Equity
1. Board representation enables IFC to:
contribute to strategic decision-making (and provide guidance on policies);
help resolve shareholder disputes;
monitor the investee company; and
provide continuity in the face of high IFC staff turnover.
But IFC should consider its ability to fulfill board responsibilities before accepting a board seat.
2. Sponsors' equity participation: IFC should be skeptical about a sponsor's long term commitment, and not take a straight equity stake, if sponsor equity is of secondary importance to its other interests, or where there exists a potential conflict of interests resulting from a sponsor's multiple role.
3. Environmental compliance: In equity only investments, IFC may have little leverage to secure compliance with environmental standards. IFC should consider adopting agreements outside the normal loan covenants to provide some leverage in these situations.
4. Put options: IFC should protect its equity investments and secure an exit mechanism through put options, whenever possible. In addition, IFC should:
maximize potential returns, through diligent supervision and by developing a close working relationship with the client;
look for mechanisms to protect against major changes in the investee company;
also seek alternative exit mechanisms, such as commitments from the sponsor to list the company; and
use valuation formulae, (e.g., higher of fixed return, book value and an earnings related measure) to both protect the downside and allow IFC to participate in the upside, particularly where the prospect of market listing is unlikely.
5. Local currency depreciation: Because losses from currency depreciation normally cannot be fully recovered in company margins, IFC should be very cautious about making equity investments in countries with overvalued currencies. IFC should consider protecting itself against local currency devaluations when considering equity investments by using quasi-equity instruments.
6. Avoid subsidiaries: Equity investments in companies that form part of a group's integrated operations should be made closest to the owners' source of cash flow to reduce the risk of transfer pricing.
7. Foreign shareholder laws: IFC should carefully examine the implications of laws restricting foreign shareholders.
The above lessons are based on 31 lessons from past IFC investments.
Last updated December 1998.
