Concept of Islamic Focused Venture Capital or Sharia Compliant Funds

What does it mean?

Globally Muslims represent 24.1% of the world population amounting to 1.8 billion people. Based on a research by Thomson Reuters, the global spend of Muslims reached an estimated USD 2.1 Trillion in 2017. In 2016, countries with a Muslim majority had an average population growth rate of 1.8% per year (when weighted by percentage Muslim and population size) as to compared with the world population growth rate of 1.1% per year.

There is without a doubt significant growth for the Islamic Economy with major countries such as Malaysia and UAE taking the lead. According to Thomson Reuters, there is a mere USD 745 Million in disclosed PE investments in the last 3 years, far lower than almost USD 595 Billion in PE and VC investment that occurred globally.

Interest in this sector increased tremendously the last few years with the Saudi sovereign wealth fund, the Public Investment Fund (PIF) committing USD 45 Billion into Soft Bank’s USD 100 Billion Vision Fund. Regardless, Malaysia was always at the forefront when it comes to Islamic Economy focused funds with the introduction of the Global Islamic Economy Fund by Malaysia Venture Capital Berhad (MAVCAP) together with Elixir Capital raising a total USD 100 mil back in 2016. Since then several funds were launched targeting this sector including the Taqwatech fund.

This is a great development as most venture capital has been part of the conventional finance ecosystem and has always been of limited significance in Muslim countries partly because most key businesses have always been concentrated on large holding structures owned and operated by the state or families. Up to only recently, few small businesses or start-ups took up the challenge to disrupt the market but due to limited operating history, that traditional funding becomes relatively hard to obtain. Within the Islamic context, banks are not willing to take the high risk and are opting for less risky financing models such as Ijara and Murabaha, both of which are a form of profit sharing debt model as well as a form of leasing respectively.

The rapid industry disruption in the US with the introduction of innovative, non-conventional solutions to daily problems has placed immense pressure on Islamic countries to demand similar innovations to be introduced into their countries as well. This is backed by tech-savvy consumers who are in their prime years and wanting similar business ideas introduced in their own countries as well, but adapt them to local needs, requirements and differences. To serve those gaps in funding, it led to the introduction of Islamic Focus funds by VCs, providing funding solutions to entrepreneurs which are taking the challenge to disrupt the market with innovative solutions.

This raises the question, how Islamic VCs or funds differ from conventional VCs and how a conventional VC can introduce or transform into an Islamic Focused VC.

The clear difference is that Islamic VCs primarily must follow financing rules that are Syariah compliant. Islamic VCs are not allowed and should not invest in funds or businesses that are deemed haram or that conduct business activities non-permissible in Islam. This includes gambling, alcohol, tobacco, or any activities that are not permissible by Islamic beliefs. As a simple example, both the VCs and invested companies should be careful not to spend on alcohol, be it for entertainment expenses or the consumption by the company. The invested companies must also not have any conventional debt on its books and any traditional debt that is based on the concept of interest or riba.

On the investment model, we can divide a model LPs use to invest in GPs as well as a model used to invest in startups or companies. In both cases, the models need to follow strict Shariah ruling.

The most popular model for Islamic VCs in raising capital is the wakala. Based on the concept of wakala, the investors or LPs permit the asset manager or GP to act on behalf of the investors or LPs, based on agreed terms and conditions and both parties share the profit and the risk of loss.

When investing into start-ups, the most common form of model is the Mudaraba. Under the Mudaraba contract, the investors or the VCs in this case will provide the financing, whereas the entrepreneur will run the business and will be responsible for the daily management and day to day operation. Both parties will agree upfront on the profit ratio resulting from the venture.

One other important criteria of an Islamic VC is the appointment of a Shariah advisor whose responsibility is to ensure that the investment contract as well as model used for investment is in strict compliance with the Shariah law at all times. The Shariah advisor is also expected to endorse any investment decision and to ensure that the activities of the investee companies remain Shariah-compliant right to the point of full divestment.

The Opportunity

With the world’s Muslim population expected to represent a quarter of the world’s population, and the huge opportunity of developing nations of which many are Muslim majority countries, it is expected that both investments into innovative start-ups in the Islamic Economy as well as VCs and funds dedicated to the growth of this sector will continue to rise.

To put it in perspective, 2 sectors that are currently driving this growth is the Islamic banking as well as the halal food industry with total assets of USD 2.4 trillion and a total sped of USD 1.3 trillion. To complete the focus on Islamic lifestyle products, the next trend of the Islamic Economy is expected to hit the Muslim friendly travel space with an estimated yearly spending volume of USD 177 billion.

Who will be the winner? Only time will tell. But one thing for certain, early adopters and pioneers in this space will see big wins in the near future.

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*Faeez is the co-founder of Tripfez and Salam Standard, travel platform dedicated to the rise of Muslim travelers. Faeez was named 30 under 30 by Forbes magazine in 2016, 40 Under 40 by Prestige, Top 10 Young Entrepeneur Rising by Top 10, People To Watch 2016 by TTG as well as the Most Innovative Young Leaders Award 2016 by UCSI.