NEEM Magazine

by, Sheheryar T. Sardar, Esq.* & Benish A. Shah, Esq.

Part I: Islamic Financing through a Joint Venture

Developing your business in an economic downturn creates a host of difficulties for businesses of varying sizes.   The most critical issue is the availability of capital to grow the business.  With a continuing credit crunch, many banks and lending institutions are denying business loans due to more stringent risk analysis and lack of liquid assets.  For those businesses that are able to secure a loan in this economic climate, high interest rates take a toll on company profits.

An untapped lending structure for businesses is found in Islamic Financing principles -  a low-risk financing structure that provides much needed investment capital for start-ups, joint ventures, and growing companies.

Structuring the Deal Under Islamic Finance Principles:  Mudaraba

The theoretical model of Islamic Financing is based in the concept of profit and loss sharing through the Mudaraba mode of financing.  Mudaraba style financing is a form of investment partnership between a lending entity and a business that mandates the share of risk and losses/profits between both parties through a pre-determined business structure.  A Mudaraba structure effectively requires the lender to take a stake in the business, with the business investing time and expertise in running the enterprise.

A fundamental component of Mudaraba is the appropriation of profits and loss.  The business procuring the loan cannot be placed at the risk of losing any monetary investment/value provided by the lending investor.  If the business venture fails, then the maximum loss to the entrepreneur is the investment they made into the business enterprise themselves, i.e., their own capital investment.  Furthermore, a Mudaraba structure releases the investor from management decisions.  Day-to-day decision making and enterprise management must be left to the business entity.

Application of Mudaraba for Joint Ventures

It is a misconception that Islamic Financing may only be provided through a banking structure.  Developing an investment strategy through a joint venture accurately utilizes the underlying concept of Mudaraba.  In the case of a joint venture, there will be three parties involved in the deal structure:  (1) Investors; (2) Fund; and (3) Business Entity.  The Investors will deposit their capital investments into the Fund and the Fund shall use the Investors’ monies to finance the projects of the business entity.  The Fund plays a two-fold role:  as the business entity being invested in by Investors and as the investor to the Business Entity.  Essentially, the position of the Fund is that of an investment intermediary.

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Sheheryar T. Sardar is a partner at Sardar Law Firm in New York City.