If the Islamic private equity industry has failed to live up to its expectations then Islamic venture capital has followed the same path with even less spectacular results. Indeed discussion of Islamic venture capital is largely theoretical because real life examples are few and far between. The government of Malaysia has done more than any other body to promote and define the industry and indeed has launched a fund, albeit a small $10m fund, to help show the way
The private sector has a few examples of Islamic venture capital at work but the reality is that often these are misnamed Islamic private equity efforts, and yet venture capital and Islamic finance are tailor-made for each other.
Rather like its cousin private equity, venture capital is a mode of investing that seems
perfect for Islamic finance through the application of various Islamic financing concepts,
with the Mudarabah concept being the most common.
Venture capital here is defined as the provision of seed capital for a new venture in the process of being established, rather than the provision of capital to a small business to facilitate its growth.
As with its conventional counterpart, Islamic venture capital appeals most to investors
who understand a sector or an industry intimately and are prepared to risk a portion of their capital on the strength of a business plan, the management team of the proposed business, and their own ability to pick a winner.
Other similarities between Islamic venture capital and conventional venture capital include the fact that deal sizes are small when compared to private equity transactions, since the startup capital that is required for a burgeoning small businesses tends not to include monies for grandiose marketing and advertising plans but tends to be much more conservative in its outlook.
Some basic principles explained:
The principle of Mudarabah in venture investing
Mudarabah financing involves a contract under which the investor, or rabal-maal, brings financing to the table and the entrepreneur, the mudarib, brings expertise, effort, and in the case of Islamic venture capital, a business plan.
Collectively the parties share the proportionate profit from the results of the enterprise as per their pre-arranged agreement. The entrepreneur cannot be placed at risk of losing money since he has contributed only expertise. If the business venture fails, then the most the entrepreneur could lose is the investment he has already made in the business and the time and effort he had put into the venture.
In other words no one can come after the entrepreneur for cash compensation. In a similar way, no one should expect the venture investor to have any say in the management of the company or any responsibility for it, since his part of the deal is to providing financing only.
The principle of Musharakah in venture investing
In the context of Islamic venture capital Musharakah financing is a partnership formed
between parties to finance a business venture where the parties contribute capital either in the form of cash or in kind. Profits are distributed based on a pre-agreed ratio. Losses are shared on the basis of capital contribution to the venture.
The principle of Wakalah in venture investing
In Wakalah financing a contract from one party gives the power and rights to another party to act on his behalf, based on the agreed terms and conditions.
Venture capital in the context of Islamic finance
The sector of Islamic venture capital had been largely ignored in theGCC until recently because of the lack of an 'entrepreneur class' which is essential for the development of a healthy venture capital environment: young, bright people with great business ideas and a determination to make a success of 'their' business. As the world becomes more of a global marketplace, and as the education and skills level of young people in the region increases, then venture investing along Shariah-compliant lines may become more common.
This is not to say that the greater Middle East and North Africa region has been bereft of venture capital. Countries such as Egypt, Lebanon and even Turkey have long had an entrepreneur class of their own and the VC industry is consequently more developed in these countries. In much of the GCC there have been impediments to foreigners owning their own businesses outright and this naturally led to an absence of such businesses in the marketplace.
As countries like the UAE have introduced 'free zones' such as Dubai Internet City, Dubai Media City, Dubai International Financial Centre, Jebel Ali Free Zone, and so on where foreign nationals and corporates can own 100 % of their own business then the market for venture capital has opened up. Naturally the business idea that will attract Islamic venture capital has to operate within the constraints of Shariah and must not dabble in haram areas.
But having a young entrepreneur class is only half of the equation. The other half of the equation is having venture investors with the risk appetite to back the business plans presented to them with hard cash. This is not simply a matter of having the money, it is also about having the tools to analyse the business plan, structuring a deal, and ensuring that the short, medium, and long term investment interests of both the entrepreneur and the investor are the same. This requires a level of education and expertise that had been lacking until relatively recently but has arrived in the region on the back of the tidal wave of oil revenues and increasing globalisation.
The combined effect of this has been that the Islamic venture capital industry was virtually non-existent, except for a few cases where Angel investors in the guise of ultra wealthy merchant families have funded new start-up businesses with their own cash, after ensuring that the business had no likelihood of straying into haram areas of business practice.
The arrival of financial centres such as Dubai International Financial Centre, Malaysia International Islamic Financial Centre, Qatar Financial Centre, and Bahrain Financial Harbour has opened up the possibility that expert venture capital talent from more mature financial markets could be transplanted into rapidly emerging Islamic finance markets and bring with it the intellectual wherewithal to do lucrative Islamic venture capital deals.
