Varthana’s Hardgrave: “Our real business model is being detectives to understand the true economic picture of the schools”

His goal is to help bridge the financing gap and substantially expand access to quality education for low-income populations across India. He said, “Varthana offers loans that meet private schools’ wide range of requirements, whether for construction and renovation of school buildings, improving infrastructure, investing in teacher training or buying land”. He emphasised that Varthana’s school loans are flexible to meet private schools’ needs.

He added that to date, Varthana has reached nearly 5,000 schools, which educate over three million students and employ more than one million teachers. Varthana’s business model contributes to Sustainable Development Goal 4 – quality education, by allowing education entrepreneurs to build and scale their affordable private schools, while addressing the core need of access to education.

Hardgrave brings with him a unique combination of investment banking expertise, entrepreneurship and international development that helped him add value to his role at Varthana. His passion to unlock every individual’s potential to excel was driven by his experience while working in Gray Ghost Ventures, understanding that financial returns and social impact can be inclusive goals.

Following key points were discussed during the conversation:

• Steve’s experience working as a grass root’s volunteer at an NGO in Mexico City helped him value sustainable business models like microfinance.
• Low-cost private schools do not have donor support but they are self-sustained through fees.
• Low-income families are foregoing free alternatives for quality education.
• Across 400,000 private schools in India, Varthana has reached to nearly 5,000 schools.
• Most of the lending to schools is secured with property.
• Non-performing assets (NPAs) were less than 3% but this has grown post the pandemic

Below is the edited transcript of the interview:

Gordian Gaeta (GG): Today, we have the great privilege and honour to have Steve Hardgrave with us. Steve is the most interesting combination of investment banker, investor and impact. I would probably say philanthropist, although it is a business, and he's in the affordable education space in India. His organisation Varthana has had a significant and is having a significant impact. By the end of the decade, you had about more than 5,000 schools, 100,000 teachers, two and a half million pupils that actually benefit from you. He is the essence of what we think Wealth and Society is all about. It's a great pleasure to have you here, Steve, and thank you for your time. Maybe to give the audience a little bit of feel of who you are, you can tell us about your journey, which took several twists and turns I understand from your education, which is pretty formidable to actually creating Varthana and then let's talk about Varthana. If you can let me know, how did you get there?

Steve Hardgrave (SH): Absolutely, thanks for having me, it's an honour to be here. I will share some quick background. I grew up very comfortably in California. And while I was in college, I grew up pretty comfortably. So, when I was in college, I think it started to hit me, the level of privilege that I had on a world level, if I looked up and down my street, I was pretty average. But if I looked at a world level, I was pretty elite. And then that combined with my faith, and then the fact that I had a disease when I was in college, and I was in the hospital for a year and I should have died. And so, all of these constraints, my mom and dad telling me to do the responsible thing and be safe and secure, that was thrown out the window. I decided that graduating college, it would be better to pursue something that had to do with helping the less privileged, rather than an aggressive commercial career, if you will. I went off the grid and moved down to Mexico City, and volunteered with an NGO and lived in a kind of a slum on the outskirts of Mexico City, supposedly for a year or two. I blinked my eyes and that turned into eight years. Over the course of that time, I was working with an NGO that was pretty left of centre and socialist in their ideology, if you will. And I came across as we were trying to help all these people generate income earning activities, which is ironic, right from a socialist organisation to be so entrepreneurial and capitalistic. But I came across microfinance and said, this is a way where we could help empower people that are already working hard to help themselves. It has the potential to be much more scalable than always having to raise donor funds for tiny projects that might create five jobs here and there. I started a microfinance business in in Mexico, that was actually driven by the savings of the local people and then the savings from some of the people who would donate to our organisation but in the form of savings. One day I woke up and realised I was running a bank. I thought, oh, my goodness, I should probably know something about finance. That's when I thought, I've been living in a slum for eight years, no one is going to want me at a nice institution, but I was very fortunate to get accepted to Berkeley and go back and get an MBA in the US. And so, then I thought it would be good to try the other side and see what investing was like. I got a job first with Omidyar Network, investing in this impact space particularly in microfinance, but also in other areas on a global scale, and then moved to Gray Ghost Ventures, which is kind of another family office impact investor working in those similar fields. That brings us right up to Varthana.

Education a core concept for well-being of an individual, family and society

GG: I find it interesting, there's the saying that says, if you're 17 or young, and you're not a socialist, you don't have a heart. But if you are 50, have a family, and you're still a socialist, you may have your priorities wrong. It's interesting that many people we talk to that do very good things, actually have experienced first-hand on what it means not to be in this environment, not to be a child of Bill Gates, and living in a privileged world. And I think that strikes me as being important that people who have experienced that have a lot more determination to make a change. You are a good example. Mexico City, of course, is a good training ground because there are a lot of issues there. Let's get to Varthana. So, then you decided to devote yourself to India?

SH: Yeah, correct. And while I was at Gray Ghost Ventures, we were looking at how we might support education, because it's such a powerful way to have a lasting impact on an individual or a family. And our approach, we really wanted to do something that was investment oriented, rather than philanthropy oriented. But in education, it seemed as though it was either NGOs or government activity, until we came across, at first, the writings of an English professor named James Tooley, who highlighted the existence of these, what you can call them low-cost private schools, or budget private schools, or affordable private schools, that really are quite pervasive throughout the emerging market countries. And they're usually one-off local proprietor driven schools that are charging enough to sustain themselves and are not being supported by any kind of donor funding. But at the same token are not being supported, usually through finance sector or through the education sector. They're kind of on an island, if you will. It struck me having a finance background, that these schools would really benefit from some project capital to help them expand their facilities and what have you. But no one was doing this anywhere in the world and in a dedicated fashion. That's what led us to create this model. And we set up a company first under Gray Ghost to start that model off. But I really saw that there was an opportunity to take this to a much larger scale. By this time, I had a wife and three daughters and got their sign off on moving from the US to India. In 2012, we moved over here to launch Varthana.

GG: The decision to go into what you call the affordable schooling, which is private schooling, is interesting, because governments, as you know, tend to take a very clear view on education, and they tend to want to direct and control education. Because it's the future mindset and culture of the people. Most people shy away from actually getting involved in education because they have restrictions left, right and centre. How did you make up your mind to get into this particular market? And how did you fight all these barriers?

SH: It's quite interesting, because what I've realised is I'm very much a pragmatist, across the board on most issues. And yet, the education sector is full of dogma and very ingrained, entrenched opinions. For every 10 people in a room, there'll be 15 opinions about the way things should get done. My view is the following. I think that education is such a core concept for the well-being of an individual, a family and a society, that I think there's a strong case to be made that this is a public good and should be provided for each and every citizen of a country. I'm a robust supporter of the public sector. I've never attended a day of private school in my life through university and graduate school. And my daughters, except for our time in India, always attended public schools in the US. Certainly, where I saw it was in places where the government for whatever reason, they're overwhelmed or there's inefficiencies where the quality is just not meeting the standard, if you have people that are living at the edge of poverty that are foregoing free alternatives and paying a high percentage of their income for a better option, for me, that's a pretty strong vote from the grassroots level that they want quality at any cost. It's with this mindset that I always tell people, if the improvement of the government education system puts Varthana out of business, I won't be too sad. As long as the children are getting access to quality education, that's a great solution.

GG: Well, that's exactly the dilemma. I come from Europe, and mostly in my country, all schooling is public, public in the general sense, not in the British sense, which, of course, is different. And the key to that, as you mentioned, is that the government understands its responsibility towards society, and does not control the schools content wise, or academic freedom, or in performance, but it supports it. And the big dilemma in emerging markets is that the government does not have the same ambition and sees the private schooling as direct competition, and actually showing them off essentially showing that they are weak. And that causes a problem. Did you find that in India?

SH: In India and in other countries where I've seen this, it's very interesting, you've got multiple levels to this. On one level, you have issues like teacher unions, that in some countries are quite powerful and are very much against the private alternative.

GG: Public schooling is employment for life. If we have competition, there's less employment for life.

SH: Absolutely. Throughout the government, you do experience different levels. I've seen political or government authorities that are big fans of the private education system, and they feel it complements very well, the public option or the government option. But by and large, you do see a lot of ingrained position that, you know, for example, the existence of private option, undermining the government and public option, and it draws away those with the most resources or the most privileged, and, therefore, creates a very skewed public setting. While I'm kind of sensitive to that, the irony, of course, is if you find these same hardcore ideologues, none of them have their kids in public schools, right? If you're going to sentence the lower income portion to suffer with this poor system then there should be some solidarity and if not, then let it improve until people choose it.

GG: You are now well ingrained in the affordable private schooling and affordable as I understand is about, they pay $35 per month for the kid, is that the threshold?

SH: Correct. The moniker is ambiguous, inherently right, affordable is always relative, but most of our schools would actually be, 95% of our portfolio is less than $25 a month of school fees.

Helping 1% of the 400,000 private schools in India

GG: Tell us about the impact because having started in that space, I read that this is very significant. Where do you stand today? What's your impact?

SH: It's interesting to talk about this across a lot of levels. I think we need to be very humble. Across 400,000 private schools in India, we've managed to reach something like 5,000 schools, so a little over 1%, hallelujah. There's a long way to go to really be able to say we've made a significant impact. We're also very real that when Varthana comes and gives a loan to the school, it's not that that school quality dramatically improves one day after they took the loan. We work on the basis that if through our underwriting, we can select for the better-quality schools at that price point, so you need to look, you know, at $10 a month, you're going to get a different quality than at $20 a month. But we want to find those schools that are within $10 a month in a certain catchment area, the best of that bunch. What was happening was those schools were full of students and couldn't expand. Parents in that community would have to choose the second-best option and then the third best option. Our first line of impact is, can we expand the capacity of those better-quality operators at that price point, and then put pressure on the guy who's horrible at $10 a month, they either have to lower to $5, or they have to raise their quality or get out of this mess. We've been able to increase that capacity and then once we engaged with the school, we try and bring additional educational resources that they may not have had access to as an independent out of the mainstream. We have seen that the schools that we’re engaged with, do improve their academic quality through third party evaluations better than schools that aren't in our programme. Both of those things in terms of expanding the capacity and improving the quality we're doing, but at a very small scale, compared to the whole universe out there.

GG: Sure, India is a huge country. But in effect, you're not only helping the better ones, but you're actually raising the temperature for the less good ones, and therefore you're raising them, or you will be eliminating them. If you continue, just project the path, you will have made a contribution to raising everybody's level. And I think if we're a country like India that's quite cool. You can't aspire in five or six years to actually cover India, it is a huge country. And bearing in mind that as I understand you have about $120 million of loans outstanding. And there's only so much you can do with it.

SH: Correct. But that is the beauty of the model, as we looked at, if I were to try and set up a bunch of schools, there's no way I could get to this scale. By trying to empower and amplify these locally based people that have already been doing this, and doing this on the basis of their own initiative and funding, that's one of the most satisfying things, those are the kinds of the superheroes in the story, there's 400,000 of them, and to be able to give them a little support and nudge is extremely satisfying.

GG: I would expect of the 400,000 that at least half of them is in the lower segment.

SH: Yeah, in fact, more than half of it. If you just look at the demographics of India, it's still unfortunately, quite a pyramid. So, the elite schools would be a very small portion at the top, your next rung would be your Central Board, higher end but still local board schools, and then at the bottom are the state board schools.

GG: You probably have a market share of 10% in your chosen segment or even more. At the end of the day, what societies need to remember is that educating our children is the future, your pupils will be the future of the country, and even in India with a caste and elite system, they will be the middle market, the upper market, and you know, the fundamental of society in 10 to 20 years.

SH: Correct. This is one of the things that's so exciting about this is because the future doesn't involve too many unskilled jobs. For a country like India, where a huge portion of the population 35% is school age, and you just don't see this size in many places in the world. They will need to have jobs that involved an education. While everyone has talked about the demographic dividend of India, if it continues down its current course, you really don't want to think about all the social issues that are going to be there when this huge, baby boomer population in India, 30-40 years old, and can't find a job.

GG: Absolutely. If you think that concurrently independent of education, AI, machine learning, all the automation processes, and some of the redundant work that will no longer exist is also happening at the same time. The outlook for a totally unskilled child today is very bleak. And the social issues will be even worse. And we see it even in the most developed nations of the United States. For those who fail to access the education system today represent a segment that is, yes, it is socially unjust, I understand, but they represent a segment that has no great hope to make it out of that. I think that's admirable. When I read the background, I thought, this is really one of the great initiatives. You should be very proud. Tell me a little bit about the business model. Because after all, it's also a business, I like it even more that it is a business and not philanthropy. Tell us a bit about the product and the business model so that we understand how it works.

Traditional lenders stay away from true economic picture of a school

SH: If you think about the traditional finance segments, it's really small, medium enterprise (SME) lending. If you look at it, what is a school’s number of employees and its turnover, and all of that is that's kind of the segment that we are at, most of our lending is secured with property. And it's often the school’s properties, sometimes it's another property. What we basically need to do is underwrite, understand the income and the expenses, the free cash flows for the school to be able to service their obligation and understand how are they using these funds, is it for the betterment of the school or is it for some other use. This is a little more challenging than you might expect, because, interestingly, schools in India are required to be non-profit, either a trust or a society. Since they're not subject to income tax, their financials are less scrutinised and less professional, which leaves for a lot of wiggle room and a lot of fudging of figures and grey areas. And this is why a lot of the traditional lenders would stay away, they don't feel comfortable at being able to get their arms around the true economic picture of the school. Varthana’s real business model or the essence was to be able to go in like detectives and walk around a school and look at real and fake papers and work our way through that and understand what the true economic picture is, and what that school can afford to take and repay in a healthy fashion. And then to have the ability to collect on that in a way that is hard when it needs to be hard, but also not too hard that it raises up outrage about some social ills. There's some fine lines to walk in there. But that's why we dedicate to it and we don't do anything else. Because we feel it's specialised enough to where you really have to know this inside and out and you should be focused on.

Securitising future school fees

GG: I have a lot of understanding.  We were in micro financing in Cambodia, in agricultural micro finance is even worse, they don't even have buildings. They have agricultural land, but it's not worth a lot. With the crop, you're running a huge weather risk and other things. I understand when you say detective on the cash flow, most of people don't have accounts, it's housewife, money comes in, buy food, money goes out, you buy a shirt, and that's about how it works. So it's pretty tough. Your main model is, as I read, cashflow underwriting, because that's the key. What's the money used for most? Is it buildings, equipment or laboratories, or is it facilities or salaries? What is it used for?

SH: Since we focus on project finance, we don't do too much of working capital lending for salaries and this sort of thing. We want to see that the school is covering those kinds of costs. Since we're operating in a low-income segment, whereas higher end segments, we would probably pay our fees on an annual basis or a semester wise basis. A lot of the low-income people can't afford to do that. So they'll pay their school fees throughout the year. So, what schools a lot of times need is that lump sum to be able to invest in bigger projects. If you look at most of the portfolio would be in infrastructure expansion, particularly because those are the biggest projects that cost the most. A lot of times the school would have maybe a ground floor level and they use our loan to build classrooms on the second floor. Or they might have extra terrain on their plot of land and they'll build another wing. But then we do things like computer equipment, laboratory equipment. Most of these schools would have the cameras in the classrooms, so they'll pay for those, or buses to help expand their catchment area. So full range, we don't outline anything as long as it either improves the quality or expands the capacity of the school.

GG: You're essentially securitising future school fees.

SH: Exactly. That's exactly it.

GG: Have you had bad debt? What is the level of bad debt or unwilling payers?

SH: Of course, if you don't have some bad debt, you're not really lending. We certainly do. There's a full range. All school owners aren't these beautiful saints that are perfect and have great intentions. Some are not very capable, and some have bad intentions. Obviously, the underwriting tries to weed that out. Historically, we ran a non-performing asset (NPA) 90 days past due rates of less than 3%. It was fairly strong and in line with SME lending, maybe even a little better. If you look at schools as a business, they're a very attractive business, because you've created a revenue stream, when the child enters kindergarten or nursery. Unless you really mess that up, most parents aren't switching their kid every year from school to school. You have another 12 or 13 years of steady cash flows. And if something bad is going to happen in the school, it usually starts to manifest itself with lower enrolment in the younger grades. And it's kind of a slow-motion train wreck rather than a huge disaster. Our NPAs have obviously gone up in the wake of COVID, which I'm sure we'll talk about, which has been a disaster, if there's a Varthana killer out there, it is COVID. But we were doing quite well before then.

COVID-19 left the education industry with no revenue for 18 months

GG: Before we turn to COVID, there is a global interest in investing in education systems. But the big difference is, and that’s why we talk to you is that it is seen as a business, there is almost no attachment to the content of that, and building a university charging $40,000 for an MBA, getting 200 international students is a great business. I teach at university, so that's fine. But it has some impact, of course, and we need them. But it is nothing like what you are doing. And I think people have to realise that what you are doing on that small scale is a lot more important for India, and for the young people there than the general investment in education. But you mentioned COVID? Of course, it's a question you have to ask, although I'm getting tired of talking about COVID. You got hit hard by COVID?

SH: Yeah, definitely. You might be aware, India took pretty drastic measures to kind of close down society. And schools were the very first things to be closed and the very last to be opened. The stores and other businesses and industries were open well before schools were opened. And then right around the time they were opening, which was December, January and February last year, and then the second wave hit India and everything got closed down again. And only now our schools again are starting to reopen little by little, the grade levels kind of getting lower and lower, and the younger kids coming back. But if you can imagine almost the whole industry has had no revenues for 18 months. Since I serve the low-end segment, they're the segment that's least capable to move to some kind of a digital format, not necessarily because of the schools but at the parent level, most parents wouldn't have the devices in the bandwidth to have good quality digital content. It's been about the biggest stress you can imagine on a concentrated portfolio. I'm not only sick of talking about COVID, I'm very sick of dealing with it even more.

GG: I can imagine. Do you think that the decisions of the government to close the schools, it's a hot topic, were they the right ones?

SH: It's so easy to have some righteous indignation and outage but you have to be sympathetic. Politicians work on short term. I look at this and say what are the costs of sending kids back too early, is that a bunch of kids get sick and die. No one wants that on their neck. And what's the negative of keeping them out of school? Well, over the course of the next decade, we're going to see that their education is horrible, and they won't get the jobs and the opportunities that they should have had, that politician is going to be long gone by then.

GG: You are making exactly the point. Politicians’ life is about re-election, so that we do what the voters say, but the consequences of 18 months, no education will be seen in 8-10 years, and it's going to be disastrous. Clearly, this decision is not a short-term decision. In the meantime, we know and we actually knew that since a long time that kids are pretty immune to that. While we allow, premier league soccer players and other people to cut rules because there's so much money involved, which is really not important in the big scheme of things, I would like to say, our kids got penalised. One has to question the wisdom, the rationality, let's leave aside wisdom, the rationality of the trade off and if that was the right decision. Can't you lay off your gap in cash flow to your refinancing, because you can go to them and say, guys, you know, we just don't, and you also have some philanthropy refinancing, as I understand and say, or the IFC, you can talk to them?

SH: Well, yeah, one would think and hope so. But unfortunately, now, what's nice is that the schools have had some capability of not paying teachers and letting teachers go find other work and most of the school expenses are teacher salaries. But of course, that loan obligation is there, which is them paying us. Now, we have not gotten one single day or any relief from any one of our lenders, be them impact lenders, or otherwise, This stops at Varthana and that we have to somehow translate lack of compassion into compassion down the pipeline, and just pull off miracles, day after day, week after week, for the last year. But I wish and if were it not from the good of people's hearts, I wish the government would have had some foresight to say, okay, if we're going to close schools, let's balance this out all the way through, but unfortunately, not one ounce of help coming down other than my own equity investors have pumped more equity into the business to keep us in good solid position and keep the lenders happy. But we've not missed a single payment, any one of our lenders throughout this whole time.

Challenges to balance financial bottom line and social objective

GG: I can hear and feel your pain, and I sympathise with you. But then you are a CEO, the single most important characteristic of the CEO is frustration and tolerance. You are between a rock and a hard place and you have to balance that. That's very demanding but it's also very satisfying. But it seems quite odd that some of your refinancing that they wouldn't have an understanding of the situation and wouldn't extend.

SH: It's an interesting thing. My whole career almost has been in this social entrepreneurship, social investment space, and we all carry different motivations. But I do think that when you get to an institutional level, whether we want to, say it as harshly as it is, the financial piece is the bottom line. And the impact in social intention piece kind of climbs on top of that and it's wonderful that it does. But in the end, people generally don't want to sacrifice on the financial side, they just want the social side on top. Especially as that translates to institutional level, I'm not talking about the individuals working there, but we all get caught up in the machinery.

GG: I think that's my main problem. Philosophically, it doesn't matter if you're on the left, on the right, in the centre or wherever you are. Philosophically, it must hold true that the happiness of the individual creates happiness in the community. But the happiness of the community is a necessary condition for the happiness of the individual. And it doesn't matter if we emphasise happiness of the individual or individual freedom or happiness of the community, but they work hand in glove. And it doesn't matter which side of the political spectrum you are. It is a compelling argument mathematically and analytically. I don't understand. One of the reasons I do that, which is one of the things I really like to talk to people like you and write and think about that is because people simply don't understand that there is no one way to heaven. That's what I don't understand, and you're in the middle of it. I'm sure that you have your own issues with that.

SH: I'd say, Amen, hallelujah, and all of that because I actually, in a very more philosophical way, probably believe that the furthest to the right and the furthest to the left, bend around to meeting each other rather than being a straight line. And I carry elements of each of those sides. I couldn't agree more. I do think that's an interesting conversation that we're not having enough of is that, we've bastardised these systems into something that doesn't actually follow the essence of the beauty and that intertwining community, or individual with the larger group, to me as it should be a very fluid thing.

GG: I think the problem is, but we're digressing here, is that the concentration of capital, in the hands of a few has relieved this concentration from looking after the community, they no longer need the community. And that's our greatest problem, I think in the developed world. That leaves the community behind, it causes the community to revolt, it causes the community to push for more rightfully so and they're not getting anywhere. That is something that we have to get to grips with. But from you, I think, most admirable, I know that we're running out of time and I don’t want to keep you too long, you are doing something truly sensational. And I know for a non-Indian in India, it is even more remarkable. I understand you have an Indian partner, but still you live in India and you live it every day, I assume that you actually visit schools and look after investments hands on.

SH: Yeah, absolutely. Everyone gets a big kick out of the tall, long-haired, white guy at the low-cost private schools.

GG: Steve, I think you have been very humble because also about yourself, you have a leading MBA, you have a bachelor in economics. You are highly academically qualified. What you are doing with very limited resources against all adversity is truly admirable. You are a true example of what could be done with very little. If we look at the total amount of loans, we have hundreds of families who could do that in a day, that amount. And they're not, and you ask yourself, you do not invest in your kids, but in their own kids, they will spend, half a million for a bachelor and MBA degree eventually, but rather not. I think that is really something that one cannot say loud enough, extremely well done. You should be very proud of what you've achieved. We are very grateful and honoured to have you here. And I hope that those people look at that, actually realise that there is a lot more of good things around than they think. Last thing, what can we do for you?

SH: Glad you asked. First of all, you’re too kind, too much support I've gotten through this, I just get to be the face at the front. But we've gotten a tonne of support from the team and investors and such. I would say open invitation to anyone out there who wants to be a part of this and help us double, triple or quadruple our impact that we're always keen to bring on new supporters. Whether that's individuals that want to come and use their talents here to work on the team, or people that would like to invest either equity debt or even philanthropy, we do our CSR activities and philanthropic activities as well. We will take any and all help that if this sparks an interest in anyone, please don't hesitate to reach out.

GG: Excellent. We'll try and pass on the message. We have annual meetings. We have newsletters, and I hope that we will get this video to a larger audience. Thank you so very much. I can only say it's easy sitting in Dubai keep on doing what you're doing. Because you have a much harder life, but you have our mental support and our hearts.