There are several ways to fund a business following Shariah-compliant principles - from project finance to Islamic funds. Islamic financial products are based on one of two types of contracts: mutual investment contracts or finance contracts. Mudaraba and musharaka are the two main types of mutual investment contracts, while finance contracts include murabaha, ijarah, salam and istisna' forward finance transactions (for definitions of all these terms, see article on the most common Islamic financial products and transactions).
Mudaraba and musharaka contracts enable a bank or a group of investors to place funds in your business, thus sharing profits and losses. In a diminishing musharaka, the bank takes a higher share of profits so as to get its stake in the firm returned after a given period of time. You can use this, in particular, to finance a start-up business while still ending up being its sole owner.
Islamic finance contracts can also be used to obtain assets or the use of assets that the bank will acquire on your behalf and sell back to you over time, with a benefit. On the other hand, a reverse murabaha can be used for you to deposit money with the bank, which will be used to buy assets and which will be repaid to you with a profit at a given time in the future.
In an ijarah, the difference is that you are paying for the right to use an asset, like manufacturing equipment, which itself remains the property of the bank. You can also fund your firm's equipment or property through an ijarah wa iktina, where you pay for the right to use the asset while progressively paying for the asset itself. This enables you to become full owner of the asset at the end of the contract.
Salam and istisna' contracts are exceptions under Shariah law because they involve the purchase of something that at the time of the contract does not exist, which is normally forbidden. These two types of contracts have been accepted to enable the financing of the growth of agricultural products (salam) or of the manufacture of goods (Istisna'a), and are therefore funding methods you can use for your operations.
PRIVATE EQUITY INVESTMENT
Several types of investment products are based on these contracts and you can use them to fund your business or invest its cash in a Shariah-compliant way.
Venture capital and private equity are by nature Shariah-compliant, since they represent an investment in a real economic venture. It is therefore safe to agree to a private equity firm taking a stake in your business, provided it is the right sort of funding for you.
Depending on the nature of your business, you can also get funding from or invest in Shariah-compliant communal investment vehicles like unit trusts and funds, equity or private equity funds, real-estate funds or sukuk.
Getting financing through funds is possible but not as direct as other means, since you will have to convince the fund managers to back you. It might also require you to list your business, depending on the nature of the fund. It is more suitable for long-term funding, while your bank remains the best provider for your short-term needs.
INVESTING IN SUKUK
Islamic bonds or sukuk are a bit different. In a typical sukuk structure, a special purpose vehicle (SPV) will take ownership of an asset and get investors to provide funds. The SPV will then put the asset to work, for example developing infrastructure. Profits are shared with the sukuk holders and at the end of the term the SPV sells the original asset and repays the holders. Getting funding in this way is possible, but would require you to set up an SPV for the realization of a specific project.
Finally, in terms of conventional financial products, the general view is that equity is acceptable, while bonds or other debt-based instruments, preferred stocks and almost all derivatives are haram. Therefore, while issuing bonds or trading in derivatives is not possible, if you list your company on a stock market, provided that your business is compliant with Shariah principles and that you do not issue preferred stocks, it is a perfectly acceptable way to get long-term funding.
If you are in doubt about the method of financing you are considering, you can review the main principles of Islamic finance in this article on 'The basics of Islamic banking and finance', and you can consult an Islamic bank.
Zawya BusinessPulse 2014
