Equity finance (mudaraba)
eg. Profit sharing
A type of partnership in which one partner provides the capital (the provider of the finance) while the other provides expertise and management.
Each gets a prearranged percentage of the profits, but the partner providing the capital bears any losses.
Although provisions can be made where losses can be written off against future profits.
Mudaraba is a concept to provide capital to somebody undertaking the work.
It could be understood as being similar to the function of an employed manager of a company.
The provider of the finance is not involved in the executive decision-making process.
As the profits are shared with the manager and the capital provider but the losses are beared only by the capital provider this mode is also named profit sharing – loss bearing.
Before the manager gets his share, the losses, however, if any, needs to be recovered. A wage could be negotiated.
Debt finance (sukuk) eg. Bond issue
Sukuk is an Arabic term in plural (singular Sakk) meaning certificates.
It is the root of the English word for cheque.
Sukuk are securitised assets or business.
The company sells the certificate to the investor, who then rents it back to the company for a predetermined rental fee.
The company promises to buy back the bonds at a future date at par value.
Sukuks must be able to link the returns and cash flows of the financing to the assets purchased, or the returns generated from an asset purchased.
This is because trading in debt is prohibited under Sharia.
As such, financing must only be raised for identifiable assets.
Venture capital(musharaka) eg Joint venture
Musharaka is the Islamic contract for establishing a joint venture partnership.
In musharaka, two or more parties contribute capital to a business and participate with the related profits and losses.
The profit and the losses needs to be shared.
This method is recommended by Muslim economists as being the most fair and just method.
In a Musharaka contract all parties may take part in the management or some parties may not take part in the management (silent partnership).
Losses need to be born proportionately to the capital provided by each party (pro rata).
Regarding the profits there is a disagreement between the schools whether other than pro rata distribution is permissible.