Ibrahim Khan is the co-founder of Islamicfinanceguru.com. He holds a BA in Philosophy, Politics, and Economics from the University of Oxford, an ijazah in the memorisation of the Qur’an from Egypt, and an MA in Islamic Banking and Finance from Markfield Institute. He also graduated from the Alimiyyah programme (traditional Islamic scholar) under the tutelage of Shaykh Akram Nadwi. He previously worked as a funds lawyer in London at Debevoise & Plimpton LLP and, before that, Ashurst LLP.
Venture capital is a mode of investing used to fund high risk business ventures that drive innovation. These ventures create whole new industries, increase productivity and create better services for everyone.
Good past examples of such ventures are companies like Google and Facebook who we completely depend on in our daily lives today but may not have imagined existing just a few decades before. These companies would not be around today if it were not for their early investors who were willing to take the investment risk and believe in these startups.
In this article we introduce what startup investing is, and how it fits into Islamic finance.
Startup investing is also among the riskiest investment classes. It is true though that the majority of startups will and do fail. But for some investors these early bets paid off and they have been rewarded multifold.
Andy Bechtolsheim, an early investor in Google, turned his $100k investment into $1.7 Billion at the time of Google’s IPO – a 17,000x return. This may be seen as an anomaly but even if you look at the average startup return in the United States, it still sits at 27% – a worthy return in anybody’s book.
The key with startup investing is to play the law of averages and build up a diversified portfolio of multiple startups. That way you give yourself the maximum chance of picking “the one” startup which goes on to make you the massive returns.
Today we see innovation all around us, and plenty of venture capitalists willing to invest in promising startups. Today’s examples could include self-driving cars or space exploration. Ventures that could define our future and push the boundaries of what we thought was possible.
How this fits in with Islamic Finance
The essence of Islamic finance is that money should constantly be invested and working in the real economy to generate benefits for mankind. Money is not a commodity to be traded for profits. Rather profits are meant to be earned by active involvement and participation in the business risks.
Venture capital most clearly encapsulates this mandate. An entrepreneur with the skillset and drive to start a novel business venture is financed by an investor who believes in the entrepreneur’s vision and they share the risk – the investor putting his hard earned capital at risk, and the entrepreneur his time, effort and opportunity cost of pursuing a different career.
The conventional VC model fits the Islamic ‘Mudarabah’ model where the investor (rab-ul-maal) is the one who solely provides the capital and entrepreneur (mudarib) solely manages the project. Profits are shared on a pre-agreed percentage while losses are borne solely by the investor while the entrepreneur loses his time and effort. The key to a mudarabah structure is the fact that the entrepreneur cannot be placed at risk to bear losses, unless proven negligent.
Startup investing therefore not only fits within Sharia guidelines, it is in fact highly encouraged by it. It should then go without saying that we should see more Muslims become startup investors and startup founders.
In particular, Muslims are around 20% poorer than the rest of the world and we need to change this. The venture capital world offers the kind of game-changing wealth that can help bridge that economic inequality. In light of that, we as a Muslim community should be particularly focused on the potential of this sector.
There are a few fiqhi wrinkles of course. Legal concepts like preference shares, SAFE, KISS or Advance Shareholders Agreements, ratchets have a number of shari’ pitfalls. These need to be navigated carefully by Islamic investors, ideally with some expert legal assistance
To help encourage movement within this space, at Islamic Finance Guru we run an angel syndicate called IFG.VC which gives accredited Muslim investors the chance to invest in Sharia-compliant startups. We invest ourselves every month in startup and share the deal with others in our syndicate. We also handle the legal review and negotiation ourselves.