AlMajna encourages investors and entrepreneurs to formulate the contracts between them using the instruments derived from the Islamic financial industry. These instruments are characterized by their flexibility and the diversity of their forms, which makes them suit various needs and achieve the interests of the different contracting parties in a balanced way. This has made them nowadays show great success and spread widely in many region of the world.
Following is a brief explanation of the most important of these transactions.
These transactions can be categorized into two forms:
Profit-and-loss-based transactions:
1. Musharaka
Through Musharaka, the entrepreneur contributes a portion of the capital and the investor contributes the remaining portion. Each of them will be entitled to a share of the equity, and the profit shall be distributed between them as per their initial agreement, while the loss shall be distributed according to each party’s share of the capital. The parties shall have a binding Musharaka contract entitled Shareholder agreement that is the basis on which an official company shall be established. The terms of this contract shall be formulated according to what they agree upon, while complying with the specificities of Islamic finance, such as no guarantee of capital for any of the shareholders, and no priority in profit for any of them. The contract shall determine the rights of management, administration, control and accountability.
Example of this transaction in an existing project:
If we assume a fabric factory owner, for example, wants to expand a production line. The invested capital of his factory, which consists of the land, building, machinery and goods, is valued at 2 million pounds, while the investment capital required for the new production line expansion is one million pounds. Thus, the parties can enter into a Musharaka contract, in which the owner of the factory and the investor own two-thirds and one third of the equity respectively, and the terms of the contract are determined by their mutual agreement.
The same transaction is also applicable for new start-ups. For instance, if he had a plan for establishing a factory but he only possessed a fraction of the required capital investment, he could enter in a Musharaka contract with an investor who contributes the remaining capital. Obviously, the above transaction is appropriate if the entrepreneur is willing to contribute a portion of the capital with the investor.
Similarly, the same transaction also applies to an entrepreneur who contributes solely with a business plan. He receives the agreed upon fund from the investor on the condition that he give up part of it to the investor after establishing the company. This part will represent the investor's share in the company. They agree on it in light of the profitability projections presented by the entrepreneur in the business plan.
This latter scheme is an established method for financing entrepreneurial plans and start-ups because it does not require the business plan owner to contribute financially, but only with his business plan.
2. Mudaraba
Sometimes, there is a project that needs someone to manage it in return of a share of the profit, or a capital that is seeking for a profitable project to invest in but without a desire to give up part of the equity. This transaction is Mudaraba. In Mudarba, the investor shall fully own the capital and equity, while the entrepreneur, whether a natural or a legal person, shall invest for him in lieu of a percentage of the profit. Both parties shall share the profit according to their prior profit sharing agreement. In case of loss, financial losses will be fully incurred by the investor alone, while the entrepreneur will lose the effort and time that he had contributed. This transaction is regulated by the Mudaraba contract, through which the investor audits the entrepreneur and has the authority to direct and restrict the investment.
Most of the applications of Mudaraba are in traditional projects that are not based on an innovative startup, especiall in small projects in agriculture and trade.
Debt-based transactions
The relationship between the entrepreneur and the investor in these transactions is a relationship between a creditor and a debtor. They include:
1. Murabaha
An entrepreneur may need equipment or machinery that he cannot purchase in cash. An investor agrees to purchase this equipment from the market in cash and then sell it to the entrepreneur in installments over a previously agreed-upon period, in lieu of a previously agreed-upon increase in the price. Thus, the investor has profited from the price difference, while the entrepreneur has benefited from the convenience of deferred payment in installments. The price of the equipment becomes a debt that the enterprise owner must pay to the investor when due, regardless of the project’s performance, as the investor is not associated in any with the enterprise or the equipment. Both parties enter into a contract governing all rights, duties and guarantees relating to this transaction, including the regulation of the transfer of ownership, the transfer of security, the regulation of payments and arrears, guarantees of mortgages or otherwise, etc.
2. Ijara
This transaction enables an enterprise owner to lease a desired asset from an investor, regardless of whether the asset was appreciable, such as land, or depreciable, such as equipment. Accordingly, the investor agrees to buy the desired asset and lease it to the enterprise owner for a certain period, which is usually a prolonged period. Thus, the investor profits from the rent, while the enterprise owner benefits from asset acquisition without incurring a large cost at once. After the lease expires, the asset remains owned by the investor, who can lease it again or sell it. The well-known financial leasing is a form of Ijara, with differences in some conditions and rules.
Another case of ijara is known as ijara leading to ownership. In this transaction, both parties agree that the ownership of the leased asset to be transferred to the enterprise owner after the lease ends. Given that this scheme combines leasing and selling transactions, the total rent is greater and some terms and conditions differ compared to the transaction solely based on leasing.
3. As-salam
The enterprise owner may be a farmer, while the investor trades in agricultural crops. This transaction can be fulfilled if the investor pays the enterprise owner the price for one or more crops in advance, in lieu of purchasing the crops at a price lower than the current market price. Accordingly, the farmer shall be committed to delivering the crops to the investor upon specifications and quantities at pre-set dates. The crops hence become a liability on the farmer.
In another realization of this scheme, the enterprise owner may be an importer of certain goods, and the investor wishes to buy the goods to profit from reselling them. Thus, the investor pays the price in advance to the enterprise owner, who becomes committed to providing the goods with the prespecified attributes at pre-set dates. Consequently, the enterprise owner profits from receiving the price in advance to cover the costs of travel, shipment, and customs, while the investor profits from purchasing the goods at a price less than the current market price.
In a nutshell, Salam has several applications, where the common characteristic in all of them is a price paid in advance by the investor, for which the enterprise owner becomes indebted for, which is repaid in goods according to their prespecified attributes.
4. Istisna'a
It is a transaction in which the investor requests from the enterprise owner to make or build something for him based on prespecified attributes or design so that he can sell it afterwards, such as a specific machine, furniture, or building. Thus, the investor profits from the price difference, while the enterprise owner earns from his professional effort. Accordingly, the parties enter into a binding contract stipulating the description, price, delivery date and other conditions.
AlMajna offers the services of drafting contracts and legal advice, through which we facilitate agreement negotiations between the concerned parties, draft the contract according to professional legal standards, and coordinate contract procedures, including payment and signature, in addition to other procedures as needs arise.
