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Debt crowdfunding is a method of raising funds in which individuals or businesses borrow money from a large number of people through online platforms, instead of traditional financial institutions.
Investors lend money in exchange for earning a profit or return on conventional platforms, while borrowers gain easy and convenient access to the funds they need.
Debt crowdfunding works with the following steps:
1- Borrowers, such as individuals or businesses, apply for finance on an online platform, specifying the amount needed and the finance term.
2- The platform conducts due diligence on the creditworthiness of the borrower
3- Investors browse the finance requests and select from different options, typically in smaller amounts, to diversify their investments.
4- The borrowers repay the principal amount with profit or interest over the financed amount.
5- The platform manages the entire process, ensuring repayment and transaction transparency.
Find out How Funding Souq Platform Works For Both Investors & Borrowers
Debt crowdfunding involves borrowing from a large number of individuals through an online platform,
while traditional lending involves borrowing from a bank or financial institution. In debt crowdfunding, the platform connects multiple small investors with borrowers, whereas traditional lending relies on a single capital provider.
Debt crowdfunding provides an easy and convenient avenue for fundraising, while traditional lending may require a credit check or other specific requirements.
Read more about: Islamic View of Lending, borrowing & Debt
Finance taken by individuals for personal use, such as home expenses, education, or medical needs, and are funded by multiple investors through a crowdfunding
platform.
Finance taken by businesses for growth, operations, and other expenses. Multiple investors lend money to the businesses, which repay the principal along with interest to the investors
In debt crowdfunding, profit is generated for investors through the profit payments or interest payments for conventional platforms.
Below is the process of how profit is generated:
i- Profit or Interest: When investors finance a borrower, they agree on an profit or interest rate, which represents the investor's profit.
ii- Repayment: The borrower repays the finance over time, which includes both the principal amount (the money borrowed) and the profit or interest (the profit for the investors).
Debt crowdfunding can be structured to be Shariah-compliant by aligning its processes with Islamic principles. In this model,
an Islamic financial institution facilitates business financing in a manner consistent with Shariah. It acts as an intermediary, connecting small and medium-sized enterprises (SMEs) seeking funds with investors, who may be individuals or corporations.
The financing method employed by Islamic financial institutions in this context is Tawarruq through Commodity Murabaha. Under this arrangement, the client approaches the Islamic financial institution to request personal or business financing.
Check out Funding Souq Shariah Compliance Certificate by Dar El-Sharia
Upon approval, the institution and the client enter into a master agreement. The financial institution then purchases a commodity at the client's request and subsequently sells it to the client on a Murabaha basis, wherein the sale price includes a pre-agreed profit margin and is payable in instalments.
Following this, the client resells the purchased commodity through a third-party broker to obtain cash for business needs.
The client then repays the financing amount in instalments over a predetermined period, as agreed with the Islamic financial institution. This structured approach ensures compliance with Shariah principles while enabling businesses to access the necessary funding.
Read more about: Your Basic Guide to Commodity Murabaha
The crowdfunding platform can be made Shariah-compliant by following these steps:
1- Avoidance of Riba: Transactions should be structured in a way that is free from Riba (interest), ensuring no interest is paid or received in any form.
2- Ensuring that only permissible activities are financed through the platform: Shariah does not permit financing or supporting activities that are impermissible, such as gambling, alcohol-related items, or unethical practices.
3- Musharrakah or Mudarabah: The investor and borrower can enter a Musharrakah (joint venture) or Mudarabah (profit-sharing) contract, adhering to the specific terms and conditions of these agreements.
4- Qard Hasan (Benevolent Loans): The platform can offer or accept loans based on Qard Hasan, which are loans provided without expecting any profit or interest, simply the repayment of the principal.
5- Transparency and Fairness: All transactions should be transparent, with clear disclosure of all terms and conditions. Profits should be distributed fairly and in accordance with the agreed terms, ensuring no exploitation or ambiguity (gharar)
Read more about: Gharar: What is it & How to Avoid it?
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
