Equity Based Modes of Financing

Faraz Younus Bandukda

Islamic Modes of Financing

Equity based Shirka (Musharakah) Diminishing Musharakah Mudaraba

Trade based Murabaha Salam Istisna Istijrar

Services or Rental based Ijarah Wakala

What is Musharakah

Basically a kind of partnership in which the partners join together with different contributions for the common objective of undertaking business and trade in accordance with the principles of Shari’ah

Means relationship established under a contract by the mutual consent of the parties for sharing of profits and losses, arising from a joint enterprise or venture.

Literal meaning “Sharing” Root of the word in Arabic is Shirkah.

What is Shirkah

In Islamic jurisprudence - “Sharing” From Quranic verse

Now send one of you with this silver (coin) of yours to the city, then let him see which of them has purest food, so let him bring you provision from it, and let him behave with gentleness, and by no means make your case known to any one …. (Kahaf – 19)

From Hadith-e-Qudsi Allah Subhan-o-Tallah has declared that He will become a partner in a business between two Mushariks until they indulge in cheating or breach of trust (Khayanah)

Ibn-e-Qudama has expressed that there is Ijma (consensus) on validity of Shirkah.

Types Shirkah

Shirkat-ul-Milk Joint ownership of two or more persons in a particular

property without any commercial intention. Optional – two or more persons purchase asset jointly Compulsory – comes into operation without any effort/action

(automatically) Shirkat-ul-Aqd

Joint venture of two or more persons with commercial intention. Partnership effected by a mutual contract.

Shirkat-ul-Milk

May use mutually or jointly May set turns in days Profit and Loss will be shared as per the ratio of capital /

ownership Every partner can sell or lease his share to other partner as well

as 3rd person Permission of other partner is required for leasing Other partner may promise to buy (unilateral) the share of other

one at any cost – Market price, Pre-agreed price, face value

Shirkat-ul-Aqd

Further divided into three kinds Shirkat-ul-Am’waal (Partnership in capital)

all the partners invest some Capital into a Commercial enterprise Shirkat-ul-A’amaal (Partnership in service)

all the partners jointly undertake to render some services the fee charged from them is distributed according to an agreed ratio. loss is also shared as per the agreed ratio of profit distribution

Shirkat-ul-Wojooh (Partnership in goodwill) partners have no investment at all. All they do is that they purchase the commodities on a deferred price and sell them at spot. profit so earned is distributed between them at an agreed ratio.

Shirkat-ul-Aqd

All three are further divided into two types: Shirkat-Al-Mufawada (Capital and labor at par)

All partners share capital, management, profit, and risk in absolute equals. It is a necessary condition for all four categories to be shared amongst the partners; Every partner who shares equally is a Trustee, Guarantor and Agent on behalf of the other partners.

Shirkat-ul-Ainan A more common type of Shirkat-ul-Aqd where equality in capital, management or liability might be equal in

one case but not in all respect meaning either profit is equal but not labor or vice versa- (Equality is not necessary)

Basic rules of Musharakah

Partners must be sane & mature and be able of entering into a contract.

The contract must take place with free consent of the parties without any fraud or misrepresentation.

The rate of profit sharing should be determined: The share of each partner in the profit earned should be identified at the time of the contract. If however, the ratio is not determined before hand the contract becomes void (Fasid). Therefore identifying the profit share is necessary.

Basic rules of Musharakah Capital

Investments come from all partners/shareholders All assets of Musharakah are jointly owned in proportion to

the capital of each partner. All partners must contribute their capital in terms of money

or species at an agreed valuation. Quantified (Ma’loom) Specified (Muta’aiyan) Not necessarily be merged Not necessarily be in liquid form

Basic rules of Musharakah

Profits shall be distributed in the ratio proportion mutually agreed

in the contract It is not allowed to fix a lump sum amount for any of the

partners, or any rate of profit tied up with his capital Different ratios can be decided. Capping and limit on

different rang of may also be set. The ratio of sleeping partner cannot exceed the ratio of

investment Ratio of profit – not ratio of capital A management fee can be paid to the partner managing

the Musharakah provided the agreement for the payment of such fee is independent of the Musharakah agreement.

Excess profit ratio can be given to other partner as Hiba

Basic rules of Musharakah

Losses are shared by all partners in proportion to their capital.

Basic rules of Musharakah

Management Every partner can manage One may be working and other one may be sleeping

Basic rules of Musharakah

Terminate the Musharakah Every partner has a right to terminate the Musharakah at

any time after giving his partner a notice to this effect, whereby the Musharakah will come to an end.

In this case, if the assets are in cash form, all of them will be distributed pro rata between the partners. But if the assets are not liquidated, the partners may agree either on the liquidation of the assets, or on their distribution or partition between the partners as they are.

One partner may purchase the shares of other if he wants to continue the business.

Condition of non liquidation – share purchase.. 

What is Mudarabah?

A kind of partnership in which one partner gives money to another for investing in a commercial enterprise.

Rab-ul-maal – a person who contributes investments and acts as a sleeping partner

Mudarib – a person who brings effort and acts as a working partner

Ras-ul-maal – Investment of partnership

Proof of Mudarabah

Prophet Hazarat Muhammad peace be upon him travelled to Damishk for selling goods of Hazarat Khadija (razi’Allah unha)

Types of Mudaraba

Al Mudarabah Al Muqayyadah

Rabb-ul-Maal may specify a particular business or a particular place for the mudarib

He shall invest the money in that particular business or place.

Types of Mudaraba

Al Mudarabah Al Mutlaqah(Unrestricted Mudarabah)  

Rabb-ul-maal gives full freedom to Mudarib to undertake whatever business he deems fit

However, he is not authorized to: keep another Mudarib or a partner mix his own investment in that particular Mudarabah

without the consent of Rabb-ul Maal.

Authority of Rab-ul-maal

Rabb-ul-Maal has authority to:

Oversee the Mudarib’s activities and Work with Mudarib if the Mudarib consents.

Capacities of Mudarib

Ameen (Trustee): The money given by Rab-ul-maal (investor) and the assets required therewith are held by him as a trust.

Wakeel (Agent): In purchasing goods for trade, he is an agent of Rab-ul-maal.

Shareek (Partner): In case the enterprise earns a profit, he is a partner of Rab-ul-maal who shares the profit in agreed ratio.

Zamin (Liable): If the enterprise suffers a loss due to his negligence or misconduct, he is liable to compensate the loss.

Ajeer (Employee): If the Mudarabah becomes Void due to any reason, the Mudarib is entitled to get a fee for his services.

.

Capital of Mudarabah

may be either cash or in kind. If the capital is in kind, its valuation is necessary,

without which Mudarabah becomes void.

Distribution of Profit

At the beginning of Mudarabah, parties must agree with the profit distribution ratio.

They can share the profit at any ratio. However in case the parties have entered into

Mudarabah without mentioning the exact proportions of the profit Mudarabah becomes void (may differ on school of thought),

Distribution of Profit

Apart from the agreed ration the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudarabah.

The Mudarib & Rabb-ul-Maal cannot allocate a lump sum amount of profit for any party

They can not determine the share of any party at a specific rate tied up with the capital.

Distribution of Loss

If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance,

the remainder, if any, shall be distributed between the parties according to the agreed ratio.

Expenses of Mudarabah

Expenses directly linked with Mudarabah shall be covered from Mudarabah.

Business Tour, Administrative Expenses, wages etc

Personal expenses of Mudarib shall not be covered from Mudarabah.

Meals, clothing, conveyance, medical

Termination of Mudarabah

Can be terminated any time by either of the two parties by giving notice.

If Mudarabah was for a particular term, it will terminate at the end of the term.

Termination of Mudarabah means that the Mudarib cannot purchase new goods for the Mudarabah. However, he may sell the existing goods that were purchased before termination.

Distribution at Termination

If all assets of the Mudarabah are in cash form at the time of termination, and some profit has been earned on the principal amount, profit shall be distributed between the parties according to the agreed ratio.

If the assets of Mudarabah are not in cash form, they will be sold and liquidated so that the actual profit may be determined.

If there is a profit, it will be distributed between Mudarib and Rab-ul-Maal.

If no profit is left, Mudarib will not get anything.

Collective Mudarabah

means a joint pool created by many investors and handled over to a single Mudarib who is normally a juristic person.

It creates two different relationships: Relationship between investors, which is Shirkah or

Partnership. Relationship of all the investors with mudarib, which

is mudarabah.

Running Mudarabah

Investors come in and go out at different dates Profits are calculated on daily product basis. Redemption before maturity

If the assets of mudarabah are in illiquid form, an investor may redeem his share by selling it to the pool..

If the assets are in liquid form, a provisional amount may be given to him subject to final settlement

Use of Mudarabah / Musharakah

In project Financing Mutual Funds In Single Transactions

Export Import Manufacturing

Diminishing Musharkah

Same as Musharkah with share purchase program

Major Financier sells his share and his profit claim reduces

Basically used in Asset Purchase and Business Venture Financing