It is fundamentally different from microlending.
In exchange for receiving the microcapital investment, the business owner agrees to let the investor partly own the business. Part ownership is known as equity.
The benefits of this arrangement are numerous.
The business gains the capability it needs to compete more aggressively and serve customers better, in the form of new equipment, premises, or technology. The business is now able to add more value to the economy, and generate more profits.
The business owner does not incur any debt. In the event of a calamity, such as flooding, a fire, or illness, the owner does not end up being indebted without the means to pay off the debt. Profits are shared with the investor if profits are made; if no profits are made, there is nothing to pay.
The investor, meanwhile, is not limited to earning a fixed amount of interest. Return on investment is open-ended and unlimited. The business can go on generating income for years, and the investor continues earning from the microcapital investment many years after any debt would have been paid off.
If a borrower of a microloan defaults on a payment, the repayment rate for the lender drops, and the lender is in immediate risk of losing money. Just a few defaulting borrowers are enough to put the lender into the red. Therefore, the investor must be ultra cautious when lending money.
In practice, this means that lenders rely on collateral. Just as banks require deeds to property or vehicles, or pawnshops require tangible assets such as jewelry or electronics, so do microlending operations require borrowers to be part of Mutual Guarantee Associations or Joint Liability Groups.
Joint Liability Groups are associations of 15 or more members, who all agree to be responsible for each other. Therefore, members work hard to repay their loans, in order not to let the other members of their group down. Joint Liability Groups are an excellent way to ensure high repayment rates in the absence of collateral.
But for most micro-entrepreneurs, becoming a member of a Joint Liability Group is impractical, since it takes time and energy to find or set up a Joint Liability Group. In the Philippines, setting up such groups is cumbersome, time-consuming, and expensive [1].
If you own a sari-sari store, and can only avail of a microloan if you are a member of group consisting of yourself and a large group of other borrowers, it may take years of negotiating and persuading and waiting to finally qualify for a loan. And in most cases, there is no need, since the 5-6 moneylenders are available [2]
Microcapital investments, meanwhile, can be given out much more freely than microloans. Just one or two highly successful investments can easily subsidize all other investments. Even if 80 percent of investments fail, the 20 percent that do succeed can generate strong profits, covering the investments in the failed businesses as well as future investments.
This is a huge difference: microlending requires 90 percent of all borrowers to repay their loans, while microcapital requires only a small percentage of all entrepreneurs to succeed. Microcapital investors can take bold risks, and the entrepreneurs have the freedom to be creative and innovative.
Venture capital funded and drove many of the most successful American companies, such as Apple, Microsoft, Google, and so on. There is no reason why the same princple of venture capitalism cannot be applied to micro-businesses in the Philippines.
Unlike microlending, microcapital has the potential to reach far more entrepreneurs, and to spark and drive vast profits, which can be pumped back into the economy.
Source: Bayan Capital
