islamic venture capital in malaysia: operation and challenges...malaysian journal of consumer and...

MALAYSIAN JOURNAL OF CONSUMER AND FAMILY ECONOMICS Vol 24 (S2), 2020

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Islamic Venture Capital in Malaysia: Operation and Challenges

Sharifah Faigah Syed Alwi1, Abdul Hadi Md Akhir3, Mohamad Nizam Jaafar1, Ismah Osman2, Amirul Afif Muhamat2, Ruhaini Muda2

1Arshad Ayub Graduate Business School Universiti Teknologi MARA Shah Alam, Selangor, Malaysia

2Faculty of Business Management Universiti Teknologi MARA Shah Alam, Selangor, Malaysia

3Hong Leong Bank Berhad Kuala Lumpur, Malaysia

Abstract Operational practices of Islamic venture capital and conventional venture capital in Malaysia differ from one another, specifically with regards to their investment activities where the investment of Islamic venture capital is restricted to Shariah compliant funds and businesses only. As at 2018, there are 64 Venture Capital Management Corporations (VCMC) registered in Malaysia. Unfortunately, in Malaysia, there are still very few of Islamic Venture Capital Management Corporations (IVCMC) that are established. Globally, Islamic venture capital seems to be quite relatively new as compared to conventional venture capital. Accordingly, this study aims to highlight the real concept and operation of Islamic venture capital in Malaysia. This research also intends to identify the challenges faced by the IVCMC for survival among the conventional VCMC in Malaysia. In addition, this study adopted qualitative method where the evidence on the real concept, operation and challenges of Islamic venture capital companies are gathered from the practice of the only two of IVCMCs in Malaysia which are willing to participate in this research. Apparently, it is found that Islamic venture capital can be considered as a participatory finance-based paradigm, established on profit-sharing principles namely in mudarabah (profit sharing) and musyarakah (profit and loss sharing) contracts, to ensure a justly inclusive economic growth. However, the main challenge for its growth is a lack of awareness among entrepreneurs with regards to the existence and function of IVCMC in providing investment and financial services. More importantly, the Malaysian government or private sector need to increase the funding of IVCMC to expand the growth so that Malaysia can emerge to be as one of the centers of excellence for Islamic venture capital.

Keywords: Islamic Venture Capital, Operation, Challenges


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1.0 Introduction Venture capital is defined as capital for equity investment in high

risk start-up and early stage private companies, with the objective of achieving investment return after a number of years (Hamzah, 2011). The return was mainly through capital gain from the appreciation in the value of the shares in the company (Securities Commission Malaysia, 2009). There are many kinds of implementation in venture capital. In most countries, venture capital would be limited to smaller investments such as risky enterprises, particularly the start-ups and technology companies. Besides, in some countries, venture capital is a subset of private equities, a generic term for all equity investment in private companies (as against public companies). In some other countries, venture capital is discrete and distinct from private equity. In this case, private equity takes on a narrower meaning, covering only larger investments in less risky and more matured private companies, company buyouts and other special situations (Hassan, Mikail & Arifin, 2011). In this context, venture capital could also be defined as adding economic value through risk capital investments, via a special financial institution, which provides management supervision as well as equity funding.

The venture capital industry has now spread globally. The United Kingdom’s venture capital industry is the second largest after the United States, traces its roots to the Second World War (Wong, 2005). The venture capital industries in Japan and Australia started in the 1970s and other part of Asia in the 1980s. For example, First Asia Venture Capital Inc. was formally established and incorporated in 1983 as a professionally managed venture capital company which involved in a number of Philippine-based businesses (First Asia Venture Capital Inc., 2019).

The realm of Islamic venture capital remained ignored by the Islamic banking sector for quite a long time, largely because an 'entrepreneur class and ecology' which was essential for the development of a healthy venture capital environment that was lacking. Most of the Islamic countries could not produce an adequate population of young and bright people with great business ideas and a determination to make a success of their business. Therefore, only some Islamic countries and other countries with sizable Muslim minorities have been founded recently by a few of Islamic Venture Capital Funds (IVCF). As in the Middle East economies underwent significant economic-industrial transformation, and many local students


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with professional education came forward for joining markets and economies of the region, the ecology needed for venture capital funding also developed considerably (Elsiefy, 2014).

Indeed, Malaysia has been very committed to develop its Islamic finance in positioning Malaysia as the International Islamic Financial Centre or formally known as Malaysia International Islamic Financial Centre (MIFC). Under the MIFC initiative, Malaysia aims to be the center for Islamic banking, Takaful and capital market products and services, as well as a center for Islamic finance education, training, consultancy and research (Securities Commission, 2016a). Securities Commission Malaysia is the main regulatory body which regulates and governs the establishment and operation both Islamic and conventional venture capital in Malaysia. It is mentioned clearly in Schedule 4 of Capital Markets and Services Act 2007 that any corporation seeking to apply as a venture capital corporation must apply to be registered with the Securities Commission and comply with the provision of the Guidelines for Registration of Venture Capital Corporations and Venture Capital Management Corporations as prescribed by the Securities Commission (Securities Commission, 2013). Securities Commission Malaysia issued Guidelines and Best Practices on Islamic Venture Capital in 2008 where in the same year the first Islamic venture capital was established in Malaysia (Securities Commission, 2016b).

According to Anwar (2016), Islamic venture capital may transform Malaysia to be one of the most prominent countries in the industry within the emerging market. She also noted that increasingly large amount of venture capital funds was moving towards Asia, and it was expected that over the next five years, venture capital funds companies planned to increase their commitments to emerging markets. Referring to Securities Commission Malaysia (2018), there are 64 registered venture capital management corporations registered in Malaysia as at 30th December of 2018. However, out of 64 companies, there are only few companies which fully implementing Islamic venture capital in their mode of financing. Even though Islamic venture capital seems to be quite competitive as compared to conventional venture capital globally, there are still very few of Islamic venture capital companies. This impose some challenges to Islamic Venture Capital Management Corporations (IVCMC), as there are currently not many IVCMC in Malaysia, and furthermore, they must have to compete with the many numbers of Conventional Venture Capital Management Corporations (CVCMC) in the market to get the


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potential business. More importantly, this illustrates that this very few number of IVCMCs in Malaysia are struggling to survive in the business. Therefore it is pertinent to identify the challenges faced by the IVCMC and consequently, the contributing factors to lack of IVCMC business in Malaysia.

According to the top management from one of the IVCMC in an interview in 2018, IVCMC in Malaysia is still new and developing. Thus, there is slow increment in terms of the percentage on the knowledge among entrepreneurs about IVCMC and the financings offered. In another interview session conducted with the Investment Director from another IVCMC in 2018, he emphasized on the lack of awareness and knowledge among entrepreneurs about the existence, benefits and advantages of Islamic venture capital in Malaysia which are not known to the entrepreneurs. The entrepreneurs are aware about the conventional financing products as compared to Islamic financing products in the market. Consequently, the study has two objectives in which firstly, to highlight the real concept and practice of Islamic venture capital in Malaysia. Secondly, to identify the challenges faced by the IVCMC for survival among the CVCMC in Malaysia.

2.0 Literature Review

Numerous Islamic Finance (IF) researchers discover that VC investments are comparable in structure to the standard IF tools (Anwar, 2019). Çizakça (1996), for instance, contends that VC has progressed, sooner before the dawn of Islam, from many periods in Arab, commencing as conventional Islamic contract of mudarabah, a form of partnership. Consequently, they applied the partnership contract through an individual, a Mudarib, the entrepreneur, who is assigned to conduct trade on behalf of Rabb al Maal (the capital provider), and profit was then divided on a pre-arranged agreement. In fact, the mudarabah contract was implemented by European buyers in the tenth century and VC is among its various advanced formation (Anwar, 2019). On the other hand, Al-Suwailem (1998) believes that VC are very much resembling the musharakah (partnership) contract, especially shirkat inan, where the partners are simply the agent and do not serve as guarantors of other partners. The partners only transact with the partnership capital according to the terms of partnership agreement and act to serve the best interest of the company (Muhammad, Sairally & Habib, 2015). More importantly it is a contract where it is a type of investment that is equivalence in terms of capital,


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management, or liability, thus, it does not require equality in the investment amount, personal status or distribution of profit and liabilities among the partners (Muhammad, Sairally & Habib, 2015). Equally important is the fact that VC promotes growth and development, as well as reduces agency costs, thus this type of investment tool certainly supports the objectives of Islamic banking and finance. Therefore, it can be considered as one of the most important devices within the components of Shariah-compliant financing instruments.

Nevertheless, Choudhury (2001) mentions thoughtful concerns on the establishment of the present mudarabah and musharakah contracts to develop IVC. According to him, in mudarabah contracts, the profit-sharing ratio is of non-participatory in nature and the work effort is based without giving appropriate considerations. In addition, the major power related to decision-making is held by the authority of the capital providers, while the entrepreneur is held responsible for production. Consequently, we witness in the inequitable distribution of resources among participants due to inefficient distribution of profit-sharing ratio. Next, Choudhury (2001) argues that there are issues pertaining to asymmetrical ownership and partial income distribution as a result in the nonexistence of mutual participatory entities. He further asserts that both of those contracts have some disadvantages in terms of cooperation, participative decision making, and involvement among owners, managers and production components. For instance, he mentioned that the capital provider or his appointed management participate in all the decision-making in mudharabah contract, while in musyarakah contract, there will be no decision-making among the minority partners.

Rather, he expresses his opinion that Islamic financial institutions need to explore some other instruments that are Shariah-compliant, within the context of ethics and productivity, simultaneously, in order to establish prosperity among the ummah, through participative cooperation and effective decision making. Therefore, it is indeed pertinent for IVC to establish the mode of financing using other contracts that can stimulate involvement among agents, businesses, segments, or other factors and relations within the Islamic ecosystem.

Indeed, Islamic venture capital appeals as another provision of seed capital for a new commercial endeavor, like conventional venture capital, except there are certain restrictions ensuring Shariah compliances in all related activities through the appointment of Shariah


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advisors to act with due care and diligence, including free from interest (riba) , gambling (maisir) and uncertainty (gharar). Additionally, Securities Commission (2008) has also provide some guidelines in relation to financing business within the Shariah boundaries, which include prohibitions in dealing in Shariah non-compliant securities and hotels and resorts, manufacturing or sale of non-halal products, entertainment activities that are non-permissible according to Shariah, or manufacturing or sale of tobacco-based products. Next, they further emphasize that the contribution from the Shariah non-compliant activities to the group revenue must be less than 33 per cent. Furthermore, Kahf (2006) reiterates that it is very important for IVC to have the issuance of only Shariah-compliant financial instruments, and not to get involved with non-permissible activities including sale of debt at discounted rate, the convertible debt and preferred shares. Accordingly, Islamic financial products should emphasize on having tangible and genuine business dealings, upholding property rights, prohibition of debt sale and speculative transactions, transfer of property rights in sales, preventing the use of money for non-prolific purposes and conducting all business financing activities to value creation, through the accomplishment of Maqasid Shariah.

Accordingly, Ahmed (2011) has developed the criteria for IVC in which it can be considered as “Shariah-based product”, as it has fulfilled those measures within the four elements, which include form, substance, market segment and needs. Apparently, IVC has satisfied the legal prerequisite concerning form and substance, since it does not comprise any engineered contract. Furthermore, IVC assists requirements of all the market subdivisions by providing capital to those corporations of dissimilar sizes and magnitudes, and additionally, producing job opportunities for middle and poor people through enhanced promotion of business dealings. Eventually, IVC can satisfy the needs of different categories of Maqasid Shariah including necessities (daruriyyat), complementary requirements (hajiyyat) and embellishments (tahsinniyat). Significantly, it is rather relevant for IVCs to finance charitable institutions through waqf (Islamic philanthropic) funds, in addition to promoting business ventures (Alias, 2012).

Tentatively, IVCs may seem to have resemblances with Islamic banks, particularly concerning the level of funds collection and agency relationship (Elsiefy, 2014). Investors, for both categories of institutions, share profit and loss according to pre-agreed ratios.


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Likewise, both the institutions evaluate the feasibility of those projects, as well as its involvement within the society. On the other hand, Islamic banks favor short-term investments, while IVC is more concentrated in long-term projects. In addition, Islamic banks abide with a very dissimilar model in relation to profit/loss sharing and project evaluation measures, thus, it seems that they are very much close to conventional banks in these areas (Khan, 2010). In fact, Omran (2015) views that if Islamic banks accept an additional position or responsibilities in advocating projects, inspiring new ideas or providing required consultancy to young entrepreneurs, they can solve the issues of sustainability and prosperity especially among Muslims, since there are not many IVCs in the Muslim countries, although that are blessed with abundance of natural resources.

More importantly, Anwar (2019) discovers that IVCs can be integrated by presenting some amendments in the conventional structure of VC. Firstly, IVCs are required to employ a full-time Shariah scholar, to safeguard the needs of Shariah-compliance in all business transactions. Secondly, IVCs should abstain from dealing in impermissible business activities where they may select any predominant method for valuation and investment mode, within the principles of Shariah. Thirdly, IVCs are visible to exceptional risks, including Shariah non-compliance risk and equity investment risk. Therefore, they should require supplementary procedures, for instance, greater transparency in contracts and constant monitoring in order to protect against these risks. Indeed, they may adopt any exit policy, provided that the funds are acquired from halal origin. Lastly, IVC is established to embrace the potential of having to accomplish the anticipating goals of Islamic finance, especially when those investments are vigilantly selected and carried out, as well as protecting the intellectual property rights of those business owners.

In another study by Anwer et al. (2019), it reveals that IVC have certain characteristics including risk sharing, as well as having the potential of incorporating Sharīʿah-compliant investment methods and higher average returns. Thus, this could be a solution for Islamic finance industry, especially due to its extreme need of equity financing products. However, VC is commonly practiced as an alternative asset class, where the capital is provided by large institutions and wealthy individuals, thus, IVC is seemingly to follow the same path. Eventually, this industry receives fewer public credit and acknowledgement, even though some initial steps have been taken in the implementation of the


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concept in its applicability. The main reason is not only due to the lack of awareness among investors but also the absence of viable investment opportunities for small and medium (SME) scale investors. Therefore, IVC has the possibility to entice the general public at large, if those venture endeavours can be somewhat established, including mutual funds, and consequently more studies are required to embrace innovative products and services in Islamic financial institutions.

3.0 Methodology

This study adopted the qualitative methodology. Both primary and secondary data are used for the purpose of this study. Interviews are carried out with the top managements from two of the IVCMC in Malaysia. The researchers have conducted the face to face interviews under the semi standardized (guided semi-structured or focused) interviews with the respondents to get the direct information and evidence on operation and challenges faced by the IVCMC in offering Islamic venture capital. The points gained from the interview session are highlighted and discussed by the respondents. This study systematically evaluated and analyzed the data using a thematic analysis, in which to fulfil the process of identifying the patterns within a qualitative data. The respondents involved in this research chose to remain unidentified or anonymous. Thus, they will be marked as R1 from IVC A and R2 from IVC B. The secondary data for this research was gathered through library works to investigate of the real concept of venture capital from the Islamic point of view.

4.0 Findings 4.1 The Real Concept of Islamic Venture Capital

In order to understand about the real concept of Islamic venture capital, a few published materials have been referred. Historically, Islamic venture capital started from the Islamic contract of mudarabah (profit sharing) which is a form of partnership used by Arab traders before Islam. Later, this contract was formalized and embodied in Islamic laws by the Muslim jurists (Mutalip, 2016). As Islamic culture spread across the world, the mudarabah contract developed and continued to be used by Muslim businessmen until the 19th century. In the 10th century, the mudarabah contract was taken up by the Italians and it was spread through Europe. Even though this kind of mudarabah partnership in the Muslim world remained undeveloped, there were an


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increasing number of entrepreneurs in Europe who were provided with financing using this method, resulting in organizations becoming bigger in size (Ahmed, 2018). The origin of Islamic venture capital could be traced back to mudarabah which is commonly translated to be Islamic limited partnership. The application of venture capital seemed to be abandoned in the Muslim world for a long time, while Western communities continued to develop it steadily. Since their inception and for almost two decades, Islamic banks were not really involved in the venture capital business and in the principle of profit and loss sharing (Hassan, Mikail, & Arifin, 2011).

Based on the Shariah guidelines, all the investments made under the venture capital business must comply with Shariah. It means that the status of any companies to be invested under Islamic venture capital must free from any of prohibited elements such as riba (usury), gharar (uncertainty), maysir (gambling) and production of non-halal (prohibited) goods and services. At the same time, any entertainment activities which are non-permissible to Shariah cannot be invested or financed under Islamic venture capital. The same rule applies to manufacturing of tobacco based or related products, stockbroking or share trading in Shariah non-compliant securities and hotel and resorts with non-Shariah compliant activities are all excluded under Islamic venture capital business (Hamzah, 2011).

Shariah encourages all types of business and investment activities which promote justice, benefits to the business community and enhance social welfare of the community. The participatory finance paradigm based on profit sharing principle in mudarabah and musyarakah (profit and loss sharing) contracts ensure a justly inclusive economic growth. One of the maqasid al-Shariah (objective of Shariah) is ensuring every citizen the “right of doing business fairly and fearlessly” where it deserves to be taken up as central thrust in the strategy of inclusive and just economic development with social justice (Bari, 2017).

The common Shariah contracts used for Islamic venture capital are mudarabah, musyarakah and wakalah (agency). Mudarabah is basically a contract made between two parties to finance a business venture. The parties involve are a rabb al-mal (investor) who solely provides the capital and a mudarib (entrepreneur) who solely manages the project. If the venture is profitable, the profit will be distributed based on a pre-agreed ratio. In the event of a business loss, it should be borne solely by the capital provider, to the extent of the capital


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contribution while the entrepreneur will lose his time and effort (International Shari’ah Research Academy for Islamic Finance (ISRA), 2016). The key to a mudarabah structure is the fact that the entrepreneur cannot be placed at risk to bear losses, unless proven negligent (Hamzah, 2011). The rule of mudarabah is explained by Ibnu Qudamah as the following;

“And there is no profit for the entrepreneur until he restores the capital. This means the entrepreneur is not entitled to anything from the business until he returns the capital to the investor, and when there is loss and profit, the former will absorb the latter, irrespective of whether they occur at the same or differenct times. This is because profit means any excess from the capital, and anything which has no excess has no profit.” (Shaharuddin, 2016; Ibnu Qudamah, 1999).

The second contract used is musyarakah where it is a partnership contract between two parties or more to finance a business venture whereby all parties contribute capital either in the form of cash or in kind. Profits are shared at a pre-agreed ratio while in the event of a loss; the loss shall be shared based on capital contribution. The last possible contract is wakalah where a party (principal) authorizes the other party or parties (agent) to act on his behalf, based on the agreed terms and conditions. Pursuant to the wakalah contract, it confers the power and rights to the agent to act on behalf of the principal based on his free will without any pressure from other and the same thing goes to the agent who is willing to do the tasks delegated to him (ISRA, 2016). A true form of Islamic financing or investment structure should have the element of sharing of profit and loss.

4.2 The Operation of Islamic Venture Capital Corporations in

Malaysia

Islamic venture capital in Malaysia is a result of a recommendation by Bank Negara Malaysia or Central Bank of Malaysia under the Malaysian Financial Stability Master Plan in the year 2000. On 17th July 2008, Musharakah Venture Tech and Musharakah Venture Management were established respectively. The fund size was RM30 million from Malaysia Venture Capital Management Berhad (MAVCAP), a venture capital arm of the Ministry of Finance Malaysia and RM5 million was raised by other investors. Prior to the establishment of this full-fledged Islamic venture capital


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industry, there are several funds which were a combination of Islamic and conventional venture capital in Malaysia such as Perbadanan Usahawan Nasional Berhad (PUNB), CIMB Bank and Navis Capital. Other than that, Kuwait Finance House (KFH) also offers Islamic private equity services under the KFH Asset Management sector (Hassan, Mikail, and Ariffin, 2011).

Basically, in Malaysia, Islamic venture capital is a mode of investing that seems perfect for Islamic finance through the application of various Islamic financing contracts, with the musyarakah contract being the most common. Venture capital is meant either for the provision of seed capital for a new venture in the process of being established or the provision of capital to a small business to facilitate its growth. As stated above, Islamic venture capital involves with certain restrictions that ensure Shariah compliances in all related activities by appointing a Shariah advisor to act with due care and diligence. The Shariah advisor is supposed to provide continuous guidance in ensuring that the investment contract and the instrument structure as well as the core activities of the investee companies must be Shariah compliant (Hamzah, 2011).

In order to understand about the operation of Islamic venture capital, the researchers have interviewed R1 who is the Investment Director of one of the IVCMC or known as IVC A in Malaysia. IVC A uses musyarakah contract in its venture capital investments. The modus operandi of IVC A is shown in Figure 1 below. IVC A is funded solely by the premiere Islamic financial institution in Malaysia and this institution is known as the Investor to the company. IVC A is the second party acts as fund manager based on the contract of wakalah to its investor where IVC A plays a role as the external manager who manages and controls the fund to be given at potential investee and has to ensure that the fund is well managed. The investee who is the customer will be the potential start-up companies or Small and Medium Enterprise companies that will be given a capital to start a business. The fund size was RM5 million and industry preference for investments is mostly on any industries except for the construction industry. As mentioned by R1 in 2018, musyarakah contract is used instead of mudarabah contract because it is less risky as compared to mudarabah because the profit and losses will be shared among the capital provider and the entrepreneurs.


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Figure 1 : Flow of Investment by Musharaka Venture Management Sdn Bhd

From the Figure 1 above, it shows how the IVC A operates as the fund manager of the Investor to manage its fund under venture capital business. IVC A may manage any number of investment funds. The contract of wakalah may entitle IVC A to earn fee for management of the fund where this fee is to be used for covering the company’s working capital over the life cycle of the investment fund. The wakalah contract will not prevent any IVCMC from participating in the venture (through a financial contribution) provided that the musyarakah contract’s condition in terms of profit and loss sharing is fulfilled (ISRA, 2015).

Hamzah (2011) explains that there are two primary parties in Islamic venture capital namely the investor and the investee company with many intermediaries such as fund managers and advisors in between including lawyers who must get involved in ensuring the compliance with law and the preparation of legal documents. Basically, there are few processes involve in Islamic venture capital investment (Hamzah, 2011).

Initially, the IVCMC whom could be considered as the investors themselves or the fund managers look for a potential deal either through the investee company approaching the investors or from an intermediary whose role is attempting to bring both parties (investor and investee company) to close the deal. In some cases, the investors may on their own initiative directly approach companies (investee

Profit and loss sharing at pre agreed ratio

50:50

Islamic Venture Capital

Management Corporation – The Investor

Venture Company-Investee Company (Venture

Customer)

Islamic Venture Capital Management Corporation-

IVC A


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company) which are expanding fast and wish to grow further. Before going into depth analysis, deal screening involves in next processes.

For IVCMC, this step involves screening the company activities to ensure compliance with Shariah principles. This step typically requires the early involvement of Shariah advisor. The core activities of the investee companies must be Shariah compliant. Effectively, this means that the underlying assets and investments of the funds must be permissible according to Shariah.

The next process is related to due diligence once the deal passes through a screening process. Like any business transactions involving some form of ownership be it Islamic or conventional, will require the investors to conduct due diligence. Essentially, due diligence is the investigation of documents and person with relevant knowledge of the investee company to discover all material facts and potential liabilities relating to investee company. There are several types of due diligence which include accounting due diligence, business due diligence and legal due diligence.

Deal structuring and deal negotiation also very crucial as it requires the lawyers to be thorough in addressing the numerous of legal issues. At both the deal negotiation and deal closing stages, lawyer should consult the Shariah advisor before finalizing the VC structure to be adopted. Once the deal structuring has been finalized, the lawyers will prepare a series of investment documentations for execution to close the deal. The documents to be prepared such as Joint Venture and or Shareholder Agreement, subscription’s Agreement, Asset or Stock Sale Agreement, Assignment and Assumption Agreements and others.

Ensuring the performance of the investee company through the active involvement of investors or their representatives is the next process in the Islamic venture capital business. Since the Islamic venture capital is based on musyarakah contract, investor or fund manager can interfere in the investee company’s business operation (ISRA, 2016). The fund manager may add value to the investee company by restructuring part or all the business activities and strategies; adapting management structures; optimizing cost structures and general assistance and guidance to realize the set growth targets. Monitoring processes may involve several venture capital deals may fail during the post monitoring phase. Many factors contribute to these failures, which include business, taxation and the legal aspects. Thus, investors should maintain diligence. Some of the legal issues they


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should focus on at this phase such as compliance with law; regulations and best practices; corporate governance; proper and regular reporting on legal and Shariah matters; and management of intellectual capital which includes both its own and the use of third party’s intellectual property. Thus, it is important that the investors are protected if the investee company does not perform especially during the initial stages of the investment. To reduce this risk, lawyers will include clauses that mitigate such risk by making it an obligation for the investors to provide the investment sum in tranches, subject to deliverables by the investee company in accordance with the agreed milestones.

The last process will be the final exit through share sale, Initial Public Offering or recapitalization at a higher premium. The investor or fund manager will negotiate and finalize the envisaged exit strategies. Depending on the Islamic venture capital structure, the investor or fund manager will take a profit share or management fee that may be dependent on a mixture of performance-based criteria or a fixed fee. Every parties involves in Islamic venture capital business are abide to Shariah compliance practices such as honesty in fulfilment of all contracts, never betray any trust, avoiding bribery and having a proper contract for every transaction. Investee company must ensure that it handle the investment with the understanding that it is a form of amanah (trust) from the investor. Allah the Almighty has said to the effects;

“O ye who believe! Fulfil (all) obligations”. (Al-Maidah: 1) “O ye who believe! Betray not the trust of Allah and the Apostle, nor misappropriate knowingly things entrusted to you”. (Al-Anfal: 27) “And do not eat up property among yourselves for vanities, nor use it as bait for the judges, with intent that ye may eat up wrongfully and knowingly a little of (other) people’s property”. (Al-Baqarah: 188) “…Disdain not to reduce to writing (your contract) for a future period, whether it be small or big; it is just in the sight of Allah, more suitable as evidence, and more convenient to prevent doubts among yourselves.” (Al-Baqarah: 282)


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4.3 The Challenges and Recommendations

In order to make Islamic venture capital’s product stands in line with conventional venture capital and other banking products, there are still many challenges that the IVCMC need to overcome or take into consideration.

4.3.1 Awareness on Islamic Venture Capital

According to R1 from IVC A in an interview in 2018, there are some challenges faced by IVCMC. The biggest challenge is to educate and increase awareness among entrepreneurs about the existence and function of IVCMC in providing investment and financial services to them (Mikail, Arifin, & Hassan, 2013). In order to educate people especially entrepreneurs about IVCMC, it needs a lot of commitment and proper guidelines from authorized parties such as Securities Commission and Bank Negara Malaysia to spread the uniqueness of Islamic venture capital. R2 from IVC B in an interview in 2018 also stressed the point that Islamic venture capital does not have any specific or effective promotions apart from mouth to mouth conversation only. Most of the entrepreneurs may only obtain information about Islamic venture capital from fund managers, Tabung Haji, MAVCAP and Bank Muamalat Malaysia Berhad. In other word, most information about Islamic venture capital has not been spread wisely and effectively.

R1 and R2 emphasized that in order to face this challenge; it is very important and vital duty for the IVCMC to spread the information with some facts and figures to make their companies known to the public and entrepreneurs whether they are Muslims or non-Muslims. However, different approaches might be needed to convince the non-Muslim to accept Islamic venture capital as they might think that Islamic venture capital is just for Muslim entrepreneurs only. IVCMC must adopt an effective promotional strategy like advertising their financial services in mass media such as television, radio, newspaper as well as the internet. IVCMC should consider promoting their companies and services through the Islamic crowdfunding platform where the promotion strategies are very robust and reachable to all kind of potential start-up companies and investors. IVCMC should also cooperate with other Islamic financial institutions such local Islamic banks, foreign Islamic banks, any information centers, universities and other institutions in order to promote and spread the knowledge about


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Islamic venture capital. Moving forward, it is hoped that these promotional strategies will boost up the business of Islamic venture capital among the entrepreneurs in Malaysia especially the start-up companies and existing small medium enterprises.

4.3.2 Processes of Islamic Venture Capital

Based on the interview with R1 in 2018, the process in giving out financing from conventional venture capital company is faster compared to Islamic venture capital’s company. In terms of processing, it will take three to six months of period for the application to be approved. This process is obviously complicated and quite long for the entrepreneurs to wait for approval. There are a few processes to be taken for the fund managers before the venture capital can be materialized. The first process is where the manager from IVC A will do a site visit in their potential investee’s company in order to make sure that the company is in existence and its nature of business comply to Shariah requirements. After that, the manager will go through the investee’s legal documents. Checking on the legal documentations is very important because it is a process where the financial documents of the investee company will be checked. Most of the time, some entrepreneurs tend to take other type of financing because they cannot wait too long for their application to be approved by IVCMC. Other challenge faced by IVC A is the timeline and dateline for financing given to the investee company to mature which is from 3 to 5 years. It can also be considered as a threat to Islamic venture capital industry because the time given is too short and not enough for the investee company to pay back. The limited timeline and dateline for the investee to repay their financing amount, especially when the amount of financing is large and high, will minimize the entrepreneurs’ interest to take Islamic venture capital financing.

4.3.3 Regulatory Issues

According to R2 from IVC B in an interview in 2018, another major challenge for the company is the nature of their company being a bank backed company. IVC B is a subsidiary company to a full-fledged Islamic Bank and it needs to comply with the regulations established by its parent company. In other word, anything that the company wants to do, it needs to comply with its parent company and any applications of investment activities will have to get an approval


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from its parent bank. Being a subsidiary company, any losses or profit will affect its parent bank performances too. Thus, any external work which relates to Islamic venture capital financings needs to comply with bank’s law and regulations especially with regards to risk department’s rules and regulations.

4.3.4 Risk and Expected Rate of Return Issues

R2 from IVC B in an interview in 2018 also mentioned about the nature of Islamic venture capital business which is an equity-based financing and the cost of capital will be quite expensive. IVC B uses purely a musyarakah contract and it is a private equity company. Thus, there are no collateral items taken by IVC B from the investee company and this practice expose IVC B to the condition of higher credit risk. This is the reason why all IVCMCs must conduct a thorough evaluation before making an investment with any investee companies. IVCMCs also involve in the management of investee companies to check on their efforts and performances in running the business. Interference of fund managers in the management of investee companies is allowed under musyarakah contract. In the event of default payment, IVCMC will also look thoroughly into their investee company problems before doing any further actions. Other than that, there are many competitions with other banking products from small and medium entrepreneurs (SMEs) where the challenges and problems will also be in terms of the required rate of return or return of investment (ROI) by these companies, and at the same time they need to manage all of the risk too.

R1 from IVC A in an interview in 2018 also emphasized on the challenges of expected rate of return as for equity-based financing. For example, the expected rate of return for equity-based financing needs to be at 15% and for debt instruments; mostly the rate will follow the bank’s rate which is 5 – 6%. Because of that, IVCMC must try very hard to match their expected rate with the bank’s expected rate which is very much lower. It will become more challenging to them also as they must manage their own fund, investor’s fund and investee companies as compared to the banks.

As the market and market player are more familiar with the banking industry, plus the fact that typical Islamic financing transactions lead to the creation of indebtedness (for instance sale and purchase; sale and lease back) compared to Islamic venture capital which is based on profit and loss sharing of risks, emphasis has been


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given towards the banking industry (Hamzah, 2011). Until the market and market players are familiar with and are willing to venture into risk sharing, Islamic venture capital will only be applicable to certain target groups like start-up and the new growing companies where it is not easy for them to get financing from any banks.

4.3.5 Way Forward

R1 and R2 emphasized on the importance of the establishment of legal and regulatory framework or appropriate guidelines to regulate Islamic venture capital industry to enable the industry to gain momentum in a particular jurisdiction and lend certainty on issues arising out of mudarabah, musyarakah and wakalah contracts. The funding of Islamic venture capital should be increased by the Malaysian government or private sector to expand the growth so that Malaysia can emerge to be as one of the centers of excellence for Islamic venture capital (Dar, 2017). The Malaysian government also needs to support and back Islamic venture capital industry in terms of giving incentives, tax exemptions, and such, to enable the industry to make way into the mainstream economy. The creation of the appropriate business structures to make Islamic venture capital products better understood and accepted by market players is another important criterion in enabling the rapid growth in the industry. In other words, the market player in Islamic venture capital industry must try to innovate and develop new investment structures given the changing investment climate and economic circumstances without compromising Shariah requirements since they are experts in the Islamic venture capital business. The Malaysian government should try to support the Islamic venture capital industry by preparing a well-trained and high caliber individuals, advisors and management teams who have expertise in investment strategies and legal documentations and at the same time understand and appreciate Shariah requirements (Hamzah, 2011).

5.0 Conclusion

This paper elaborates the information and knowledge about Islamic venture capital. Most people especially the entrepreneurs with start-up companies or small medium enterprise do not know or aware about the existence of IVCMC and how it works in Malaysia. Promotional strategies and advertisement of the financial services provided by IVCMC is very crucial to make the entrepreneurs aware


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about the Islamic venture capital. IVCMC may help entrepreneurs to start-up or setting up their new or existing businesses but they must propose a strong proposal with clear objective of the business. However, Islamic venture capital is less popular in Malaysia as compared to other financing products and services offered by banks. By knowing the true nature and specialty of Islamic venture capital, the entrepreneurs may want to try to be financed in the future using this special kind of financing or facilities. Under the musyarakah contract, the fund managers will work together with the investee companies to ensure the success of their business and not just give financing and leave them alone to run their business as practiced by many banks in giving financing to customers. Despite all the challenges faced by the IVCMC, the Malaysian government and private sectors shall need to provide support to boost the growth of Islamic venture capital in Malaysia.

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