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. Investment banks, private equity boutiques and law firms around the world are all dealing in Islamic Finance, so why not your small business? Islamic Finance is merely a creative funding structure that can assist your business even without banking support.
The Financing Concept
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.
Structuring the Fund
The Fund is created through an open “investment” arrangement where time deposit accounts are accepted by the Fund with the explicit understand that the monies will be invested into projects on a profit and loss sharing basis. These Funds bear neither guarantee of capital nor of profit. It is a sharing of risks between profit and loss.
There are three partners under a Mudaraba structure: (1) Investors; (2) Fund; and (3) Business Entity. The investor is a pure financier who plays no other part in the joint venture. The Business Entity is a pure entrepreneur charged with managing and directing the business without investing any monies. The investment intermediary is the Fund that is charged with multiplying the monies of the investors and financing the Business Entity .
Lack of Interest, Lower Debt Risk
Developing a business structure without the weight of lender interest rates optimizes business profits and minimizes the risk of businesses going under or declaring bankruptcy based upon the inability to pay creditors.
This untapped lending structure for businesses is a low-risk financing structure that is cutting edge for companies in the U.S. and in emerging markets. It exists outside the credit crunch, focusing on the development of trust between the Investors and the Fund, and the Business Entity and the Fund Much like its counterpart in private equity financing, Islamic Finance may prove useful as an alternative to traditional lending and borrowing.
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