ng to invest in a business is how they plan to exit from the business. All things being well, the chosen form of exit by the venture capital fund will be by way of an initial public offering (IPO) of the shares in the business to the general public. However, electing to have an IPO as an exit strategy in an Islamic venture capital investment financing structure is not permissible. Thus, an alternative mechanism needs to be considered.

On the flip-side, as previously mentioned, in a worst case scenario, if the business venture fails, the entrepreneur (mudarib) cannot lose more than the time and effort they have invested in the business. As such, in effect, the investor bears the brunt of the financial risk that the business will fail. Thus, traditional mechanism that would otherwise limit the venture capital fund’s losses, or would otherwise give the venture capital firm a preference over the other investors in the business in a bankruptcy scenario, such as with the use of a preference share structure, are prohibited under Islamic law.

The second core difference between a Western structure ven

The Islamic & Middle Eastern VC Market Despite the fact that there are literally millions of Muslim entrepreneurs in both developed and developing nations looking for investment capital for their new start-up ventures, the realm of the Islamic venture capitalist remains in an evolutionary state. Nonetheless, the untapped potential for Islamic venture capital remains huge. Moreover, the Islamic world has more than its fair share of investors with high-end net worth looking to invest in potentially lucrative deals. Thus, the convergence of both a ‘need’ and a ‘supply’ invariably lead to the creation of a new product, and this is equally so in the case of purely Islamic venture capital.

The core to any proposed Islamic financing transaction is that Shariah (Islamic law) prohibits interest-based lending. Moreover, Shariah further prohibits investments in certain activities which are seen as being in violation of Islam, such as gambling.

However, in essence, the mechanisms of venture capital do not provide for interest-bearing lending. Rather, at the core of any venture capital funding is an agreement to share in the risks of the business venture in return for the profits derived from such business venture.

As such, rather than being contrary to Islamic law, many scholars hold that venture capital funding complies with one of the cornerstone principles of Islam: it provides much needed investment to start-up companies in return for potential rewards, while accepting the risks that may be involved in such a deal. This type of structure in Islamic Finance is called mudaraba financing that is used over many centuries in the Islamic world.

Structuring an Islamic venture capital deal

The most accurate translation of a mudaraba financing is a contract under which one person, the investor (known as the rabal-maal), brings financing and the other person, the entrepreneur (known as the mudarib), brings expertise and effort. Collectively they share the proportionate profit as per their pre-arranged agreement.

Fundamental to the mudaraba financing structure, however, is the fact that the entrepreneur cannot be placed at risk of losing any monetary investment/value. If the business venture were to fail, then the maximum the entrepreneur could lose is the investment they make in the business enterprise themselves (i.e., their own money); plus any time and effort they put into the venture. The reason why this is the case is because under Islam, you cannot loose what you do not contribute.

In addition, under a mudaraba financing structure, strictly speaking, the investor is not allowed to partake in the management affairs of the business venture in which they have invested, they’re simply an investor – period. Day-to-day and overall management of the business must be left to the entrepreneur.

Differences between Islamic and Western VC funding

While the mudaraba Islamic financing structure does provide for a form of venture capitalism, it also raises certain issues that Western venture capital funds may find un-easing.

One core difference between venture capital investments that comply with Shariah law and those more commonly seen in the West is the allocation of loss risk.

Traditionally, venture capital funds invest in high-risk businesses in which there is an above average chance that the business will not be a viable enterprise, but where the profit upside is huge. In most cases, this has concentrated around the area of technology companies, but today it could equally apply to other industry sectors; such as media and medicine. A recurring theme, however, is “high risk”. For example, each of Yahoo!, Google, Apple, YouTube and MySpace have, at some time or other, received venture capital funding. And for each of these successes, there have been a hundred failures!

Given that venture capital funds historically invest in high risk industry sector businesses, over time, venture capital firms have put in place a structure that allows them to exit from the investment: (a) with maximum profits; and (b) with minimum losses. As we shall see, under Islamic Shariah law, both of these create a problem. One of the first discussions that takes place for any venture capital fund looking to invest in a business is how they plan to exit from the business. All things being well, the chosen form of exit by the venture capital fund will be by way of an initial public offering (IPO) of the shares in the business to the general public. However, electing to have an IPO as an exit strategy in an Islamic venture capital investment financing structure is not permissible. Thus, an alternative mechanism needs to be considered.

On the flip-side, as previously mentioned, in a worst case scenario, if the business venture fails, the entrepreneur (mudarib) cannot lose more than the time and effort they have invested in the business. As such, in effect, the investor bears the brunt of the financial risk that the business will fail. Thus, traditional mechanism that would otherwise limit the venture capital fund’s losses, or would otherwise give the venture capital firm a preference over the other investors in the business in a bankruptcy scenario, such as with the use of a preference share structure, are prohibited under Islamic law.

The second core difference between a Western structure vent

re in the risks of the business venture in return for the profits derived from such business venture.

As such, rather than being contrary to Islamic law, many scholars hold that venture capital funding complies with one of the cornerstone principles of Islam: it provides much needed investment to start-up companies in return for potential rewards, while accepting the risks that may be involved in such a deal. This type of structure in Islamic Finance is called mudaraba financing that is used over many centuries in the Islamic world.

Structuring an Islamic venture capital deal

The most accurate translation of a mudaraba financing is a contract under which one person, the investor (known as the rabal-maal), brings financing and the other person, the entrepreneur (known as the mudarib), brings expertise and effort. Collectively they share the proportionate profit as per their pre-arranged agreement.

Fundamental to the mudaraba financing structure, however, is the fact that the entrepreneur cannot be placed at risk of losing any monetary investment/value. If the business venture were to fail, then the maximum the entrepreneur could lose is the investment they make in the business enterprise themselves (i.e., their own money); plus any time and effort they put into the venture. The reason why this is the case is because under Islam, you cannot loose what you do not contribute.

In addition, under a mudaraba financing structure, strictly speaking, the investor is not allowed to partake in the management affairs of the business venture in which they have invested, they’re simply an investor – period. Day-to-day and overall management of the business must be left to the entrepreneur.

Differences between Islamic and Western VC funding

While the mudaraba Islamic financing structure does provide for a form of venture capitalism, it also raises certain issues that Western venture capital funds may find un-easing.

One core difference between venture capital investments that comply with Shariah law and those more commonly seen in the West is the allocation of loss risk.

Traditionally, venture capital funds invest in high-risk businesses in which there is an above average chance that the business will not be a viable enterprise, but where the profit upside is huge. In most cases, this has concentrated around the area of technology companies, but today it could equally apply to other industry sectors; such as media and medicine. A recurring theme, however, is “high risk”. For example, each of Yahoo!, Google, Apple, YouTube and MySpace have, at some time or other, received venture capital funding. And for each of these successes, there have been a hundred failures!

Given that venture capital funds historically invest in high risk industry sector businesses, over time, venture capital firms have put in place a structure that allows them to exit from the investment: (a) with maximum profits; and (b) with minimum losses. As we shall see, under Islamic Shariah law, both of these create a problem. One of the first discussions that takes place for any venture capital fund looking to invest in a business is how they plan to exit from the business. All things being well, the chosen form of exit by the venture capital fund will be by way of an initial public offering (IPO) of the shares in the business to the general public. However, electing to have an IPO as an exit strategy in an Islamic venture capital investment financing structure is not permissible. Thus, an alternative mechanism needs to be considered.

On the flip-side, as previously mentioned, in a worst case scenario, if the business venture fails, the entrepreneur (mudarib) cannot lose more than the time and effort they have invested in the business. As such, in effect, the investor bears the brunt of the financial risk that the business will fail. Thus, traditional mechanism that would otherwise limit the venture capital fund’s losses, or would otherwise give the venture capital firm a preference over the other investors in the business in a bankruptcy scenario, such as with the use of a preference share structure, are prohibited under Islamic law.

The second core difference between a Western structure ven

ing structure, however, is the fact that the entrepreneur cannot be placed at risk of losing any monetary investment/value. If the business venture were to fail, then the maximum the entrepreneur could lose is the investment they make in the business enterprise themselves (i.e., their own money); plus any time and effort they put into the venture. The reason why this is the case is because under Islam, you cannot loose what you do not contribute.

In addition, under a mudaraba financing structure, strictly speaking, the investor is not allowed to partake in the management affairs of the business venture in which they have invested, they’re simply an investor – period. Day-to-day and overall management of the business must be left to the entrepreneur.

Differences between Islamic and Western VC funding

While the mudaraba Islamic financing structure does provide for a form of venture capitalism, it also raises certain issues that Western venture capital funds may find un-easing.

One core difference between venture capital investments that comply with Shariah law and those more commonly seen in the West is the allocation of loss risk.

Traditionally, venture capital funds invest in high-risk businesses in which there is an above average chance that the business will not be a viable enterprise, but where the profit upside is huge. In most cases, this has concentrated around the area of technology companies, but today it could equally apply to other industry sectors; such as media and medicine. A recurring theme, however, is “high risk”. For example, each of Yahoo!, Google, Apple, YouTube and MySpace have, at some time or other, received venture capital funding. And for each of these successes, there have been a hundred failures!

Given that venture capital funds historically invest in high risk industry sector businesses, over time, venture capital firms have put in place a structure that allows them to exit from the investment: (a) with maximum profits; and (b) with minimum losses. As we shall see, under Islamic Shariah law, both of these create a problem. One of the first discussions that takes place for any venture capital fund looking to invest in a business is how they plan to exit from the business. All things being well, the chosen form of exit by the venture capital fund will be by way of an initial public offering (IPO) of the shares in the business to the general public. However, electing to have an IPO as an exit strategy in an Islamic venture capital investment financing structure is not permissible. Thus, an alternative mechanism needs to be considered.

On the flip-side, as previously mentioned, in a worst case scenario, if the business venture fails, the entrepreneur (mudarib) cannot lose more than the time and effort they have invested in the business. As such, in effect, the investor bears the brunt of the financial risk that the business will fail. Thus, traditional mechanism that would otherwise limit the venture capital fund’s losses, or would otherwise give the venture capital firm a preference over the other investors in the business in a bankruptcy scenario, such as with the use of a preference share structure, are prohibited under Islamic law.

The second core difference between a Western structure ven

at comply with Shariah law and those more commonly seen in the West is the allocation of loss risk.

Traditionally, venture capital funds invest in high-risk businesses in which there is an above average chance that the business will not be a viable enterprise, but where the profit upside is huge. In most cases, this has concentrated around the area of technology companies, but today it could equally apply to other industry sectors; such as media and medicine. A recurring theme, however, is “high risk”. For example, each of Yahoo!, Google, Apple, YouTube and MySpace have, at some time or other, received venture capital funding. And for each of these successes, there have been a hundred failures!

Given that venture capital funds historically invest in high risk industry sector businesses, over time, venture capital firms have put in place a structure that allows them to exit from the investment: (a) with maximum profits; and (b) with minimum losses. As we shall see, under Islamic Shariah law, both of these create a problem. One of the first discussions that takes place for any venture capital fund looking to invest in a business is how they plan to exit from the business. All things being well, the chosen form of exit by the venture capital fund will be by way of an initial public offering (IPO) of the shares in the business to the general public. However, electing to have an IPO as an exit strategy in an Islamic venture capital investment financing structure is not permissible. Thus, an alternative mechanism needs to be considered.

On the flip-side, as previously mentioned, in a worst case scenario, if the business venture fails, the entrepreneur (mudarib) cannot lose more than the time and effort they have invested in the business. As such, in effect, the investor bears the brunt of the financial risk that the business will fail. Thus, traditional mechanism that would otherwise limit the venture capital fund’s losses, or would otherwise give the venture capital firm a preference over the other investors in the business in a bankruptcy scenario, such as with the use of a preference share structure, are prohibited under Islamic law.

The second core difference between a Western structure ven

ng to invest in a business is how they plan to exit from the business. All things being well, the chosen form of exit by the venture capital fund will be by way of an initial public offering (IPO) of the shares in the business to the general public. However, electing to have an IPO as an exit strategy in an Islamic venture capital investment financing structure is not permissible. Thus, an alternative mechanism needs to be considered.

On the flip-side, as previously mentioned, in a worst case scenario, if the business venture fails, the entrepreneur (mudarib) cannot lose more than the time and effort they have invested in the business. As such, in effect, the investor bears the brunt of the financial risk that the business will fail. Thus, traditional mechanism that would otherwise limit the venture capital fund’s losses, or would otherwise give the venture capital firm a preference over the other investors in the business in a bankruptcy scenario, such as with the use of a preference share structure, are prohibited under Islamic law.

The second core difference between a Western structure venture capital financing deal and an Islamic venture capital financing deal relates to the management of the business itself. In nearly all cases of venture capital investments in the West, the venture capital fund will bring in a team that either manages the business directly (“hands-on”) or carefully monitors the direction in which the business is being taken. Indeed, so important is this aspect of venture capitalism in the West that most advisers will tell entrepreneurs that if a venture capital fund is or not willing to undertake this role, and bring onboard the experience they have gained, then they should not select that venture capital fund as part of the deal. Given the limitations of mudaraba, a lot of scholars regard this as prohibited!