IB1005 DEPOSITS AND FINANCING PRACTICES OF ISLAMIC FINANCIAL INSTITUTIONS CHAPTER 9 : MUSYARAKAH JOINT-VENTURE FINANCING

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IB1005DEPOSITS AND FINANCING PRACTICES OF
ISLAMIC FINANCIAL INSTITUTIONSCHAPTER 9
MUSYARAKAH JOINT-VENTURE FINANCING

• COMPILED BY
• HAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking
  Finance)
• Certified Professional Trainer (MIM)
• Industry Expert
• INCEIF

• PRESENTED BY
• HJ MAHMUD HJ BUNTAT, MBA (AUOL, UK), DBM (Swansea
  Inst., UK), CIL (UIA)
• Part-time Lecturer (INCEIF)
• Former Head of Islamic Banking Division, OCBC
  Bank (Malaysia) Bhd

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Chapter 9 Musharakah Joint Venture Financing

• When Islamic banks are not allowed to make profit
  by making loans to customers, what are the
  alternatives available?
• Theoretically, Islamic banking can offer two
  categories of financial contracts. First, it
  deals with asset-based financing such as, such as
  murabahah, salam, istisna and al-ijarah.
  Secondly, an Islamic bank can pursue business on
  the basis of partnership such as mudarabah and
  musyarakah.

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• How would Islamic finance respond to the
  requirement of capital and risks associated with
  the new business?
• To answer this question, the musyarakah contract
  can be useful. It is useful to remember that
  musyarakah is not a financial contract meant for
  banking alone. In fact it is meant for any
  ordinary financial transaction.

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• In Islamic jurisprudence, the term shirkah is
  commonly used to denote musyarakah. Shirkah means
  sharing.
• It can be classified into two, namely
  shirkat-ul-milk and shirkah-ul-aqd.
• Shirkat-ul-milk is a joint ownership of two or
  more persons in a particular property.

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• Shirkat-ul-aqd means a partnership affected by a
  mutual contract, which can be translated as a
  joint commercial enterprise. Shirkah-ul-aqd is
  divided into three categories-
• 1. Shirkat-ul-amwal - All partners invest some
• capital as well as expertise into the new
• business.
• 2. Shirkat-ul-amal - Involves only services
• rendered by partners.
• 3. Shirkat-ul-wujuh - Where no capital input
  is
• required. The business purchases goods on
• credit and sell them cash.

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• The profit generated from the business of shirkat
  will be distributed among the partners at an
  agreed ratio or percentage.
• Of the three types of shirkat-ul-aqd, the first
  kind, namely shirkat-ul-amwal, is associated with
  musyarakah financing.
• In fact, the term musyarakah is not readily found
  in books of Fiqh.
• It was casually used in Islamic banking
  literatures to imply shirkat-ul-amwal as it deals
  with capital investment

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• Let us look again at the role of musyarakah/
  shirkat-ul-amwal in all business set up.
• In fact, all forms of modern business
  organisation today are based on musyarakah with
  the exception of sole proprietorship and a
  sleeping partnership.
• In musyarakah all partners are required to take
  active role in running the business.

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Musharakah Financing
Shirkat (Partnership)
Shirkat-ul Milk (Holding Partnership
Shirkat-ul Uqud (Contractual Partnership
Inheritance (Faraid) Wills (Wasiyat)
Shirkat-ul-Wujuuh (Receivable Partnership)
Shirkat-ul Amal (Abdan) (Partnership in work)
Al-Mudarabah (Trustee Partnership)
Shirkat-ul Amwal (Partnership in capital)
Shirkat-ul Mufawada (equals shares)
Shirkat-ul Inan (unequals shares)
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• What are the rules available in musyarakah on the
  distribution of profit? There is no single
  definite rule available but here are some
  opinions of Muslim jurists.
• According to Imam Shafii, each partner receives
  a profit exactly in the proportion of his
  investment.

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• Imam Ahmad contented that the ratio of profit may
  differ from the ratio of investment if it is
  agreed between partners with their free consent.
• A middle view was adopted by Imam Abu Hanifa that
  the ratio of profit may differ from the ratio of
  investment under normal conditions.
• Despite the differences in opinion on profit
  distribution, the jurists are unanimous with
  regard to two principles-

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• First Principle,
• The distribution of profit cannot be determined
  in an absolute or lump sum amount.
• This is because there is no certainty of profit
  in the venture. In other words, in a financing
  contract Islam only allows a predetermination of
  profit in ratios but not in the absolute sum.

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• Second principle
• All jurists agree that each partner shall suffer
  loss exactly according to his capital investment.
• However, this does not imply that musyarakah is
  only confined to a limited liability company.
• If the loss exceeds the paid-up capital, the
  balance could be raised from the partners
  personal assets.

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Application of Musharakah Contract for Venture
Capital

• Venture capitalists provide equity funds to small
  business, especially start-ups.
• At a later stage, they provide capital for a
  company that expects to go public within a year.
• Venture capitalists supported entrepreneurs with
  capital in exchange for an ownership stake of the
  business.

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• Unlike banks and unit trust investors, venture
  capitalists work closely with entrepreneurs and
  investee companies.
• In this manner, the venture capital business
  elucidates the Islamic system of profit-loss
  sharing
• Not only it injects risk capital, venture
  capitalists also provide value-addition such as
  reviewing business plan, giving financial advice
  and improving networking.

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• The essential element in Islamic venture capital
  is the profit-loss sharing system (PLS) than runs
  on the principle of al-ghurm bil ghonm (i.e. the
  entitlement to return is related to the exposure
  of risk).
• One of the highlights of venture capital
  investments is the due-diligence process
  conducted by the venture capitalists.

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• It serves to investigate the characteristics of
  the entrepreneur who is seeking financing.
• Both the behavioural and mental traits of the
  entrepreneur will be assessed to measure his
  level of trustworthiness (amanah).
• Conducting the due-diligence on the entrepreneur
  is therefore compulsory (wajib) to prevent undue
  moral hazards that may undermine the venture.

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• A venture capitalist usually makes profits
  through capital gains generated from sale of
  shares upon exiting either via public listing or
  by stock repurchase by the investee company.
• They are not interested in a venture on permanent
  basis.
• In this way, one must closely studies the nature
  of the venture capital partnership and see
  whether it fits in the musyarakah framework.

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• Division of ownership in venture capital is not
  based on relative monetary investment of the two
  parties.
• Rather, determining percentage of ownership
  usually involve a number of uncertain investment
  outcomes such as expected revenues, profit margin
  and price-earning ratio in order to obtain the
  current value of the company.

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• Most of the rules on musyarakah are fiqh i.e.
  they are derived from human understanding of the
  Quranic teachings about justice and equity.
• The fuqaha (Islamic jurists) uses reason (aql)
  when they exercise ijtihad (independent thinking)
  on pertinent issues involving welfare (maslahah)
  of the people.
• When exercising Ijtihad they are guided by the
  Quran and will not make opinions based on whims
  and fancies.

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• The fuqaha must look into this issue on ownership
  determination as it (i.e. owneship shares) is a
  parameter bearing legal claims once profits are
  realized
• The issue of gharar (ambiguities) is a cause for
  concern since ownership is determined by
  estimated and projected variables such as
•   - Projected profit of venture
• - Price-Earning ratio (P/E)
• - Venture capital return (VCR) 

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• Gharar must be avoided in Islamic law of contract
  (aqd), otherwise the contract is deemed null and
  void.

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