Debt Or Equity For Funding Business
Debt or Equity in Islam?Non-interest debt financing and equity financing have both been permitted in Islam. It is no surprise that there is no explicit or implicit text giving one form of financing preference over the other. Financing is part of business activity which is highly contextual and variable depending where the business is in its lifecycle. Whilst equity financing might be the only reasonable method for a start-up, an established business would generally seek debt-based financing.
It is from the beauty and comprehensive nature of Islam that no such stipulation to adopt a particular form of financing is found. If we were bound to get one type of financing only, it would put businesses into difficulty. Shariah has given us some principles with which we need to adhere to. Debt is discouraged when there is no strategy to service it. Likewise, taking on debt when it is unmanageable and beyond one's capacity to repay is also discouraged. Beyond that, it is an economic and business decision which the business can make considering what is in its best interest.Business ConsiderationsDebt vs Equity Financing – which is best for your business and why? The simple answer is that it depends. The equity versus debt decision relies on a large number of factors such as the current economic climate, the business’ existing capital structure, and the business’ life cycle stage. Some of the key factors to consider are[1]:
- The cost of finance: Debt finance is usually cheaper than equity finance. This is because debt finance is safer from a lender’s point of view. From a conventional perspective, interest has to be paid before dividend. From a Shariah perspective, debt and profit in Shariah compliant debt-based products is paid off first. In the event of liquidation, debt finance is paid off before equity. This makes debt a safer investment than equity and hence debt investors demand a lower rate of return than equity investors. Interest debt is also corporation tax deductible (unlike equity dividends) making it even cheaper to a taxpaying company. Arrangement costs are usually lower on debt finance than equity finance and once again, unlike equity arrangement costs, they are also tax deductible.
- The current capital gearing of the business: Although debt is attractive due to its cheap cost, its disadvantage is that an additional return has to be paid. If too much is borrowed, then the company may not be able to meet interest and principal payments and liquidation may follow. The level of a company’s borrowings is usually measured by the capital gearing ratio (the ratio of debt finance to equity finance) and companies must ensure this does not become too high. Comparisons with other companies in the industry or with the company’s recent history are useful here.
- Security available: Many lenders will require assets to be pledged as security against loans. Good quality assets such as land and buildings provide security for borrowing - intangible assets such as capitalised research and development expenditure usually do not. In the absence of good asset security, further borrowing may not be an option.It is also possible to offer unsecured financing. Unsecured financing is Shariah compliant as long as the other principles of financing are met. To mitigate the credit risk in unsecured financing, a director can give a personal guarantee.
- Business risk: Business risk refers to the volatility of operating profit. Companies with highly volatile operating profit should avoid high levels of borrowing as they may find themselves in a position where operating profit falls and they cannot meet the interest bill. High-risk ventures are normally financed by equity finance, as there is no legal obligation to pay equity dividend.
- Operating gearing: Operating gearing refers to the proportion of a company’s operating costs that are fixed as opposed to variable. The higher the proportion of fixed costs, the higher the operating gearing. Companies with high operating gearing tend to have volatile operating profits. This is because fixed costs remain the same, no matter the volume of sales. Thus, if sales increase, operating profit increases by a larger percentage. But if sales volume falls, operating profit falls by a larger percentage. Generally, it is a high-risk policy to combine high financial gearing with high operating gearing. High operating gearing is common in many service industries where many operating costs are fixed.
- Dilution of earnings per share (EPS): Large issues of equity could lead to the dilution of EPS if profits from new investments are not immediate. This may upset shareholders and lead to falling share prices.
- Voting control: A large issue of shares to new investors could alter the voting control of a business. If the founding owners hold over 50% of the equity, they may be reluctant to sell new shares to outside investors as their voting control at the AGM may be lost. This would make equity financing disliked for the current shareholders and debt would be preferred.
- The current state of equity markets: In a period of falling share prices many companies will be reluctant to sell new shares. They feel the price received will be too low. This will dilute the wealth of the existing owners. Note this does not apply to rights issues where shares are sold to the existing owners of the company.
ConclusionThese are some of the many considerations which businesses need to consider before raising equity or debt financing. This shows that the decision of debt and equity is not something set in stone from a Shariah perspective; as long as the debt-financing and equity financing are Shariah compliant, the business is at liberty to choose what is most favourable for their purpose and objective. From an investor’s perspective, they should ensure that the business is Shariah compliant and that it has passed the Shariah screening criteria. This can be ascertained by the review from a Shariah advisor.
[1]https://www.accaglobal.com/ca/en/student/exam-support-resources/fundamentals-exams-study-resources/f...
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Islamic Finance And Money Management
Islamic finance sets out principles for Muslims to follow when it comes to managing their money, investments, and assets. Managing money in a Sharia compliant way is not part of the ethical framework of Islam, but also serves as a guideline for Muslims to follow when transacting and managing finances.
The aim of Islamic finance is to ensure that financial dealings are not speculative, exploitative, or unfair. Instead, the focus is on creating an ethical financial economic system and markets that promote equality, social welfare, and justice within the economy and outside of it.
Every Muslim, business, and industry should follow Islamic finance principles when dealing with money. This is not only a religious requirement, but also an ethical one.
Traditional methods of money management focus on growing wealth and often this is based on interest and speculative investments. Islam is the opposite. It teaches people to manage their money in a reasonable and ethical way.
Islamic Finance - The Holistic Approach
Islam encourages a holistic approach to life. This includes having a wide lens when it comes to financial transactions and wellbeing. When it comes to money, Islam takes a holistic approach that goes far beyond focusing on the economy and markets.
Instead, the Sharia approach aims to emphasize socially responsible, ethical, and spiritual dimensions that align with the wider principles of the faith.
Let's have a look at the aspects of the holistic approach taken by Islamic finance:
- Social responsibility: this is key for Muslims in all aspects of their lives, but especially when it comes to money, payments, economic growth, and activity. The focus is placed on ensuring that people behave in such a manner so as to alleviate poverty and redistribute wealth.
- Ethics: like social responsibility, ethical conduct is a key component of the holistic approach of Islamic finance. Honesty, fairness, and transparency are widely encouraged when it comes to money management. Islam aims to ensure that people and societies as a whole benefit from money (hence the reason interest is strictly prohibited as it is seen as being rooted in the concept of unfairness).
- Intention: the niyyah (intention) behind money management decisions is important for Muslims. The aim is for transactions to be carried out with intentions that focus on ethical conduct and fairness. The idea behind this is that wealth comes from Allah so it should not be used to produce unfairness.
- Consumption and lifestyle: Islamic finance is not simply about how we manage money. Islam requires us to carefully consider our consumption, to avoid over consumption, understand the concept of wealth management, and to behave ethically. Muslims should make mindful and meaningful purchases and not spend frivolously.
- Wealth distribution: an important element of Islam is education and understanding in relation to the principle of sharing wealth. Through the obligations of zakat and charitable paying, Islam places great emphasis on ensuring that wealth passes from the rich to the poor.
- Real economic activity: investments in Islam cannot be speculative or ambiguous. Transactions must be based on a fair agreement with real asset backed and tangible items.
Trends In Islamic Finance
As the landscape of the globe changes with the introduction of digital banking and mobile banking, so too the Islamic finance landscape is changing. More and more people want to save, invest and store money in an ethical way and Islamic finance offers this ethical approach.
Sharia compliant money management offers people with a conscience the opportunity to manage their finances in a way that not only benefits themselves but also those around them.
There is currently an upward trend in the demand for ethical financial services, and Islamic finance is built on ethics and socially responsible finance.
In the UK, The Islamic finance industry is growing fast. This industry not only serves Muslims as individuals and business owners, but also serves Muslims from across the world including the Middle East and other Muslim territories. The Muslim fintech market is growing fast, and research indicates that this will be a key growth area in the coming decade with the fast rise of digital banking.
In addition, the green and sustainable industry is also seeing huge growth. Incorporating Islamic finance with green investment is the perfect alliance as both industries offer each other the perfect ethical partner.
Money Matters In Halal Business Ventures
When it comes to managing finances in business in a Sharia compliant way, it requires more than financial acumen. What is needed is a good understanding of Islamic finance principles. This includes knowing why interest is haram, and how to run your business so it is compliant with Sharia rules.
From opening your business bank account, to making deposits and withdrawals, there are many Islamic finance options available to people. Financial institutions understand the need to cater to those wanting to manage money in a Sharia compliant and ethical way.
Problem Solving Strategies In Islamic Money Management
The starting point is to always ensure that you live a Sharia compliant lifestyle. Whether you are a consumer, customer, business, corporation, or homeowner, there are principles set out to guide you.
Other strategies to help you include:
- Follow the Islamic finance principles when it comes to all and any financial dealings. When in doubt, seek guidance from scholars and financial advisors who are knowledgeable about Islam and Sharia rules.
- Review and adjust accordingly: assess and review your investments and finances regularly and don't assume everything you do is compliant.
- Address debts quickly: it is very easy to take out a loan and fall into debt. Debt that is interest based should be avoided at all costs. Think about the need and value of the purchases you make and do not rely on security that is interest based.
- Zakat: plan and prepare for your zakat payments. This will ensure you are constantly reviewing your finances and preparing for your zakat payments through the year.
- Income: ensure any income generated is halal.
Balancing Money And Morality In Islam
Balancing money and morality in Islam is not difficult. The Islamic finance principles give you a great foundation from which to align your finances with Islam. Make sure you understand these rules and apply them.
The main thing you can do is to avoid interest. It is strictly forbidden. In addition to this, you should prioritise halal earnings and avoid engaging in activities that are deemed to be forbidden.
Fulfilling your zakat obligations is a means through which you can fulfil your rights as a Muslim and share your wealth ethically. Practice disciplined budgets to ensure that your finances do not run away with you and you have the financial security you need through the year.
Always avoid excessive risk and speculation. Be cautious when engaging in any financial dealings that include any element of speculation of gambling.
Instil and teach Islamic values to those around you and ensure that those in your life, whether on a personal or professional level, share your values.
Banking Solutions For Muslims
Look out for banking solutions, products, and services that offer Islamic finance options for Muslims. These days it is not hard to find Sharia compliant bank accounts, mortgage products, loans, and investment options.
There are even Islamic insurance services and wealth management services. So, there is no reason to not do your research and ensure that your money management aligns with the teachings of Islam.
Qardus Ltd do not provide financial or investment advice.
WHAT IS QARD AL-HASSAN?
Qard al-hassan, also known as qard al-hasan, is an Islamic finance term that essentially refers to a loan that is interest free. Typically in a transaction that includes qard al-hassan, the borrower will repay the amount owing under the principal amount without any other mark up or interest payment being charged. Qard al-hassan financial products are compliant with Sharia rules that dictate that interest (riba) payments are not permissible, whether the interest is being paid or being charged.
These types of loans offer financial solutions for Muslims looking to borrow funds that do not include any interest payments.
Qard al-hassan loans are loans that are provided to help others. The word hassan itself means acceptable or good (of good faith). Islamic banking services are now offering qard al-hassan loans for both Muslims and non-Muslims.
Qard Al-Hassan Loans
In Islam and Islamic banking, Qard al-hasan loans do not have an interest rate element, and this means that businesses and consumers are able to borrow money on a goodwill basis. Generally speaking, qard al-hasan loans tend to be used for welfare purposes. The Quran stipulates that Muslims should endeavour to provide these types of benevolent loans where possible and to those who need these kinds of services.
"Establish regular prayer and give regular charity and give Allah Qard Hassan" (Quran 73:20)
The principle of qard al-hassan in Islam enables Muslims to further the social justice ethos that underpins Islamic finance. Islamic finance facilitates loans from those with the funds to those who need financial assistance without breaching Sharia rules. Qard al-hassan can be viewed as a loan agreement that is akin to giving charity. The borrower and lender sign an agreement confirming the terms of the qard.
HOW DOES QARD AL-HASSAN WORK?
In Islam, qard al-hassan works in the following way. A lender will lend a business or service an amount of money that they need (usually for social justice purposes). The principal amount borrowed will be interest-free. The borrower will then repay the amount of money borrowed without any interest or surplus payments owing. Borrowers are permitted to pay an additional amount back to the lender as a gesture of goodwill, but this cannot be done based on any promise or commitment.
Qard al-hassan loans do not increase over time or accumulate any interest charges like traditional loans do. This means they offer problem solving solutions for Muslims.
The most important element of Islamic qard al-hasan loans is that they are untouched by any form of riba. There should not be any reference or link to the economic market conditions and fluctuations, and the lender cannot ask for the return of the loan before the contractual repayment period ends.
Qard Al-Hassan - The Redistribution Of Wealth
Islamic finance systems focus on socio-economic justice and the enhanced wellbeing of society, especially the alleviation of poverty. Alongside sadaqa and zakat, qard al-hassan is an essential Islamic finance instrument of redistribution of wealth.
Qard al-hassan minimises the cost of borrowing and remains compliant with Islamic Sharia law. It's one of several halal investing principles that guide how Muslims manage and grow wealth ethically.
Social Justice, Qard And The Islamic Finance Economic System
The Islamic finance economic system has always centred on principles of social justice (as mirrored throughout the practices and teachings of Islam). The focus of the finance system is to ensure and improve the overall wellbeing of society and using money to enhance social conditions.
Qard al-hassan is a key concept that acts as a crucial redistributive instrument. The distribution of funds from the rich to the poor aims to reinforce social unity and cooperation. As the global experience of, and appetite for, ethical finance options and factor analysis continues to grow, qard al-hassan is fast emerging as an important tool in the fight against poverty and the drive to ensure there is more financial freedom and equity for poorer communities.
As more and more Islamic finance companies and banks are offering innovative qard al-hassan products and financial services, project management for those customers and business operations working within the social justice sector will become easier and more accessible. Qard al-hassan services will start to become more readily available in banking and private sector financial industries.
The opinion of scholars is that qard al-hassan loans are problem solving as they facilitate the redistribution of funds that are compliant with ethical and Islamic finance principles. Islamic finance is facilitating financial freedom and investment options for those who have historically been excluded from traditional financial markets and industries that did not cater to their religious requirements.
According to Sharia law, qard al-hassan loans are deemed to be acts of good faith, and loans that help those in need. Advancement of news relating to qard products and websites, and information technology means that qard al-hassan financial services are more readily available and searched for online, especially in Middle Eastern territories. This has enhanced the supply and demand of qard services. Historically, qard al-hassan loans have proved to be effective for economic growth, enhancing employment, and alleviating poverty.
Whether you are a beginner or seasoned investor, when it comes to halal investment this article will explain everything you need to know. This guide is your gateway to understanding Islamic finance, investments, assets, and the value of making informed investment decisions.WHAT CONSTITUTES INVESTMENT?
Investment refers to the process of buying assets with the aim of the assets increasing in value over time. As the value of the asset increases, the investor is provided with a return that takes the form of capital gains or income payments. Investment has historically always been associated with the growth of wealth and the pursuit of capital income. However, investments can also be a means to improving lives and the lives of those in your community.
Investing becomes profitable when the asset you invest in increases in value and you are then able to sell it at a higher price. When the asset increases in value this is known as appreciation.
Investment can be complex and fraught with risk and technical difficulties. Add in the Sharia rules and the world of halal investment can seem increasingly daunting for Muslims. Sharia compliant trading and investments are those investments that do not breach the Sharia rules which are based on the idea of ethical investment and saving. Islamic finance principles relating to finances and investment are based on social justice, non-exploitation, and halal investments that lead to a mutually beneficial partnership.
WHAT IS SHARIA COMPLIANT OR HALAL INVESTING?
Halal investment refers to the investment of money in accordance with Islamic finance principles. Sharia finance law is centred on the concepts of social justice, ethics, and using finances to help build communities. For any Muslim considering halal investment strategies, the focus should be partnerships that are mutually financially beneficial.
Sharia law lays down principles and regulations Muslim investors must comply with if they want to invest in halal products. According to Sharia rules, compliance with Islamic finance principles leads to a more ethical and just society. This goes against the western notion that making money is the ultimate aim for investors. Whilst Islamic finance does not prohibit making money, it does place emphasis on ethics and justice, so that a balance is achieved between religion, family, life, intellect, and property.
Halal investments should not be dismissed by those wanting to generate income. Islamic finance is not restricting or limiting, it simply proposes ethical practices and mutual benefit. Halal investments encourage Muslims to invest responsibly and always ethically. It is still very possible to make money ethically with the right investments. Investing within Sharia compliant products actually reduces the risk for investors, and is one of the reasons that Islamic banks were able to withstand the economic collapse in 2008.
Investment And Islamic Finance Principles
Islamic finance principles provide financial principles for Muslim investors to operate within to ensure that the financing and investment activities comply with Sharia law. Whilst the main principles of Islamic finance have been around for centuries, formal Islamic banking and finance was established in the 20th Century.
As the global Muslim population continues to grow, so too does the demand for Islamic finance products and banking. The Islamic finance sector is increasing in size every year, with Islamic finance institutions overseeing over $2 trillion.
The core difference between traditional investment and Islamic investment is that Islamic finance principles dictate what investments are deemed to be halal or not. Islamic finance needs to comply strictly with Sharia law, and the following Islamic finance principles are expressly prohibited:
Paying And Charging Interest (Riba)
Interest payments, or investments that include an interest element, are strictly prohibited in Islam. Charging interest is not considered to be Sharia compliant as it is deemed to be an exploitative practice.
Risk And Uncertainty (Gharar)
Sharia rules do not allow participating in contracts where there is excessive uncertainty or risks. Investing or partaking in any short-selling or uncertain contracts are forbidden in accordance with Islamic finance principles.
Investing In Prohibited Activities
For Muslim investors, investment in any business that is involved in prohibited activities such as gambling, and selling alcohol is prohibited.
Speculation (Maisir)
Sharia law prohibits speculation or gambling. So, if any form of investing includes contracts where the ownership is dependent on events in the future that are uncertain, this is deemed to be precarious.
Benefits Of Halal Investments
As the Muslim economy continues to increase year on year, the Islamic finance industry is also growing to cater for the need for growing halal investment options and products. Some of the main benefits of halal investments for Muslims (and no-Muslims) include the following:
- Social Responsibility - taking a socially responsible approach to finances and investment not only means the investment is Sharia-compliant, but it can also lead to human rights protections, just distribution of wealth, and ethical investments that minimise environmental degradation.
- Less Risk - Islamic finance principles mean that halal investment products are less susceptible to huge market changes and fluctuations. Global crises do not impact Islamic finance as they do more traditional banking. As short term speculation is discouraged in Islam, the exposure is much lower overall.
- Growing wealth in a halal way - this is the most critical benefit for Muslim investors. Not only does halal investment mean that Muslims can engage and involve themselves with global markets, it also means that Muslims partake in disciplined investment that requires ethical due diligence.
Stocks, Bonds And Shares
Stocks, bonds and shares are the most common publicly traded investments. Stocks are essentially ownership shares of companies that have publicly traded. A stock is a share of the companies earnings and assets, owning one stock is equivalent to owning a part of the company. If the value of the company increases then the value of the stock increases at the same rate. Similarly, if the market value of the company decreases then so will the value of the stocks owned. Muslim investors who purchase stocks will want to know the modus operandi of the company so that they can be sure that any income derived from their stocks is Sharia compliant.
Bonds are ownership shares of debt, and are usually interest-bearing. This means that the bond effectively acts as a loan to the company. On the whole, bonds are not considered to be a Sharia compliant investment as they are rooted in interest payments. Sukuks are a more acceptable form of Islamic finance bond (see below).
Gold
In terms of investment, gold is considered a safe and traditional means of investment that is Sharia compliant. Gold often appreciates in value, is easy to obtain and invest in, and is not deemed to be in breach of any Islamic finance laws.
Sukuk
Sukuks are an alternative to traditional bonds as they do not bear any interest. They are often referred to as Islamic bonds, and are normally asset based. They are deemed to be conservative investments on the basis that they form part of the 'fixed income' market.
Sukuks are able to generate income for halal investors without breaching the Sharia rules.
Property
Investing in property is a great way for Muslims to invest. The only caveat is that if a mortgage is obtained it is deemed to be a halal mortgage without any element of riba.
Prohibited Industries
Any halal investment must be in accordance with the Sharia principles mentioned above, and must be done with consideration of ethics and social justice. Companies whose main business goes against the central tenets of Islam are considered universally unacceptable as investment opportunities.
There are certain industries that are deemed to be unethical or at risk of causing harm to society, and Muslims should therefore avoid opportunities in these sectors:
- Industries manufacturing, promoting, advertising, or selling alcohol
- Industries manufacturing, promoting, advertising, or selling cigarettes or drugs
- Banking products or financial transactions that include interest (riba)
- Any industries related to gambling
- Industries related to prostitution or pornography
- Industries relating to pork
Sharia law prohibits investing in industries and businesses where at least 5% of their income comes from unethical sources (this is known as the 5% rule). Before investing in any business, Muslims should check out the financial statements and positioning of the company and do some research on their sources of income and profits and where they are derived from.
Halal Investment - What To Look For
When undertaking due diligence prior to investing, you should consider the following 3 types of investing opportunities:
1. Companies with halal practices - these are known as clean companies (from a halal investment perspective) and are companies that operate in a completely halal way. These companies operate within the Sharia finance rules, and have a clear halal audit trail.
2. Companies with haram practices - these types of companies operate within prohibited industries such as gambling and alcohol.
3. Mixed companies - these companies may have halal practices but these are mixed with haram practices or activities.
For halal investors, option 1 is always the best option as there is no overlap of the halal-haram considerations. Companies that have a cross-over between halal and haram should be avoided.
As one of the fastest growing finance sectors, Islamic finance has opened up many opportunities for halal investors. In the UK alone, there are many banks that offer specialist investing products, loans, and savings accounts.
Conclusion
Islamic finance promotes the concepts of ethical financial management and investment and reciprocal profits. The use of interest, risky investments, and unethical industry investment is discouraged. Halal investing is a growing financial niche, and it is available for Muslims and non-Muslims alike. Investing in products that are Sharia compliant is not difficult or impossible, it just requires some information gathering and due diligence.
Prominent private equity institutions like Gobi Partners have realised the growing demand for halal financial products. Over the last decade, more and more financial institutions and foreign exchange markets have taken steps to place themselves in the Islamic finance and private equity market. High net worth individuals in emerging markets such as Africa and the Middle East are entering the private equity investment market rapidly and this has led to an increase in demand for Sharia compliant investment opportunities. Islamic finance is no longer considered to be a niche and exotic sector within the banking industry.
Of course, the most important factor behind the growth of the Islamic finance industry is that Muslims make up almost a quarter of the world's population. The Muslim investor base is large and it is growing. This growth has not been lost on wealth managers and banks who are keen to tap into the wealth and investment funds in the hands of wealthy Muslims. Coupled with the economic expansion of many Muslim countries, it is likely that halal investment products will become more accessible within the next 10 years.
As the Islamic finance sector continues to grow annually, a faith-based approach to investing and trading is becoming more mainstream. However, the application of Islamic finance to investment products needs to be undertaken and can be nuanced, so always make sure to check the financial information of any company you are considering investing in.
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