This document discusses micro equity finance as a potential financial product for small and micro enterprises in India. It notes that over 90% of Indian establishments currently have limited sources of financing beyond self-finance or loans. Micro equity finance could help more establishments access capital market financing through a structured process where financiers gradually decrease their equity stake in customer enterprises over time as the customers buy back shares periodically. This would help customers eventually take full ownership of the capital in their enterprises while providing a new financing option accessible to more small businesses. The document outlines the proposed process, stages, and precautions for implementing micro equity finance through MFIs and banks.

1. Micro Equity Finance
A Sought financial product
to empower
Over 90 percent Indian Establishments
Major Sources
of Finance for
Indian
Establishments
Stock Markets
Family &
Friends
Cooperatives
MFIs
Banks
Private Lenders /
Equities
Government
Funding

2. Untapped Micro Equity Market in India
1. Inclusive Finance is not just meant for allowing the poor open bank account;
but it should also mean to assure that poor among us are allowed to access
the surplus of capital hold by rich among us.
2. For inclusive growth ( Sabka Saath Sabka Vikaas) we need to ensure justice in
provisioning supply of capital to the rich and poor. It is not justified that
corporate avail capital from stock market at zero cost whereas poor have no
choice except availing loans at cost over average rate of interest.
3. Still 98.5% Indian commercial establishments are not registered as company
under Ministry of Corporate Affairs. Only equity finance can induce more
and more establishments to convert into companies.
4. India has high potential to convert informal sector establishments to convert
them into formal sector establishments condition they are induced by
suitable products and mechanism. Micro equity can be one sought product.
5. Despite rise in business of private equities, India’s 80% establishments are
yet not allowed to get equity finance from any source. Had they been tapped
by any source, Indian capital market could become world’s largest with
inclusion of as much as 50 million establishments into capital market.

3. Major Sources of finance for Indian Establishments
1. According to All India Report on Sixth Economic Census 2016, there are
around 58.49 millions establishments providing employment for 131.29
million workers in activities excluding crop production, plantation, public
administration, defense, and compulsory social security in India.
2. Major source of finance for 80.1% Indian establishments is Self–finance. Just
2.2% urban establishments are financed through borrowings from financial
institutions against 2.4% rural establishments financed by this source.
3. Just 1.36% establishments (7,93,446 out of 5,84,95,359) are registered as
companies under Ministry of Corporate Affairs (MCA). It means still 98.64%
Indian establishments are unable to access stock market for capital support.
4. The equity support for MSMEs from SME Exchange is negligible because
during 2015-16 only 50 companies out of registered 21,33,885 Udhyog
Aadhar succeeded raising amount of Rs. 379 crores through SME platform.
5. Indian Banks being constrained for investing less than 30% paid up capital of
any company, opted investing major amount on listed companies. But after
global financial crisis with fall in international trade, these companies found
difficult to grow further. Ultimately these companies kept loosing their stock
prices and also burdened Indian banks with as much as 55% of total NPAs.

4. Private equity is gaining grounds in Indian Market
1. Generally equity is considered as tradable stocks in the capital market. But
recent growth trend in private equities for unlisted companies outside stock
market opened gateway for equity business to serve unlisted companies.
2. While Indian stock exchange observed 6.5% decline (Rs. 19,36,844 crores) in
market capitalisation during 2015-16 compared to 2014-15, India registered
36% growth in FDI (Rs. 1,44,674 crores) during April to September 2016,
mainly due to private equities.
3. The performance of SME Exchange to support only 50 companies raising Rs.
379 crores with no trading during 2015-16 shows that 99% smaller and micro
establishments are still looking to access private equity for their growth.
4. According to Report on Fifth Annual Employment – Unemployment Survey
2015-16 average monthly income for 94.7% Workers in India is less than Rs.
20,000. India’s 45% workers with monthly income below Rs. 20,000 through
Self-Employed Establishments are deprived of equities from any source.
5. Since private equity players have yet not reached 41.9 million Own Account
Establishments in India, banks (with restriction to invest less than 30% paid
up capital in any company) can opt strategy to invest in MFIs with intention
to use their network for reaching potential establishments with micro equity.

5. Micro Equity for Indian Micro Establishments
1. The micro and tiny establishments in the unorganized sector with inability to
access the SME exchange are facing shortage of required capital for growth.
2. Notably banks in general don’t prefer targeting customers who seek loan
under Rs. five lakhs; and MFIs in rare cases extend loan over Rs. 50,000 and
in no case sanction loan above Rs. five lakh.
3. Thus the financial needs of micro and tiny enterprises ( for amount between
Rs. 50,000 to Rs. 5 lakhs) in general is not fulfilled through stock market. For
banks they are smaller ticket size whereas for MFIs they are too large.
4. 60 millions Self Employed Workers engaged in Micro or Tiny Establishments
with financial need between Rs. 50,000 to Rs. 5 lakhs is too big to ignore.
There is huge untapped market for MFIs in India who could arrange supply of
formal finance under ticket size in range of Rs. 50,000 to 5 Lakh. Still private
equity players are not tapping this market, so MFIs could easily tap them.
5. Considering the fact that 27.46% establishments (16 out of 58 millions) are
engaged into sales and trade activities in India where rate of profit could be
higher; MFIs should prefer using ‘Micro Equity Finance’ so as to earn better
returns over investments against interest rate changed over loan under
present regulations for MFIs in India.

6. Defining the Product of Micro Equity Finance
• The Micro Equity Finance may be defined as participative finance product used
to support micro enterprises through providing capital on terms of sharing
floated risk and reward in the enterprise.
• In India the amount of equity finance in range between Rs. 50,000 to Rs.
5,00,000 could be set limit for Diminishing Micro Equity which may be
appropriate to serve as much as 90% credit accounts.
• The process of Micro Equity starts with collective investment in any enterprise
by two or more parties; but ends with complete conversion of ownership for
one party who purchases the shares of other/s in that particular enterprise
during a time frame.
• Whole process needs three different set of contracts defining –
• Collective Investment in any project / enterprise by two or more parties
• Terms of diminishing share in enterprise / project for different partners
• Contracts defining terms of selling out the undivided share of one or more
partners in the enterprise / project to the other partner.
• After completion of Micro Equity Contract, complete ownership of total
enterprise capital / asset is transferred in favour of the customer.

7. Different Stages under Micro Equity Finance
Initial
Stage
• Financier makes fractional investment in Customer’s Enterprise
• Customer Invites investment from financier on profit / loss sharing
basis with option to periodically buy back investor’s share.
Middle
Stage
• Financier receives amount for sell of unit share along with profit /
Loss against outstanding investment in customer’s enterprise. Rate
of profit keeps decreasing with diminishing share in enterprises.
May also need to adjust customer’s account in case the customer
do not buy back unit share according to scheduled repayment.
• Customer periodically keep buying back investor’s unit shares in the
enterprise and shares proportionate profit / loss according to
investor’s outstanding share in the enterprise. May buy back more
unit share if financial conditions allow the customer do so.
Final
Stage
• After selling out all shares in the enterprise the Financier declares
customer as sole owner of the enterprise.
• The Customer becomes sole owner of the enterprise after buying
back investor’s all share in the enterprise.

8. Micro Equity may also help in National Accounting
• Under Micro Equity Finance it may be possible for financier to envisage how
much value addition is created, how much income is earned and how much
capital accumulation is done through equity finance. Under debt financing we
may not be able to calculate net value addition, income or capital formation.
Lending on interest terms Micro Equity Finance
Loan Amount in Rs. 1,20,000 Equity Investment in Rs. 1,20,000
Rate of Interest 24% Profit / Loss Sharing Ratio 24% to 0%
Interest charged over Principal Profit / Loss Shared from Profit
Total Repayable Amount 1,48,800 Total Receivable by end 1,59,000
Max. Monthly Installment 12,400 Max. Monthly Installment 16,000
Min. Monthly Installment 12,400 Min. Monthly Installment 10,500
Months for Repayment 12 Months for Repayment 12
Gross Income to MFI 28,800 Gross Income to MFI 39,000
Income earned by Customer ? Income earned by Customer 1,41,000
Capital Accumulation ? Capital Accumulation 1,20,000
Gross Value Addition ? Gross Value Addition 3,00,000

9. enMonths
MFI’s
Capital
Share
Customer’s
Capital
Share
Profit
through
Enterprise
Total
Instalment
to MFI
Equity Buy
Back Per
month
Net
Profit to
MFI
MFI’s
Profit
Share
1 1,20,000 2,50,000 25,000 16,000 10,000 6,000 24%
2 1,10,000 2,60,000 25,000 15,500 10,000 5,500 22%
3 1,00,000 2,70,000 25,000 15,000 10,000 5,000 20%
4 90,000 2,80,000 25,000 14,500 10,000 4,500 18%
5 80,000 2,90,000 25,000 14,000 10,000 4,000 16%
6 70,000 3,00,000 25,000 13,500 10,000 3,500 14%
7 60,000 3,10,000 25,000 13,000 10,000 3,000 12%
8 50,000 3,20,000 25,000 12,500 10,000 2,500 10%
9 40,000 3,30,000 25,000 12,000 10,000 2,000 8%
10 30,000 3,40,000 25,000 11,500 10,000 1,500 6%
11 20,000 3,50,000 25,000 11,000 10,000 1,000 4%
12 10,000 3,60,000 25,000 10,500 10,000 500 2%
Total 3,70,000 3,00,000 1,59,000 1,20,000 39,000 0%
Hypothetical cash flow under Micro Equity Finance

10. Process involved under Micro Equity Finance
1. Identifying the geography after economic survey of the village / town area.
2. Explaining the model to the target group, identification of potential customer,
analyzing constraints and prospects for customer’s livelihood.
3. Prepare the customer realize the significance of equity to increase income
through existing livelihood; and eagerness to share returns with the investor.
4. Filling Application, appraisal of applicant, counter party check and explaining
the transactional cash flow to the customer, fixing co-obligant and finalizing
sought measures to mitigate the financial risk; and approving application and
approving amount for finance against collateral.
5. Signing the Micro Equity agreement between the investor and Customer;
Transferring sought amount into customer’s account after handing estimated
repayment schedule to customer with option to buy back investor’s share.
6. The customer periodically buys back investor’s unit share. After personal
verification, the Investor prepares notes on cash flow of customer’s activity.
7. Repayment of amount by customer in accordance to the actual cash flow
retrieved in customer’s business activity / livelihood. The investor makes
adjustment into Customer’s account after each received repayment.
8. Closing customer’s account after receipt of sought repayment amounts.

11. Banks and MFIs can execute Micro Equity
1. With no source of equities between Rs. 50,000 to Rs. 5 Lakhs for 50 millions
micro enterprises, Indian banks / MFIs should try exploring this opportunity.
2. Considering the limitation about investment and limited exposure to the
micro and tiny enterprises, it would be better for banks to invest in MFIs for
reaching the micro and tiny enterprises. This may allow banks get better
returns with lesser hassle and lower chances for NPAs.
3. Considering the growth trend in private equities, if banks pass on equities to
MFI asking to finance micro equities, it may open avenues for banks to draw
private equity investors to subscribe bank’s capital.
4. Equity support from banks to MFI for micro equity finance may open
avenues to earn better returns through micro equity at one hand and get
additional loans through bank’s equities on other hand.
5. According to Section 19 (2) of Banking Regulation Act, any bank can invest
any amount less than 30% of paid up capital in any particular company; bank
also needs to assure that total investment in all companies should be less
than 30% of its own paid up capital. If Section 19 (2) is edited it may allow
banks to invest any suitable amount in any company and banks can also
directly execute Diminishing Micro Equity Finance.

12. • Since the returns under Micro Equity Finance is linked with actual profit /
loss of enterprise, the Weighted Risk for this product could be 100%.
• It should not be used as general financial product. It should only be used for
customers with potential to yield better returns over investment duly
supported with relevant source to prove the transactional account genuine.
• There may be customers seeking this product to cheat financier with false /
manipulated cash flow to draw attention of financier / investor. Thus it is
always required to check and verify the transactional accounts as genuine.
• Investor needs to guide the customer transact digitally. In case where digital
transaction is not feasible, there should be receipts and vouchers to check
and verify the genuineness of submitted transactional account.
• Further it is expected that genuine transactional account may vary from the
proposed transactional account and accordingly the received amount may
keep varying from proposed repayments. In such cases the customer’s ledger
should be provisioned with option to edit repayment with modified rate of
profit / risk sharing or equity buy back.
• The risk can be further mitigated if actual transactions be made digitally and
provisioned to share between investor and customer.
Weighted Risk under Micro Equity Finance

13. • Since the return over investment under Micro Equity Finance may not be fixed,
but just predicted according to submitted business plan, there is high
probability that on monthly basis the actual repayment may differ from
scheduled repayment. In such cases the team has to -
1. Check and verify all related receipts and vouchers to ensure that transactional
account submitted by the customer is not fake / scripted.
2. Adjust customer’s ledger to update the entries about equity buy back,
retrieved profit / loss share and percentage of profit / loss to share according
to outstanding percentage share in the enterprise / project.
3. Field staff need to periodically visit and observe performance of customer’s
activity to ensure that business is going smoothly. They need to behave like
sleeping but aware partner in customer’s enterprise.
4. Periodically update the customer about investor’s outstanding share in
customer’s enterprise and accordingly liable percentage of profit / loss
sharing ratio from actual retrieved profit.
5. There should be counter checking system at field level staff so as to ensure
that field level staff could not find any chance to take bribe from customer by
making undue favour for the customer and ditch the investor. On random
basis the filed executive may check their sub ordinates and similarly the
manager should check the filed executive.
6. Before signing the agreement, it should be ensured that the customer has no
problem in appointing the common arbitrator referred by the investor.
Sought Precautions under Micro Equity Finance

14. Micro Equity may help building Capital for India
Micro Finance Institutions (MFIs) / Livelihood Service Institutions (LSIs)
Extend micro Equity support to Micro
and Tiny Enterprises
Helping Micro enterprises build
required capital base
Indian Scheduled Commercial banks
Invest in Equities of MFIs/LSIs
May ask MFIs / LSIs to maintain
separate account for Micro Equity
Potential Investors for Banks
Invest in equities of Indian Banks
May buy bank’s shares with condition
of equity assets

15. Micro Equity may support transactional tax system
1. Micro Equity Finance may be a better product than subsidized loans for micro
enterprises as it needs no subsidy; and also helps to develop transparent
accounting system where customers may be asked to transact digitally.
2. Since under Micro Equity Finance, the returns are linked with actual cash flow
of the customer’s business only, the Banks / MFI’s would be required to obtain
record of actual transactions held in customer’s livelihood activity.
3. The transactional records provided by the customer to Banks / MFIs would
ultimately help us calculate the volume of transactions, value additions,
income generation, capital accumulations and paid taxes. This may help us
retrieve better estimates required under national accounting and taxation.
4. India may need to develop technical support system for micro and tiny
entrepreneurs to use mobile app to maintain transactional records along with
financial entries related to investment, sale purchase and taxation. The cost of
the app may be borne by Government through taxes raised under this system.
5. If India resolves promoting product like Micro Equity Finance it would be easier
for the Government to implement the system of Transactional tax even among
50 million informal sector enterprises. Such system may also enable banks to
collect taxes for the Central and State Governments.

16. References for source of data used above
1. http://www.mca.gov.in/MinistryV2/paidupcapitalreports.html
2. Report on Fifth Annual Employment – Unemployment Survey 2015-16
3. All India Report on Sixth Economic Census 2016 (Table 3.9 & 4.12)
4. https://dbie.rbi.org.in/DBIE/dbie.rbi?site=publications
5. https://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/PPT1102166AB61D0F35C54
6539EF4DCD3C83B3668.pdf
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