English
Mudarabah contracts – an Islamic contract whereby a financier (Ras Al Mal) enters into a profit-sharing agreement with the recipient (Mudreb) with the former assuming all financial risk – can be extremely beneficial to business owners and founders.
Whether you are an SME or a startup looking for capital to start or grow a business, the range of use cases that mudarabah contracts makes them an ideal funding solution for a variety of business needs.
Furthermore, with the scales weighing in favor of the Mudreb, mudarabah contracts allows cash-strapped SMEs to tap into much needed capital at minimal financial risk.
That said, because they are skewed to favor the Mudreb, getting access to mudarabah funding may be hard to come by.
Read more about: The Basic Guide to Mudarabah Contracts
First and foremost, any funding that comes through a mudarabah bears no financial risk on the recipient, making them ideal for an SME looking for funding.
The SME (when acting as the Mudreb) isn’t obliged to provide any funding to the business or project they’re seeking funding for, thus, the entire financial risk of the project falls on the financier.
If the business fails, they bear no financial responsibility for that failure.
Mudarabah also allows the SME to gain access to capital to start or grow a business, without giving up any collateral, or bearing interest. These make mudarabah contracts an attractive proposition for budding entrepreneurs and startup founders.
Depending on how the profit-sharing agreement is structured, the SME could stand to reap a substantial amount of the profits, while risking none of their own capital.
This gives them a portion of the upside, without the financial pressure of the downside, weighing the scales in their favor.
And finally, under a mudarabah, the SME is free to manage the business as they see fit, with little or no interference from the funding partner, depending on the type of contract.
In the case of an unrestricted Mudarabah (Mudarabah Mutlaqah), the Rab Al Mal gives no restrictions (beyond the investment being Shariah-compliant) to the Mudareb.
But even in a restricted mudarabah (or Mudarabah Muqayadah) – which does limit the business to a certain extent -- day-to-day management of the business is still in the SMEs hand.
When looking to start a business, access to seed capital is extremely hard to come by if the founder doesn’t already have the funds to kickstart a business.
Founders may also find it extremely difficult to tap into banks that usually will not lend to businesses without at least three years of operations. Mudarabah contracts may provide a founder with access to seed capital if they lack the necessary funds.
However, be prepared to give up a substantial portion of the profits to a prospective Ras Al Mal, as founders have yet to bring anything tangible to justify keeping a large sum of the profits.
Business at various stages will need at some point to dip into new sources of funding as the needs of the business changes.
Depending on the size of the business, venture capital funding could be a great source of additional funding to help grow and expand the business.
If these deals are structured through a mudarabah contract, the business may see an injection of financing without having to give up too much control.
Venture capital firms tend to seek as much control as they can get in exchange for their funding, which can be mitigated through a mudarabah contract.
Without access to VC or other forms of investor funding, many businesses are forced to resort to bank loans to obtain working capital financing.
Businesses can obtain working capital through a mudarabah contract. The benefits of a mudarabah (as opposed to a loan) is that it the business would not need to pay interest on a loan or give up any collateral.
Many businesses that operate on a project-by-project basis, or those that are seeking to build a factory, facility or buy capital goods to help grow their businesses, will need funding to support the development of these projects. Mudarabah contracts can be used to fund specific, one-off projects.
While most of the ways that SMEs can benefit from a mudarabah will see them act as a Mudreb, there are ways that an SME can benefit by being a Ras Al Mal.
Project financing, whereby the SME can pay for the project and the contractor acts as a Mudreb is also possible.
Any earnings or profits retained after the profits are divided and are not going towards CAPEX spending will need to be invested.
Whether that be opening up business savings accounts with an Islamic bank or investing in an Islamic mutual fund, the SME (acting as a Ras Al Mal) can use mudarabah as a Shariah-compliant means to invest their retained earnings.
Takaful
Any business needs insurance coverage, whether it is protection from hazards, accidents, property damage or theft or providing health coverage for employees. Takaful (or Islamic insurance) can be a way to provide that form of protection, while also being an investment vehicle for the business.
As noted in a previous entry, takaful are a built on a profit-sharing mechanism whereby the policy-holders are investors and the takaful operators manage their investments.
This makes them highly conducive to mudarbah contracts, with the policy holders acting as Ras Al Mal, and the takaful manager acting as the Mudareb.
Read more about: Conventional insurance vs Islamic insurance "Takaful"
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
