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Islam and Venture Capital

March 26, 2008

dubaiYou might be surprised that Islam has more than 1.5 billion followers on the planet (there are 2 billion Christians) and they have money to buy things you make and money to invest in your business (and they won’t fire the founder).  Turns out the Islamic world is an untapped market for entrepreneurial activity.  We are evaluating the possibility of launching a new business in Dubai and raising money from various sources in the UAE.  From what I can tell, Islamic venture capital is in an evolutionary state, but there are some basic things you should think about when considering raising money from Islamic investors:

  • Sharia (Islamic law) will govern ALL investment activity.  Spend some time making sure your proposal and planned activities will be consistent with Sharia.  For example, a typical preferred stock offering may not pass muster if it includes the collection and payment of riba (interest). Also, don’t bother attempting to raise money for any business if you intend to service businesses that are considered haraam (unlawful) such as companies that sell pork, alcohol, porn, gossip and so on.
  • Capitalism was developed between the 8th and 9th century in the Islamic world (medieval Europe didn’t pick up these concepts until the 13th century).  My point is that instead of thinking you (as an American) invented capitalism; realize that the Islamic world invented various concepts including contracts, partnerships, limited partnerships, credit, debt, profit, loss, capital, revenue, promissory notes, trusts, startup companies, savings accounts and so on long before anyone knew America existed.
  • Mudarabah (profit sharing) is the most common arrangement between a rabal-maal (Islamic investor) and the mudarib (entrepreneur).  The entrepreneur provides expertise, labor and management. Profits made are shared between the bank and the entrepreneur according to predetermined ratio. In case of loss, the bank loses the capital, while the entrepreneur loses his provision of labor. It is this financial risk, according to the Shariah, that justifies the bank’s claim to part of the profit.  The profit-sharing continues until the loan is repaid. The bank is compensated for the time value of its money in the form of a floating interest rate that is pegged to the debtor’s profits.
  • Musharakah (joint venture) is the most common arrangement between an Islamic company and a Western company.  Musharakah is a relationship between two parties, both of whom contribute capital to a business, and divide the net profit and loss pro rata. This is often used in investment projects, letters of credit, and the purchase or real estate or property. In the case of real estate or property, the bank assess an imputed rent and will share it as agreed in advance. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions.

At the end of the day you need to understand that the core of any Islamic venture capital funding is an agreement to share in the risks of the business venture in return for the profits derived from the venture.  Interest-bearing lending is a violation of Sharia.  The good news for entrepreneurs is there is no such thing as ‘personal guarantees’ under Sharia; specifically because it is unlawful to lose what you have not contributed (i.e. if you didn’t invest any money in a deal, you can not owe any money in the event the venture fails).  Additionally, under a typical mudaraba financing structure the investor is prohibited from involvement with management of the business, under Sharia, day-to-day and overall management must be left to the entrepreneur.

Looking for resources?  The DIFC (Dubai International Finance Center) and the DFSA (Dubai Financial Services Authority might be good places to start.  Major Islamic venture capital firms include: Injazat Capital Limited  and Venture Capital Bank BSC.   Good luck!

Written by Alexander Muse · Filed Under Blog, Startups, Venture Capital 

Comments

4 Responses to “Islam and Venture Capital”

  1. Aziz Gilani Says:
    March 26th, 2008 at 5:17 pm

    Good primer on Islamic VC. I am not sure if I agree that all Islamic investors are concerned about Sharia compliance. I have chatted with several major players in Islamic finance over the past few months and have some takes as well, especially in the area of sukkuks. Let me know if you wish to discuss.

  2. Anthony Kuhn Says:
    March 27th, 2008 at 1:53 pm

    Alexander:

    Good thoughts on broadening the horizons of VC funding beyond the shores of one’s own country and also, a nice cultural insight to how Islam handles the idea of these particular investments. I linked to your piece in my blog post today at the Innovators-Network, as this is just the type of thing that is of interest to our readership. I look forward to more excellent, and useful posts at Texas Startup Blog.

  3. Alexander Muse Says:
    June 15th, 2008 at 5:29 pm

    To clarify, investors in Dubai are allowed to follow western traditions (i.e. not necessarily Sharia concerned), but many that I have talked to are actually based in Abu Daubi so they really want you to follow the rules…

  4. zahied parker Says:
    November 5th, 2008 at 7:46 am

    i enetered into a venture capital deal with an entrepreneur.i invested an
    an amount in equipment and fixtures and aslo provided the premises to do
    bussiness and aslo a place to live.i charging him rent for six years and
    after the lease period all the equioment and fixture will be his.my profit
    is derived from a fixed rate of 14.77% per year on the total amount invested
    im i complying with islamic law.

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