Investing in Edufinance – opportunities and challenges
The Global SME Finance Forum meets this week in Amsterdam. Through this blog we would like to highlight another SME sector – edufinance – that represents a huge opportunity for creating social impact through expanding education and an attractive investment opportunity.
This is the second post in a three-part blog series summarizing Grassroots’ research on edufinance, especially the affordable private school sectors, in Latin America, Asia and Africa and recommendations for how investors can support them. In a previous post we described the “edufinance” (education finance) opportunity. In this next post we discuss the investment opportunity in more detail, laying out the reasons why investing in edufinance could be a good opportunity. We also highlight some of the challenges that have led to the huge credit-gap we see in the market today.
In the third and final post we will reflect on the experience of investing in microfinance and how it can offer important lessons to investors and managers looking to enter the edufinance space.
What do we talk about when we talk about edufinance
Edufinance, defined as lending to existing private schools and colleges for infrastructure and materials, school-fee loans to parents and loans to school suppliers, is estimated to be a $25-30 billion opportunity, or more. Edufinance products fall into four categories –
- School improvement loans to renovate facilities, add more classrooms, purchase IT/furniture. Average ticket size demanded ranges ranges from $10,000 to $25,000, tenor ranging from 2 to 5 years.
- Working capital loans to manage school cash flows. Average ticket size between $500 to $2,000, tenor ranging from 6 months to 1 year.
- School-fee loans to parents to afford the school fees, buy technology, etc. These ranged between $50-$500, payable in twelve months or less, and
- Loans to school bus operators and other vendors who provide furniture, textbooks, uniforms and technology to the schools
During interviews with school owners an overwhelming majority indicated a need for capital. Yet, we did not find a single bank or financial institution with a dedicated school financing business in any of the countries we visited. India being the sole exception with at least 4-5 NBFCs focused solely on education finance. Two of these have built sizeable businesses with a combined portfolio of over $250 million loaned to 10,000+ schools and colleges, early childhood education centers and school suppliers. Our research has confirmed that the edufinance opportunity is not unique to India and that other countries share the characteristics that create an opportunity for edufinance to increase access and improve quality of education for lower income populations and girls. Below we describe some of the features that make edufinance an attractive opportunity for impact investors.
The edufinance opportunity:
- Impact potential: Low-cost schools are nearly half of the 1 million+ private educational institutions in developing countries, representing a huge opportunity to expand education for out of school children and fulfill the UN Sustainable Development Goals. Even for children currently attending a school the learning outcomes have not been up to par. Edufinance investments can enable a school to improve existing infrastructure, lower the teacher-student ratio by adding classrooms, acquire technology solutions like tablets and smart classrooms, and improve teacher training.
- School lending is a proven business model: Companies like ISFC and Varthana in India have shown that lending to low-cost private schools is a viable business model. Together, these two companies lend to over 10,000 private schools in India and have been growing their business profitably over many years. During our visits to Nigeria, Pakistan and Philippines, MFIs lending to schools reported that their school-loan portfolio performs better than other sectors.
- Private schools are sustainable SMEs, and underwriting is not complicated: Private schools are often owned by motivated edupreneurs, employing 10-15 staff and run profitably. Investors will find private schools as a sizeable SME sector, in some countries even larger than the microfinance market. During our visits to Lagos, Manila, Karachi, Lima, Sao Paolo and elsewhere we saw private schools that have been operating for over 5 years, many even 10+ years or longer, suggesting that the private school business is sustainable. Cashflows of these schools are easy to verify – majority of their revenues are earned through school fees, and teacher salaries are the biggest expense. A school loan is more secure as it is backed not by one borrower, but by the hundreds of parents who pay the fees at the beginning of every school term.
- Growing market: There is a large and growing demand for education in developing countries and new schools are being built every year. There are nearly 250 million out-of-school children in developing countries. This number is likely to grow as developing countries see an increase in population below the age of 15 (the ‘demographic dividend’) over the next two decades. In Nigeria, which has largest number of out of school children in the world, Lagos alone adds 100-200 private schools every year; private schools enroll an estimated 70% of all primary school students. Besides school-level education, developing countries are also seeing a huge demand for tertiary education and vocational training among the unskilled youth.
- There is a fintech play here: Besides credit, the low-cost education ecosystem also offers opportunities for fintech players. Schools collect small amount of school fees from parents every month to cover their expenses, usually cash payments to teachers, staff and vendors. These schools spend an enormous amount of time in tracking their cash receipts and payments. All of this could be automated with the help of a mobile app. Parents could also use the app for example to follow school buses and otherwise coordinate scheduling and communication with schools.
Challenges, and some suggested solutions:
Despite the large opportunity the huge credit gap suggests there are many barriers to lending to private schools. Interviews with school owners, bankers and government officials revealed a number of these challenges faced by lenders. Based on our experience investing in other impact sectors we have also included possible solutions for each.
- No collateral, no credit, no growth: Most of the low-cost schools operate in urban centers where the land prices are very high, so the schools operate from a leased building. Usually the Education Department only issues a license to schools that own their land and building. As a result large number of private schools, especially the low-cost schools, are unregistered. These schools are unable to borrow from a bank because of their registration status and inability to offer a collateral. Due to this inability to put up a collateral, schools cannot raise growth capital and are unable to increase profits, so they cannot afford to buy the property. Sometimes, even when the school owns the property the lender is hesitant to take that as a collateral. School-owned properties are not easy to foreclose, thus lenders demand additional security even when schools are able to offer a facility as collateral. Loan to value ratios can be much lower than other mortgage loans.
Solution: A credit guarantee facility can provide comfort to the lenders wherever a borrower cannot meet the threshold collateral requirements. The Africa Guarantee Fund is a good example of such facility for SMEs.
- Complex regulatory environment: Education Department policies in developing countries can be archaic and very unpredictable. Recently, the Supreme Court of Pakistan issued a freeze on private school fees. Without getting into the merits of the case, it is interesting that no less than the Supreme Court of the country steps in to decide school fees, a matter that would usually be settled by the Education Department or provincial governments.
Solution: During our research we found Department of Education officials in most countries very accessible and more than willing to engage. Financial institutions that maintain strong communication with the regulator, and that practice ethical lending practices can mitigate this risk effectively.
- Business model overly reliant on single revenue source: Schools are heavily dependent on school fees, which creates dependency on a single revenue source.
Solution: Schools should not be expected to diversify their revenue sources. Instead, a lender can diversify its portfolio and thus reduce their risk. Through strict underwriting guidelines lenders can also avoid overburdening the school with debt, and avoid defaults if there are small fluctuations in revenues.
- Weak financial management: Low-cost schools often do not employ professional managers and accountants, and are unable to produce key records like financial statements required by the lenders.
Solution: Loan officers/relationship managers must be trained to offer training to school owners/managers on basic financial skills, cashflow management, etc. Modules on financial management courses for school owners are now available through TA providers like Opportunity Edufinance.
We hope that investors and lenders alike will see low-cost private schools for what they really are – underbanked SMEs representing a huge opportunity for creating social impact through expanding education and an attractive investment opportunity. The success factors seen in Edufinance industry in India aren’t unique to that country alone. In the last year we have helped launch school finance companies in Pakistan and Nigeria and have laid the groundwork for several others. But we see this as just the tip of the iceberg, with tremendous potential to expand to many other countries and engage with what is truly a global phenomenon.
In the next blog we will reflect on our experience of investing in microfinance, another financial inclusion industry that came on the scene twenty years ago and has proven to be a successful strategy for impact investors and see what lessons it can offer for investors and managers in Edufinance.