This checklist describes the forms joint ventures can take in the Islamic world, including mudarabah and musharakah.
Joint ventures and partnerships in the Islamic world can take a variety of forms, as described below.
Mudarabah (Profit Sharing)
This is an arrangement whereby a capital provider (rabb-ul-maal) provides capital to an entrepreneur (mudarib), who uses the capital for a business activity. Any profits that accrue will be shared between the capital provider and the entrepreneur according to an agreed ratio, while losses are borne solely by the capital provider. This is because the mudarib is considered to have lost the time and hard work he or she has invested in the partnership. However, if the mudarib has not worked with due diligence and is guilty of negligence or dishonesty, he or she will be liable for the loss caused by his or her negligence or misconduct. The capital provider has no right to participate in the management of the business, which is carried out by the mudarib only. The liability of the rabb-ul-maal is limited to his or her investment, unless he or she has allowed the mudarib to incur debts on his or her behalf. In addition, any goods purchased by the mudarib are solely owned by the rabb-ul-maal, and the mudarib can earn his or her share of the profit only if he or she sells the goods at a profit.
There Are Two Types of Mudarabah
The rabb-ul-maal may specify a business in which to invest, in which case the mudarib is restricted to this business. This is called restricted mudarabah, or al-mudarabah al-muqayyadah.
If the rabb-ul-maal does not specify a particular business in which he or she wishes to invest, the mudarabah is considered unrestricted, or al-mudarabah al-mutalaqah.
The two parties agree on how the profits are to be distributed. The amount of profit given to either of the parties must be independent of the capital amount, and dependent solely on the actual profit generated by the commercial enterprise. It cannot be calculated as a percentage of the capital invested in the business, as that would be considered a fixed return, or interest. Neither can the profit be given as a lump sum, since this would constitute interest. Thus, the share of the profit that either party receives must be based upon the actual profit earned by the enterprise. Shariah does not restrict or specify proportions to be distributed between the parties, leaving it to the judgment of the two parties.
The mudarabah contract can be terminated by either of the parties at any time as long as notice, as specified in the contract, is given to the other party. However, there are some differences of opinion between Islamic scholars regarding other aspects of termination. Some believe that a maximum term of the mudarabah contract can be set, and the contract is terminated automatically thereafter. However, others believe that no term restriction can be added to the mudarabah contract.
Musharakah (Joint Venture)
This concept is normally applied to business partnerships or joint ventures, and is used instead of interest-bearing loans. The profits made are shared in an agreed ratio, while losses incurred are divided based on the equity participation ratio. The main difference between musharakah and mudarabah in terms of investment is that in musharakah it comes from all the partners, while in mudarabah, the investment is the sole responsibility of the rabb-ul-maal. In addition, and unlike mudarabah, in musharakah, all the partners can participate in the management of the business and can work for it. Furthermore, all the partners in musharakah share in the loss based on the ratio of their investment.
Partners in musharakah are also exposed to unlimited liability. Thus, if a business is liquidated and the liabilities exceed its assets, all the exceeding liabilities are borne (on a pro rata basis) by all the partners. The only exception is if the partners have agreed that no partner shall incur any debt during the course of business, and that any excess liabilities will be the responsibility of the partner who has incurred a debt on the business.
All the assets of the musharakah are jointly owned by all of the partners according to the proportion of their respective investment.
These partnerships are shariah-compliant. Musharakah, for example, allows the financier to achieve a return in the form of a portion of the actual profits earned, instead of charging interest as a creditor, which is banned by shariah.
The two different types of joint ventures should ensure that the individual needs of financiers and clients can be met.
The partnerships can be more cumbersome than some simplified arrangements available in non-Islamic countries.
Mudarabah tends to attract more risky projects and provides an incentive to the project manager to understate profits.
Companies seek to minimize the cost of funding and so may be reluctant to enter into musharakah financing. They may prefer a fixed-rate type product such as murabahah.
Explore all of the options available to ascertain which form of joint venture is best suited to your needs.
Carry out counterparty and credit checks as one would under a non-Islamic arrangement.
Dos and Don’ts
Take legal advice before entering into any arrangement.
Make sure you sign a legally binding contract before carrying out any transactions or activities.
Don’t forget that it takes time and effort to build the right relationship and that partnering with another business can prove challenging.
Don’t assume that the objectives of the venture are 100% clear and have been communicated to everyone involved.