability and scope for scaling up, but the sector's problems had started when Lok was half way through its fund-raising programme. Lok's efforts to raise the second fund were also affected by the crisis in Europe, because of which closing the fund got delayed by a few months.

According to Mr Natarajan, a couple of other large LPs (Limited Partners) have invested in the second fund. One is the French development agency Proparco (the private sector investment arm of Agence Francaise de Development – AFD) and the other is ASN Novib (a microfinance investment vehicle of the Netherlands).

Ideal mix

“We believe we have the right mix. We have 80 per cent of our capital from these multilateral agencies and 20 per cent from institutions and individuals.”

For a fund like Lok, this is the ideal mix, says he. “We don't want to go too far into raising private capital or making it completely development oriented.”

The Lok Capital initiative was launched at the end of 2000, with support of a grant from the Rockefeller Foundation. Lok Foundation, the charitable trust at the heart of Lok Capital, was set up in 2003 to promote financial and social inclusion, by giving grants, technical support, research and advocacy.

The foundation itself is funded by grants and by investment gains from its VC funds. The multilateral agencies that invested in the first fund, and in the second fund also, include IFC, CDC, KfW and FMO.

From the first fund, Lok invested in companies in the microfinance space, including Ujjivan, Janalakshmi and Basix. “We invested in nine companies. We had four exits,” says Mr Natarajan, and adds that Lok had reasonable success from the first fund, “because we have already returned close to 50 per cent to the shareholders.”

A few of the exits from the first fund were before the crisis hit the microfinance sector and hence the returns were quite attractive in commercial terms, is all that Mr Natarajan would say.

The returns from those companies in which Lok sold its stake — mainly to a secondary investor — after the crisis affected the microfinance sector, were “more in line with what you would expect from a bottom of the pyramid type of fund.”

It will be at least five years before Lok liquidates the first fund fully. It has just started deploying money from the second fund and it will take at least another three-and-a-half years before all the money gets invested.

New sectors

“It is quite interesting because a lot of the sectors that we are looking at are new from a private equity perspective even though they have been around for ages,” says Mr Natarajan.

For instance, he says, providing affordable healthcare to the bottom of the pyramid population is quite challenging. The same too with education, more so because the regulatory environment is not too clear. “What we have embarked upon is more difficult than investing in micro-credit or in top of the pyramid businesses,” he says. The investment cycles take much longer.

The average time it takes is nine to 12 months before Lok can close the investment from the time of the first engagement. Typically, because of the nature of the companies and the businesses it invests in, Lok would look at being an investor for at least six years before thinking of selling its stake.

To take larger stake

Also, Lok plans to take a much larger stake in the companies it invests in. In the first fund, its holding was in the eight per cent to 10 per cent range; now it will look for a 20-30 per cent stake. This is because Lok wants to have a larger role in the companies it invests in, “especially in terms of how to balance commercial returns with social impact.”

In the first fund, Lok picked up a five per cent stake in some companies, “which was neither here nor there.” “We were always ending up in a situation where the impact interests are getting compromised whenever there was a large commercial investor coming in.”

“We believe that we want to take the company to a certain stage before it brings in more commercial private equity investors. That is the reason behind this,” explains Mr Natarajan on Lok's change in strategy.

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