English
Musharakah – which comes from the Arabic word to partner or to share – is, as the name suggests, a Shariah-compliant agreement where two or more people enter into a partnership or joint venture.
Just like any form of partnership, it sees the parties commit their time, labor, and/or capital into a venture with the goal of sharing in the returns of that business. It is also a method by which somone can obtain financing without having to resort to interest-bearing funding.
As with all things related to Islamic finance, Musharakah comes with its own rules, methods, advantages, various types, designed to be Shariah-compliant, fair, and spread the risks of financial loss.
Partners enter into a Musharakah by contributing capital. This, however, does not necessarily mean financial capital – although contributing financing is important to start operating, so at least one partner should pitch in financially.
It could also mean contributing assets to the venture, including real estate, property, a production facility, etc. or labor and expertise. As with a conventional partnership agreement, the contribution of the partnership does not have to be equal.
Partners must agree on the outset on the profit-sharing ratios in the venture, which will be distributed pro-rata at the end of the contract period or financial year. These ratios must be set out in percentages (as opposed to individual shares in a business).
The ratios need not be determined by financial contribution, meaning that an investor that contributed the most financially isn’t necessarily entitled to the majority of the profits, as labor and time can count as capital contribution.
One of the key elements in a Musharakah is that loss is shared among all the partners in proportion to their contribution and ratio established in the contract. That means if the business incurs a loss, every partner must bear the financial burden of that loss according to their contribution.
In a Musharakah, all partners have the right to take part in the management of the business, although this isn’t an obligation. Partners can choose to appoint someone to act on their behalf.
One of the key elements that distinguishes a traditional Musharakah from its non-Islamic counterpart is that (generally speaking) liabilities in the business are unlimited.
Meaning that each partner could be held personally liable for the debts and obligations incurred by the business according to their share in the business. This is in stark contrast to limited liability companies, where the partners are not personally held liable for the business’ debts.
That said, in contemporary Musharakahs there are mechanisms by which partners can shield their personal assets.
This is done either through a “Diminishing Musharakah” (more on that below) or by structuring the business under a separate legal entity that limits the partners’ liability. This, however, would require careful Shariah and legal consultation.
Partners can exit the venture at anytime they wish and terminating the partnership. Each partner has the right to withdraw under certain conditions, including that their exit does not cause any losses or damage to the business and after providing proper notice. Terms for dissolution of the partnership, which includes distribution of profits, losses, assets and capital, must be outlined in the contract.
This is a type of partnership which is formed for a specific project and for a specific duration, with termination taking place once that objective is completed or time duration expires.
This is a long-term agreement without any limitations put in place on the duration of the agreement.
This is a type of partnership agreement, whereby one partner gradually buys out the interest and shares of another over time until they own the asset completely.
This is the primary mechanism by which Musharakahs are used to fund the purchase of assets such as real estate or equipment.
In this case, since the partnership is formed to purchase a particular asset at a set price, there is an already-established ceiling on the liability incurred by the partners.
It goes without saying that in setting up a Musharakah and in all its activities, the venture must abstain from any form of activities forbidden in Islam, including gambling, overspeculation, trade in illicit goods, and interest-bearing financing. As noted, by its very nature, Musharakah is meant to be an alternative form of financing to interest-bearing loans.
Read more about: The pros & cons of Musharakah contracts
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
