What does and does not work well with Omidyar Network’s investment framework? B Why is financial inclusion an important investment sector? How does it fit into Omidyar Network’s inve

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Senior Lecturer Vikram S. Gandhi, Program Director Caitlin Lindsay Reimers Brumme (Impact Collaboratory), and Associate Case Researcher James Barnett (Case Research & Writing Group) prepared this case. It was reviewed and approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School and not by the company. Certain details have been disguised. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2018, 2020 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

V I K R A M S . G A N D H I

C A I T L I N L I N D S A Y R E I M E R S B R U M M E

J A M E S B A R N E T T

Financial Inclusion at Omidyar Network

It was early March 2012 and Arjuna Costa (HBS 2001), Director at the impact investing firm Omidyar Network (ON) and lead investor for ON’s new financial inclusion initiative, had just left the company office in Redwood City, California. He and Matt Bannick (HBS 1993), ON’s Managing Partner and the Chair of the investment committee, had spent the day discussing how they would apply their newly adopted financial inclusion strategy and what investments would align with ON’s company mission: ON only made investments intended to create social impact around the world. Several months prior, ON had launched its financial inclusion initiative in order to better serve the more than 2.5 billion people worldwide who lacked access to basic financial services. Costa, who joined ON in 2010 to focus on investments primarily related to financial services, took the initial lead.

That day, Costa and Bannick had discussed investing in two different companies—MicroEnsure and Lenddo—both of which, despite intriguing characteristics, raised questions for the financial inclusion team. MicroEnsure, a nonprofit entity intended to deliver microinsurance to underserved populations in emerging markets, was requesting a bridge loan on commercial terms that would enable it to spin off from its parent nonprofit into a standalone commercial enterprise. While MicroEnsure’s product seemed aligned with ON’s financial inclusion strategy, the team wondered if its return and impact potential warranted risky interim funding and a long-term commitment on a for-profit basis.

At the same time, ON was considering an investment in Lenddo, a credit scoring and verification service that used online data to provide loan opportunities for those with limited or no credit history. While Costa and Bannick were excited by Lenddo’s innovative model for leveraging big data, they were concerned that traditional banks and lenders might not accept Lenddo’s unconventional credit scoring system. Furthermore, Lenddo largely targeted the aspiring middle class that had a social media presence in markets where much of the population was well below the poverty line.

Costa and Bannick used ON’s investment framework to evaluate MicroEnsure and Lenddo. The framework categorized investments by looking at both their financial and impact potential. Costa and Bannick had to decide: Should ON make an investment into one, or both, of these companies? What type of investment made the most sense given their impact and financial goals?

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Impact Investing The Global Impact Investing Network (GIIN) defined impact investing as “investments made into

companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return.”1 Impact investing as an established field had only existed since the mid- 2000s. The GIIN was launched at the annual Clinton Global Initiative conference in 2009.2 Although the GIIN and other organizations had begun to establish industry infrastructure, clear consensus on what constituted an impact investment and how to measure impact did not exist. Impact investment strategies included those seeking risk-adjusted returns (an investment return that considered the risk taken in the investment over time) and sub-market returns. (See Exhibit 1 for characteristics that define an impact investment business.) Impact investing was sometimes referred to as sustainable investing, social investing, or social impact investing.

Omidyar Network In 1995, before launching ON, Pierre Omidyar founded the online marketplace that would become

eBay. Following the company’s initial public offering (IPO) in 1998, Omidyar became a billionaire, and shortly thereafter, he and his fiancée, Pam, agreed they would use their newfound fortune in an altruistic fashion.3 Omidyar moved out of his day-to-day role at eBay (he remained board chairman), and, in 2000, he and Pam founded the Omidyar Family Foundation (OFF). At first, the foundation ran as a nonprofit donating to charities in need of consistent financial support. However, within three years, Omidyar realized OFF could make a greater impact if it were run more like a business and less like a charity.4 His belief that philanthropy differs considerably from charity added to the underpinning for what came to be ON. In 2011, Omidyar explained:

Most people don’t distinguish between charity and philanthropy, but to me there’s a significant difference. . . . Charity is inherently not self-sustaining, but there are problems in the world, such as natural disasters, that require charity. . . . Philanthropy is much more. Philanthropy is a desire to improve the state of humanity and the world. It requires thinking about the root causes of issues so that we can prevent tomorrow’s suffering. . . . In thinking about philanthropy, I began looking for ways to harness the incredible power of business in order to make the world better.5

In 2004, the Omidyars decided to create an innovative hybrid structure that gave them more flexibility to achieve their philanthropic goals. They established ON as both a limited liability company (LLC) and a private foundation, with operations conducted from the limited liability company. This change enabled ON to fund potentially impactful organizations and causes beyond what fell under the traditional notion of being charitable as defined by the United States tax code. The ON LLC made for- profit investments, and the foundation provided grants. The 2004 establishment of ON helped pioneer the growing impact investment industry.

The transition from a traditional charity to ON’s for-profit/nonprofit blended structure proved difficult. ON struggled to match its culture with the new company vision. Philanthropies were generally risk averse, so the new personnel and previous OFF staff approached investments with different philosophies.6 In 2007, the Omidyars led a restructuring intended to shift the organization to run more like a business; Omidyar remarked that he wanted ON to operate similarly to a venture capital (VC) partnership model, with an egalitarian team of investors collaborating and willing, when necessary, to take risks on both nonprofit and for-profit investments.7

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As part of the restructuring, Matt Bannick came on as Managing Partner. Bannick knew Omidyar from his time at eBay, when he joined just after the IPO and went on to serve as President of eBay International. Bannick had also been President at PayPal for three years.

Over time, ON continued to adjust its strategy for advancing scalable change worldwide. The organization operated under a set of beliefs inspired by Omidyar: primarily that people were inherently good but often lacked access to opportunity. Moreover, businesses could be a catalyst for good, particularly when driving large-scale social change.

ON’s flexibility to invest in both for-profit and nonprofit entities, however, required a way for investment teams to rigorously evaluate investment opportunities with specific expectations for financial return.

Impact Investment Framework

To address this challenge, ON developed a proprietary framework to guide how it would make investments across a “returns continuum.” Bannick explained, “We believe that for investors seeking impact there is a broad range of investment profiles. Many impact investments can be fully commercial, as success scales both financial return and social impact in tandem, while others involve a trade-off between returns and impact.”

Omidyar and Bannick remained intentional about, if not wary of, potential investments that, while fitting with ON’s social mission, were likely to deliver below-market returns. Omidyar did not want social impact to cover up for underperformance. Perhaps more importantly, Omidyar saw the potential for subsidies to distort a market—and an investment with below risk-adjusted market rate returns had the potential to do exactly that.

As a result, ON determined it would accept below-market returns in certain circumstances, namely where an investment had the potential to not only deliver value to its customers (direct impact) but also accelerate the development of a new market paradigm to reach the underserved (market-level impact). According to ON, market-level impact could be achieved in three ways: first, an investment could pioneer a new service or model previously undeveloped in a given market; second, an investment could develop infrastructure that might catalyze future growth; or third, the investment influenced policy critical to a market’s development.8

ON’s investment framework integrated these concepts into all investment decisions. ON began by confirming the investment’s potential for direct impact and then assigned an investment to one of the categories on the continuum: commercial (A1, A2), subcommercial (B1, B2), or grant (C1, C2, C3). Investments that were not expected to generate commercial returns faced greater expectations for their market-level impact (see Exhibit 2 for ON’s breakdown of its investment framework).

Category A: Commercial Investments in this category were expected to achieve risk-adjusted financial returns, while having a strong positive impact. While Category A investments were not required to have evidence or likelihood of market-level impact, ON sought to avoid investment in companies where the financial or business model put them at higher risk of “mission drift,”9 such as targeting more affluent customers.10 ON often sought to make Category A investments in companies where impact was implicit in the business model, and therefore impact could be achieved simply through growth in customers. ON invested in Category A companies due to their capacity to scale massively through retained earnings, in addition to their ability to raise substantial outside capital. ON believed that Category A investments that scaled were also likely to deliver market impact, as high

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levels of profitability would attract competitors, driving up quality and continuing the cycle of innovation.

Category A investments were subdivided into A1 investments and A2 investments. A1 investments involved commercial co-investors alongside ON.11 A1 investments generally occurred in established VC markets like the U.S., Europe, and India before being adapted into emerging markets upon productive returns.12 ON made A1 investments because it believed that it could bring value beyond financial capital, a fact recognized by entrepreneurs.

A2 investments were those for which ON expected commercial returns but commercial co-investors were absent. These investments tended to be in sectors or regions in which ON had relative expertise or familiarity and therefore presented a lower risk profile than a commercial investor might perceive.13 ON found A2 investments attractive because they were not likely to get funded without ON involvement, and they had the potential to generate both direct and market-level impact. These investments were often in regions outside the U.S. and in companies serving mass-market customers, which traditional investors might not see as viable.

Category B: Subcommercial ON accepted potential below-market financial returns in commercial entities in which it anticipated market-level impact. ON recognized that entrepreneurs in new markets, however promising, often had to overcome significant market-level barriers before becoming viable commercial entities. Companies building market infrastructure or seeking to influence policy might never achieve commercial returns but were critical to market creation.

Category B investments were subdivided into B1 and B2 investments. ON anticipated positive absolute returns with B1 investments and capital preservation with B2 investments. B2 investments were distinguished from B1 in that their financial returns were harder to estimate, often because they existed in emerging markets that had previously received little to no private-sector investments.14 Few of ON’s investments fell within the B2 subcategory.15

Category C: Grants Anytime it made a grant, ON required evidence of potential for significant market-level impact. While there was never an expectation of returned capital on grant funding, ON divided Category C grants into three subcategories (C1, C2, and C3) reflecting the extent to which ON expected the respective nonprofits to eventually cover their own costs through operations. C1 grants went to organizations expected to earn revenue that would cover 80% to 100% of their costs over time; C2 grants went to organizations expected to cover 20% to 80% of their costs over time; C3 grants went to organizations expected to cover less than 20% of their costs over time, sometimes not covering any costs at all.16

By 2012, the organization was starting to organize itself according to different impact priorities, which it called initiatives, each with its own specific mission, metrics, and team. Each initiative developed an impact portfolio that represented a different mix of Category A, B, and C investments. The portfolio reflected a number of factors, including the team’s strategy, the relative maturity of the sector and consequent need for catalytic capital, and the structure of the markets in which they operated. The five initiatives were: education, emerging technologies, financial inclusion, governance and citizen engagement, and property rights. (See Exhibit 3 for a description of each initiative.)

Financial Inclusion

Financial inclusion was the term used in the broader economic development ecosystem for making financial services available to all individuals and businesses; it represented the evolution of the

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economic development narrative beyond microfinance.17 The World Bank stated: “Financial inclusion means that individuals and businesses have access to useful and affordable financial products and services to meet their needs—transactions, payments, savings, credit, and insurance—delivered in a responsible and sustainable way.”18 The World Bank estimated that more than 2 billion adults worldwide did not have access to a bank account.19

Financial inclusion gained relevance as studies revealed negative correlations between poverty and access to formal financial services.20 Experts on the topic argued that those without access to formal financial services, also referred to as “unbanked populations,” reinforced poverty. Unbanked individuals generally used cash and had greater difficulties accessing loans. Formal financial services eased the ability to access loans and created a platform to build credit history. Academic research provided evidence that access to financial services improved the lives of those previously without such access. In one such study, poor farmers who were offered rainfall insurance began planting different crops that yielded profits up to 35% higher.21 Another study found that when offered banking services, entrepreneurs in Kenya saved more money and invested it back into their businesses.22

Financial exclusion was not limited to developing nations. According to a 2015 report by the U.S. Federal Reserve, 46% of American adults would be unable to come up with $400 for an emergency expense, or would need to sell something or borrow funds to do so.23 The same report found 8% did not have a bank account.24 In the aftermath of the financial crisis, the number of bank branches serving low-income postal codes dropped by 10%, compared to a 3% decline for high-income communities.25 These same regions, sometimes called “banking deserts,” were often populated by companies operating in the alternative financial services industry—check cashers and payday lenders—which often charged high fees.26 “Those places are open during convenient hours. They are friendly and accessible. They are also deathly expensive and often result in a spiral of debt for their users,” noted one financial inclusion expert.27 Managing money outside the commercial bank system was costly for individuals and businesses. Unbanked and underbanked people paid high fees to cash paychecks and government benefit checks, and lacked a secure, reliable method for saving money.28

Traditionally, populations with limited or no access to financial services did not receive attention from banks due to assumptions of high customer acquisition costs, high lending costs, and low transaction values because of limited incomes. However, some argued that firms could in fact offer financial services to unbanked and underserved populations profitably. Doing so would require an understanding of customer needs, innovative product design that might differ from traditional financial services, and the ability to manage challenges and opportunities when introducing financial services to new populations (through engaging governments and other stakeholders).29

ON’s Financial Inclusion Initiative

In 2011, ON expanded its microfinance investing into the financial inclusion initiative that Costa described as a natural evolution stemming from recent investments and developments in the field:

Initially, our financial inclusion investments were not categorized as a separate initiative. Many of our initial investments that fell under the financial inclusion umbrella stemmed from our work in the microfinance space. As a reaction to the evolution of microfinance and the landscape at large, we decided to create the initiative to better focus our investments and structure our investment strategy.

Each investment from the team had to align with the stated goal of the financial inclusion initiative: “To accelerate ubiquitous access to an affordable and complete suite of financial products and services by financially educated individuals from a commercially viable industry.” (See Exhibit 4 for ON’s

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financial inclusion approach.) Equally, Costa recognized the financial services industry had many unique attributes: it was heavily regulated in each local jurisdiction; it was dominated by incumbent banks with significant market power; and scale invariably required large amounts of capital best raised through the capital markets. Costa believed market-level impact could therefore come in two forms: (1) scaling a direct-to-consumer business, and/or (2) building new products and services for incumbent service providers, altering how they approached mass-market customers. The returns continuum framework would have to be thoughtfully applied in every investment decision that the financial inclusion team would make—with investments in both emerging and developed markets.

MicroEnsure

Founded in 2005 by Opportunity International, a faith-based charity aiming to end global poverty, MicroEnsure worked to provide affordable insurance products in developing markets. MicroEnsure operated as an insurance broker, meaning the majority of its products were offered on behalf of other insurers. MicroEnsure was responsible for intermediation between insurers and insurance customers, administration throughout the process, and claims management. Historically, MicroEnsure offered insurance products through partnerships with microfinance institutions; however, in Ghana, MicroEnsure had pioneered an innovative partnership model with mobile phone operators. Given the scale benefits, the company shifted to emphasize growth through this type of partnership. The company offered a range of insurance including credit, life, health, property, and weather.

Before MicroEnsure, the majority of companies that tried to offer insurance to low-income populations in developing markets failed, due to either high subsidy requirements or high churn rates. However, MicroEnsure’s unique partnership approach with mobile carriers had significant promise. The vast majority of cell phones in developing markets were prepaid.30 Capitalizing on this, MicroEnsure and its partner mobile carrier offered subscribers free insurance products as an add-on if they spent a pre-specified amount on airtime each month. Each subsequent month, customers had to spend the same or greater amount on airtime to keep the insurance coverage. This created an embedded loyalty program for the mobile operator’s services and also provided the insurance providers a low- cost sales method to reach previously inaccessible markets. Moreover, customers submitted claims via text messages, which also reduced claims-management costs and settlement time. After spending time using the free add-on service, many customers saw the benefits of insurance and paid for upgraded plans with more expansive coverage options.31

MicroEnsure had the potential to have a meaningful impact on its customers and the market. Its insurance products sought to help minimize the financial distress of unexpected life events for low- income families, often the hard-to-reach “last mile” customers. As a true pioneer, MicroEnsure had the potential to demonstrate to the insurance ecosystem that a company could profitably serve mass- market and low-income consumers in the emerging markets. Moreover, MicroEnsure was committed to developing and selling products beyond the typical “credit life”a product to the mass market. If successful, MicroEnsure would generate both direct and market-level impact.

Most of MicroEnsure’s revenues came from a small commission earned on a per-policy basis when providing sales and front-office support for the insurance provider. However, MicroEnsure also had some revenues related to its back-office support. Per policy, earned monthly commissions averaged $0.02 per month. While commissions through partnerships with mobile carrier partners were low, they

a Credit life insurance was a product covering the outstanding principal and interest of a loan upon death of a borrower.

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resulted in significantly more scale. (See Exhibit 5 for MicroEnsure’s business model.) MicroEnsure’s business model thus required scale to be a compelling financial investment.

The company projected it would sell 27.1 million policies by 2016, of which 19 million would come from mobile carrier partnerships. Major costs included staff on the ground and in the central office. (See Exhibit 6 for financial projections for MicroEnsure.)

Investing in Insurance

In 2009, ON had made a $4.5 million grant to MicroEnsure’s parent organization, Opportunity International, to fund electronic and mobile banking technology in Africa.32 Upon joining ON, Costa had been tasked with managing this grant. While Costa ultimately decided not to renew the grant, he remained interested in MicroEnsure and continued to communicate with the CEO, Richard Leftley.

MicroEnsure’s primary funding had been in the form of grants from Opportunity International and a multiyear $24.2 million grant from the Bill and Melinda Gates Foundation (Gates) in 2007.33 By 2011, MicroEnsure’s funding was under pressure. Opportunity International faced competing demands on funding, and the Gates grant had been not been renewed due to a shift in focus at both Gates and MicroEnsure in terms of product and geography.

At the same time, Costa believed MicroEnsure was showing signs of commercial promise. Costa remarked on the situation: “When I looked at Opportunity International’s portfolio, I found that MicroEnsure could be an intriguing potential addition to our growing financial inclusion portfolio. However, because the Gates Foundation was not going to renew their grant, and the partnership with mobile operators showed commercial promise, I thought this represented a unique opportunity to try and create a standalone commercial entity.”

In May 2011, Telenor, a multinational telecommunications company interested in expanding into microinsurance, approached MicroEnsure about an acquisition. Leftley was concerned about making such a significant decision with an untested partner and instead opted to form an Asia-focused joint venture (JV). When finalized, this JV would give MicroEnsure access to approximately 130 million potential customers.

These factors encouraged Leftley to focus on spinning out MicroEnsure as a for-profit entity and raising external capital to fund growth. The company had received a term sheet from one other investment fund, but that deal would be complex and remove management from any ownership position. MicroEnsure’s leadership was not convinced this was the right partner to help navigate the transition from nonprofit to for-profit. Therefore, MicroEnsure continued discussions with Telenor and several other commercial investors to seek funding as it pursued independent growth.

In November 2011, Leftley approached Costa to see if ON would provide a short-term $1 million bridge loan that would convert into equity when the company raised its priced Series A. The company would run out of cash in the summer of 2012, so a decision would need to be made quickly. Based on valuation negotiations at the time, ON had an opportunity to secure a 20% ownership stake in the company upon conversion of the $1 million note and a further infusion of $250,000 in MicroEnsure’s A round. Costa felt that the valuation seemed reasonable. While MicroEnsure had been in operation since 2005, in many ways, the new commercial business model was unproven. Additionally, there were no comparables to look at, as there were no precedents for a spinoff from a nonprofit.

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The Opportunity

Costa and Bannick believed MicroEnsure offered a promising alternative insurance model with a large potential market. In addition to the potential for massive customer scale, the partnership delivery model offered the opportunity for a viable and compelling future business model, one that could spur the microinsurance industry and solidify a symbiosis between financial inclusion and mobile businesses. Along the key dimensions of reach, engagement, and influence, MicroEnsure’s business model and market potential were exciting.

The partnership model also underpinned the financial case. In 2012, MicroEnsure served 4 million people, which Costa estimated represented only 2% to 3% of its market potential. Total potential premium volume was upwards of $40 billion.34 If able to execute, MicroEnsure might be uniquely positioned to capitalize on the $40 billion market potential due to its innovative partnership model.

MicroEnsure’s experience with one of the leading telecom operators in Ghana showed it had a compelling value proposition: the partnership had reduced churn and increase