musharaka

(equity and venture capital financing)

This is a partnership or a joint venture where the financial institution and the investor provide financing for a specified project in agreed proportions. The parties share equally in the profit and loss of the project in proportion to their initial investment. The structure is permissible under Sharia since the partnership or the joint venture is based on the principles of sharing in, and benefiting from, risk.

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Islamic finance

+ musharaka

International, USA

An investment partnership or joint venture compliant with Sharia in which the financing party and its client (the borrower) contribute assets (cash or property) to a joint venture and share in the profits of the joint venture in agreed percentages (usually structured so that the financing party receives its initial investment plus a return (usually calculated by a reference to a benchmark such as LIBOR plus a margin)). Losses, however, are shared in accordance with the parties' initial investment. All musharaka parties have the right to exercise control over the joint venture but it is typically managed by the client/borrower. Musharaka is widely regarded as the purest form of Islamic financing because it is based on the principles of sharing in and benefiting from risk. There are three types:

• permanent musharaka. The financing party's interest remains unchanged and it is entitled to receive its share of the profits as long as the partnership or joint venture continues to exists. This formulation is used for an ongoing equity investment.

• diminishing musharaka. Sometimes used in residential mortgages, the financing party's interest in the partnership or joint venture is reduced over time as the borrower buys out the financing party's share.

• temporary musharaka. Used to provide working capital, the financing party is a partner for a specified period and receives its share of profits and the rest of its principal contribution at the end of the agreement.

Musharaka is similar to mudaraba except that in a mudaraba only the financing party bears the losses associated with the joint venture/partnership.