Islamic crowdfunding - what is it and who benefits
Crowdfunding
For new businesses, entrepreneurs, and those with creative ideas, finding the appropriate finance to fund their ideas and projects can be difficult. It is even more difficult for those who are looking for funding options that are Sharia compliant. Without the necessary funds, creating a successful business or launching an idea is near impossible. Crowdfunding has emerged as a great way to raise capital and find the financial backing you need.
For Muslims, crowdfunding can be viewed as a halal way to raise funds, without having to resort to conventional funding options which are interest-based.
Crowdfunding facilitates economic growth for many companies, startups, medium enterprises, and individuals. In return for the investment, investors aim to receive a return from the profits generated.
This article will examine what crowdfunding is, who benefits from it, why more and more Muslims are using crowdfunding platforms, and what you need to look out for if you want to keep your money halal.
Basic Concepts Of Crowdfunding
The very basic concepts of crowdfunding revolve around raising funds from a crowd of people - hence the name crowdfunding. Essentially, it is the crowd that funds the project.
This is an alternative to going to a bank for a loan and securing funding that is essentially a debt.
Some of the key concepts that crowdfunding is based on include:
- the project: a creator or company starts the crowdfunding campaign based on a project or idea. The idea is presented via the online crowdfunding page coupled with a request for for investment and financial backing.
- the platform: the crowdfunding platform is the means by which creators are connected to the angel investor, venture capitalists, potential donors, investors, companies, and backers. Some popular crowdfunding platforms include Indiegogo, GoFundMe, and Crowdfunder.
- Investors: the investors or backers are the individuals or companies that contribute funds to the campaign. In return, they can either receive rewards, equity or just the satisfaction of knowing they have made a contribution to a campaign they believe in.
You can see why any startup company or entrepreneur would look to crowdfunding as a viable way of raising funds.
A crowdfunding campaign should include full details of the project and present it well on the relevant platform or website. The details should be precise and include:
- the project details (including the industry, the market targeted, services on offer)
- the funding goal
- what the money will be used for
- timeline of the deal
Conventional Crowdfunding Types
Some conventional crowdfunding types include the following:
- Donation based crowdfunding: this is where donors contribute to the campaign without expecting anything in return. Many charitable causes raise money this way, but it is also used by individuals for personal fundraising.
- Reward based (equity crowdfunding): this type of crowdfunding is when backers contribute funds to a particular project in exchange for non equity rewards. These can include incentives, early access offers, or special merchandise.
- Debt based crowdfunding: this is the type of crowdfunding where backers lend money to the crowdfunder on the understanding that the money will be repaid (this usually includes interest repayments).
Crowdfunding - Islamic Finance
Some of the basic Sharia rules relating to finance must be complied with if any crowdfunding campaign is to be considered halal. As a financial model, Islamic finance has been successful for many decades. Not only does it facilitate financial inclusion for marginalised communities, but also ensures that small and medium sized businesses have accessible finance.
Islamic crowdfunding aligns with the ideals of Islamic finance, with the focus on the development of society and individuals whilst meeting Sharia goals.
Conventional finance and management has not been able to support small and medium Muslim businesses in the way that crowdfunding has. This is because conventional financial transactions relating to funding are based on interest and debt repayments. For Muslims, this is a price they are not willing to pay.
Crowdfunding is a public-private collaboration, and when done in a Sharia compliant way, it can offer Muslims a viable way of raising money whilst also delivering economic growth.
In fact, crowdfunding as a concept is not unfamiliar to Islamic finance. The current crowdfunding concept can fund its roots in the concept of Islamic microfinance which aims to bring social justice and equity into financial transactions.
IS CROWDFUNDING SUITABLE AS A HALAL FORM OF FINANCING?
To answer this question we need to examine whether crowdfunding can be compliant with Sharia rules, and what Sharia rules state in relation to crowdfunding. Crowdfunding at its very essence is a social collaboration idea, and this fits with Islamic finance principles.
The idea is that individuals collaborate and donate resources to a project, service, or trade that they believe in. With Islamic finance's emphasis on equitable wealth distribution, crowdfunding certainly meets this focus.
Wealth distribution in a fair way is a core principle of Islamic law, and what better way to flow funds from one person to another than crowdfunding. Crowdfunding enables the public to help private sector companies and individuals to grow their enterprises in a socially responsible way.
Another important aspect of Islamic finance to mention here is the focus on ethical responsibility and profit and loss sharing (risk taking). This is pretty much what crowdfunding does. It allows companies and individuals to share in the risks being faced as well as the opportunity to share in the rewards and returns that are generated.
Of course, not every form of crowdfunding model is halal. For example, any form of crowdfunding that includes interest payments or haram industries or enterprises is not permissible and not Sharia compliant. In fact, any crowdfunding model involving interest or speculation is prohibited.
It is important to ensure you do your research and find a project and platform that works within the parameters of Islamic finance rules.
Islamic Crowdfunding
Islamic crowdfunding enables investors to support small and medium businesses in their economic activities via a distribution of wealth. Look out for projects that have an element of social and economic justice attached to them.
There are many crowdfunding projects out there which aim to relieve poverty and to provide financial aid to the poor based on charitable donations and these projects always do well.
Mudaraba contracts can be used in Islamic crowdfunding. They work on the basis that:
- profits from the projects are distributed between the creators and the investors.
- predefined percentages are used in relation to profits
- Investors do not influence the project or have veto powers
- the contracts are beneficial for startups with innovative ideas
In addition, having a zakat based crowdfunding project would also be a concept that is compliant with Sharia rules. Those in need of zakat can set up campaigns asking for zakat money or charitable donations.
Sharia Rules And Regulations
As already mentioned, any crowdfunding project must be Sharia compliant if it is deemed to be in accordance with Islamic finance rules. This means:
- the project, goods, or services must not be involved with any haram industries (porn, alcohol, gambling).
- the capital used to finance the project must be halal
- no interest can be paid or charged
- a Sharia supervisory review should be in place to monitor and track the crowdfunding campaign
Challenges For Those Offering Islamic Crowdfunding
Despite their popularity, crowdfunding campaigns also have their own unique challenges.
Some of the challenges include:
- Generating public interest: one of the main reasons crowdfunding campaigns fail is that they do not generate enough interest from people. Getting the attention of potential funders and investors is key to a crowdfunding campaign.
- Trust: with so many crowdfunding campaigns live at any given moment, some investors shy away from crowdfunding. Before you try and raise any money via crowdfunding, it is important to be able to tell the story of the project and why funding is needed.
- Ideas protection: as with anything these days, once a crowdfunding campaign does well, 10 similar projects will come forward. When presenting your project on any platform you need to ensure that you provide enough information to garner interest from backers, but also keep enough back so you can protect your idea.
- Risk management: as Sharia rules state that profits, losses and risks should be shared equally it is important to ensure that the crowdfunding arrangement meets these goals.
- Technology: in many countries around the world, electronic payment methods are still not common. This means crowdfunding still has limited availability to the poorest in our society.
Overcoming Challenges
The best way of overcoming the challenges relating to crowdfunding is to make it more accessible. By its very definition, crowdfunding is a concept that relies on the crowd to forward fund projects.
Due to the importance crowdfunding places on sharing and participation, crowdfunding platforms across the world are demonstrating cultural and social benefits. As a new platform, there is still more regulation and development to come, but for Muslims it is an innovative approach to raising finance in a halal way.
One of the most fundamental points to remember with crowdfunding is that crowdfunding itself is not automatically deemed to be halal. Each crowdfunding investment opportunity of project needs to be evaluated by the investor or creator to make sure the investment complies with Islamic finance rules.
In addition, the crowdfunding platform and the project need to be assessed on an ongoing basis. Do not assume that once a project starts it will remain halal. Muslims who want to use crowdfunding to raise funds or to invest must ensure that they continue to ask questions, undertake due diligence and consult with scholars and financial advisors who understand Islamic finance.
Explore more news
ISLAMIC SAVINGS ACCOUNTS - WHAT ARE THEY?
An Islamic savings account, also known as a Sharia compliant savings account, is a type of savings account that is designed to be compliant with Islamic law. Islamic finance rules prohibit the payment and collection of interest, also known as riba.
Instead of interest, Islamic savings accounts typically pay profit or loss sharing. This means that the bank and the customer or account holder share in the losses or profits of the bank's investments.
HOW DO ISLAMIC SAVINGS ACCOUNTS WORK?
Instead of offering interest on deposited funds, an Islamic savings account operates on the principle of profit and loss sharing, where the profits made by the bank are shared between the bank and the account holder.
An Islamic savings must adheres to the principles of Islamic finance. These principles, derived from the teachings of the Quran, prohibit the payment or receipt of interest on financial transactions. The bank offering Islamic savings accounts ensures that the account is not charged or paid any interest.
Islamic savings accounts are also known as interest-free savings accounts or sharia-compliant savings accounts offer a number of benefits to those who choose to use them.
Conventional Savings Accounts
To compare, conventional ISAs are a type of savings account offered by banks and financial institutions in the United Kingdom. ISAs are regulated by the Financial Conduct Authority (FCA).
Conventional ISAs are essentially offer the customer to save money and earn interest on their savings without having to pay taxes on the interest earned. The main difference between a conventional ISA and an Islamic savings account is they way in which they earn money for the account holder.
Islamic Savings Accounts And Sharia Rules
An Islamic savings account, also known as an Islamic finance account or a Shariah-compliant savings account, is a type of financial account that is designed to be compliant with the principles of Islamic law (Shariah). In contrast, a conventional ISA, or Individual Savings Account, is a type of savings account that is offered by traditional banks and financial institutions in the UK.
One of the key differences between these two types of savings accounts is the interest rate. Islamic law prohibits the charging of interest, known as riba, on loans and financial transactions. Therefore, an Islamic savings account does not offer interest on to customers on the deposited funds.
Instead, an Islamic savings account operates on the principle of profit and loss sharing, where the profits made by the bank are shared between the bank and the customer or account holder. This means that the returns on an Islamic savings account may vary depending on the performance of the bank.
Ethical And Socially Responsible Investments
Another key difference between Islamic and conventional savings accounts is the use of investments that are considered to be ethically and socially responsible.
Islamic finance is based on the principle of avoiding investments in businesses that are considered to be harmful to society, such as those involved in the production of alcohol, tobacco, gambling, and other activities that are prohibited by Islamic law. Conventional ISAs, on the other hand, do not have any restrictions on the types of investments that can be made with the deposited funds.
Taxation Of Islamic And Conventional Savings Accounts
In addition to the differences in interest rates and investments, there are also some differences in the way that Islamic and conventional savings accounts are taxed.
In the UK, ISAs are tax-free savings vehicles, meaning that the interest earned on the deposited funds is not subject to income tax. However, the profits earned on an Islamic savings account may be subject to income tax, depending on the specific details of the account and the tax laws in the country where it is based.
It is always best to find out as much information about the savings account you are opening. The bank or provider of the service should be able to help you identify the exact tax implications for you. A comparison of the accounts can also be done via the website of the bank.
Overall, the main difference between an Islamic savings account and a conventional ISA is the way they are structures and the principles each account is based upon.
Structuring Of Conventional Savings Accounts Vs Islamic Savings Accounts
Islamic savings accounts are designed to be compliant with the principles of Islamic finance, this includes the prohibition of interest and the promotion of socially responsible investments. Islamic savings accounts need to ensure they are structured in a way that does not contravene any Islamic finance principles. The structure and the way they progress are important components as the obligation to be Sharia compliant applies to the lifetime of the savings account.
What this means is that the bank offering Sharia compliant savings accounts must ensure it meets all the Islamic finance requirements of operating such an account.
Conventional ISAs tend to be more flexible and do not have the same restrictions as an Islamic savings account would have. However, for Muslims and other customers who do want an ethical form of saving, Islamic savings accounts are useful tools for saving in a Sharia compliant way.
It is therefore important to understand the differences between the two types of savings accounts.
The Benefits Of An Islamic Savings Account
There are over a billion Muslims worldwide. As a result, the principles of Islamic finance and banking have gained increasing recognition and popularity in recent years.
One of the key products offered by Islamic finance institutions is the Islamic savings account.
An Islamic savings account must operate in a way that is consistent with the values and beliefs of Islam, including the prohibition of interest (riba) on loans and financial transactions.
There are several benefits to using an Islamic savings account. Here are just a few:
- Alignment with religious beliefs: For Muslims, the prohibition on interest is an important religious principle. By choosing an Islamic savings account, individuals can align their financial practices with their religious beliefs.
- Higher potential returns: Because Islamic savings accounts do not pay interest, banks and other financial institutions that offer these accounts often provide higher potential returns in other ways. For example, some Islamic savings accounts offer profit-sharing arrangements, where the bank shares a portion of its profits with account holders.
- Increased transparency: Islamic finance is based on the principles of transparency and fairness. As a result, Islamic savings accounts often provide greater transparency than traditional savings accounts, with clear and straightforward fee structures and a lack of hidden charges.
- Support for ethical investing: Islamic finance prohibits investment in certain industries, such as gambling and alcohol, that are considered sinful in Islam. By choosing an Islamic savings account, individuals can ensure that their money is not being invested in ways that conflict with their religious beliefs.
- Contribution to the Islamic finance industry: Islamic finance is a growing industry, with an increasing number of people around the world choosing to use sharia-compliant financial products. By choosing an Islamic savings account, individuals can support the continued growth and development of this industry.
- Higher Returns: Because Islamic savings accounts operate on the principle of profit and loss sharing, they may offer higher returns than conventional savings accounts that offer interest. This is because the returns on an Islamic savings account are linked to the performance of the bank, and the profits made by the bank are shared with the account holder. This means that the returns on an Islamic savings account can vary depending on the bank's performance, but they may be higher than the fixed interest rates offered by conventional savings accounts.
- Ethical and Socially Responsible Investing: Islamic finance is based on the principles of ethical and socially responsible investing. This means that Islamic finance institutions avoid investing in businesses that are considered to be harmful to society, such as those involved in the production of alcohol, tobacco, gambling, and other activities that are prohibited by Islamic law. By choosing an Islamic savings account, you can ensure that your money is invested in businesses that align with your values and beliefs.
Choosing The Right Savings Account For Your Needs And Values
An Islamic savings account offers a wide range of benefits for savers. Some of these benefits are financial and others are beneficial for those with religious beliefs who want to adhere to Sharia compliant savings.
There has been a significant growth in lenders who are now offering Islamic savings accounts, so it is always worth doing your due diligence to find the right account for you.
WHAT IS GHARAR?
Islamic finance defines gharar as something that is uncertain, risky, or hazardous. If there is a financial transaction where any of the basic elements of the agreement are unclear, uncertain, or ambiguous then the transaction or activity could be deemed to have an element of gharar.
Using the principles of Sharia law, the reason gharar is prohibited in Islam is that it removes transparency, openness, and certainty in financial transactions and contracts.
Gharar And Islamic Finance
According to Islamic finance principles, which themselves are based on Sharia law, gharar is a fundamental prohibition in Islam as it results in a lack of certainty.
This lack of certainty then increases the level of risk and liability to one or both parties.
Islamic Finance And Ethics
Islamic finance is based on ethical finance. What this means is that whilst Islamic finance and Sharia rules recognise the importance of finance in society, there is a need to ensure that there is intrinsic value and ethical boundaries when parties transact.
The underlying ethical principles in Islamic finance aim to ensure that there is transparency and certainty for the parties involved.
When you understand the ethical nature of Islamic finance you appreciate how it works to protect the parties and ensure there is fairness.
Examples Of Gharar
Some examples of gharar in modern contracts and financial transactions include the following:
- options contracts
- future sales
- selling the unknown
- short selling
- sales of debt
- day trading
Essentially, the sale of anything which is not present or tangible is gharar, and therefore not permissible in Islam.
Similarly, if ownership of an asset or product is uncertain this could also be considered to be gharar.
This is why it is important that you understand the concept of gharar and how it is applied, whether you are dealing with a bank, business, financial institution, web page or individual.
Elements Of Gharar
In order to decide if any financial tranaction or business dealing has an element of gharar you need to assess the level of certainty within the terms of the deal.
Some of the main terms you need to understand include the nature of the transaction, the parties, the language of the contract, the product, or service involved.
Gharar has certain characteristics that you need to be aware of.
- the parties: gharar does not always relate to uncertain or risky terms in the contract. Gharar could also occur in the nature of the parties involved, their relative bargaining power, their openness and the level of risk they take on
- contract terms: language used in the contract must be clear and concise.
- two or more sales in one: this refers to deals that are uncertain with timings. For example, if a seller states they will 'sell this asset for £100 in cash today and £150 next week'. The timings here are uncertain.
- conditional contracts: this refers to conditions in a contract that are unknown and uncertain. For example, if a seller states they will sell the buyer an item if the market improves.
- price : if the price in a contract is not known then this could be deemed to be gharar. You should always be careful where the payment terms are not clear.
- Speculation: if you have agreed terms that are speculative then this is not permitted.
- Subject matter: ie, if there is uncertainty in the subject of the contract.
- Delivery: again, be careful if there are no specified delivery terms or final contract date.
Impact Of Gharar
In Islamic finance, certain types of contract are void. These include contracts that are deemed to be invalid, and contracts that are defective.
Invalid contracts are those where key details are missing, such as the price, the payment terms, and the duration.
Defective contracts are contracts which do not contractually bind the parties correctly.Based on these principles, any contract that includes elements of gharar can be deemed to be both invalid and defective in Islam.
How To Avoid Gharar
Whether you are looking to avoid gharar in your financial dealings or daily life, there are some things you can do to ensure that you are compliant with Sharia rules.
You can ensure that there is certainty in your dealings, fairness and openness, and that you are not misleading anyone else. Any transaction should involve the consent and knowledge of the parties involved.
Gharar And Trade
When it comes to trading or business, one of the main ways to ensure you do not fall into the gharar trap is to ensure that any trading has the consent of both parties.
Any form of trading in risk is not permissible. If it is likely that one party in the transaction is likely to make a significant gain at the cost of the other, then the result is that this is generally forbidden under Sharia law.
Any exchange that could lead to exploitation and injustice should be avoided. Instead, you should aim to ensure that all your dealings are transparent, consensual, and satisfactory to both parties.
The success of your business depends on you maintaining a healthy cashflow. You want to have money available in order to pay your bills and your staff on a weekly or monthly basis, along with having capacity for growth.
It doesn't matter how great your product or your marketing might be. The foundation of success for businesses, and the reason why some don't make it, is cashflow. The moment you don't have the money in the bank to pay your staff, suppliers or tax bills, you could be in big trouble. Cashflow planning helps you to see this coming, giving you time to take action.
Cashflow planning is essential
It's much more comfortable when you have consistent, positive cashflow. There are no moments of panic when you fret over how you'll pay a particular commitment. You have more time to plan ahead, to have an eye on the future rather than worrying about today.
Consistent, positive cashflow doesn't just happen. Being profitable doesn't guarantee that your business will always have the cash to meet your commitments. Income from sales doesn't always flow in fast enough to cover payments you need to make. Achieving a steady cashflow requires planning. It starts by making a cashflow forecast.
Prepare a cashflow forecast
A cashflow forecast is a plan of the money your business expects to receive and to pay out in the near future. It helps you to predict how much money will be in your bank account at any point in time. A cashflow forecast is usually broken down into months or weeks to make it easier to plan.
To construct your cashflow forecast you'll want to use a spreadsheet or a cashflow planning tool. Your accounting system can provide useful information about your past cashflow but it's not so helpful for predicting the future, because it's based on transactions that have already occurred.The benefits of preparing and maintaining a cashflow forecast include:
- You have better control over your business finances.
- It helps you to make realistic decisions about spending.
- You can plan for the future more easily.
Your cashflow forecast is just that - a forecast. The reality will turn out differently, although a well-prepared forecast won't be that far off what actually happens.
Use a forecast to make better business growth decisions
Growing a successful business requires you to make choices. If your business model is sound it's likely your business will expand naturally, at least in its early days. However, it won't be too long before the rate of growth levels off, as you've satisfied the initial levels of demand. Maintaining growth, or restarting it, requires decisions and actions that will bring in more customers and extend your opportunities to earn more revenue.
Your cashflow forecast will help you to assess the impact of these decisions. It allows you to model what's likely to happen in the future, as you incur more costs with the objective of growing sales.The forecast will help you determine the costs and benefits of actions such as:
- Launching a new marketing campaign.
- Taking on a new member of staff.
- Selling a new product.
- Purchasing new equipment.
- Expanding into a new geographical area.
- Raising additional working capital.
Forecasting requires making some estimates about likely future income based on your choices.
How to build a cashflow forecast
Whatever tool you use to build your forecast, it will have three basic sections. These are:
- Incoming cash
- Outgoing cash
- The net balance
Step 1 - Incoming cash
This section is a list of your different sources of income. Depending on how you sell, you may want to break this down into different categories based on the type of income, such as cash sales, credit sales, credit card settlement and the like.
Not all incoming cash is from sales. You may also receive cash from loans, equity investments, tax refunds and other sources.
Once you've completed this section, you should have a clear idea of how much money you expect to receive on a weekly or monthly basis, over the period of the forecast. Typically, a cashflow forecast will look six months to a year ahead, and longer for bigger projects.
Step 2- Outgoing cash
In the same way, list all the payments made from your business. Be sure to include every form of payment, and take care to include irregular or annual payments. To help you check that you've not missed something, take a look at your accounts for the previous year to see what payments were made.
Payments you're likely to have in this section include:
- Stock purchases
- Payroll
- Tax payments
- Loan repayments
- Asset purchases
- Expense reimbursements
Once you've completed this section you should have a total for the cash outgoings on a weekly or monthly basis.
Step 3 - Net balance
The net balance is the difference between the total incoming cash and the total outgoing cash. If you add your opening bank balance, the cashflow forecast will now give you an estimate of how much money you will have in your bank account on any particular day.
In a strong, healthy business the net balance should be positive. If it's not, the forecast will help you to identify the reason. It may be that you're investing in business growth, which will bring in more future sales income but involves advance costs. The forecast will help you identify whether you need to source short or medium-term funding from elsewhere, and the scale of that funding.
Common problems with cashflow forecasts
Errors occur in cashflow forecasts because the process involves making estimates and it often relies on data that's input into a spreadsheet manually, rather than taken directly from your accounting system.
Problems to look out for in your cashflow forecast include:
- Overlooking VAT on sales, purchases and tax payments.
- Inaccurate information about future receipts and payments.
- Big differences between actual and estimated sales.
It takes time to build and refine an accurate cashflow forecast. Don't be surprised that you need to alter yours often, adding in unexpected receipts and payments.
Keep your forecast up to date
Because your cashflow forecast is based on estimates and assumptions, it will very quickly differ from what actually happens. This means you should update it regularly and often. A well-run business will maintain their cashflow forecast several times a week, perhaps even daily, to keep it as accurate as possible.
Cashflow planning is a vital business activity that you can't afford to overlook or put off. If you're planning to grow your business successfully, the time you put into cashflow forecasting is a wise investment.
Ethical business funding from Qardus
We support growing businesses by providing growth finance of between £50k to £200k on terms of between 6 and 36 months. This finance is helping UK-based small and medium-sized companies to expand their operations and their market share.
We fund businesses that have demonstrated their capability with a proven product and management team. Our clients are drawn from many different industries, but our ethical position means we cannot work with companies involved with products considered detrimental to the welfare of society, such as gambling, alcohol and tobacco. This is because we operate based on Islamic community principles. Our funding process is certified as Sharia-compliant.
We work with businesses and their owners both inside and outside the Muslim community. Any business that operates in line with our ethical values is welcome to apply for funding.
If your business is looking for growth funding that's fast, affordable and ethical, get in touch with us today.
Stay informed on finance
