Part-2: Islamic Private Equity: What Contracts Are Used

In the world of Islamic finance, private equity plays an important role as an investment instrument that offers potential profits through equity participation in companies that have not gone public. Islamic private equity operates under the principles of sharia in every transaction, including in the selection of contracts used. In the first part of the discussion, we discussed the contracts that can be used by Islamic private equity to raise funds from investors, so in the second part of the discussion, we will discuss the contracts used to channel funds from private equity to businesses that apply for financing. 

The contracts used between private equity and the financing recipients: 

In carrying out its business activities in channelling funds from investors to businesses that apply for financing, private equity itself can use several sharia contracts, including: 

Musyarakah Contract 

A musyarakah contract is a cooperation agreement between two or more parties to include capital in a business with a mutually agreed profit sharing.

In the context of a contract between private equity and the recipient of financing, private equity channels funds to the recipient of funds to be used in business activities together with its own funds. The profit from the business activities carried out by the fund recipient is shared by a percentage of the profit between the fund recipient and the private equity. The DSN MUI fatwa that regulates the musyarakah contract is: 

Mudharabah Contract 

Mudharabah contract is a cooperation agreement between the owner of capital (shahibul mal) and the capital manager (mudharib) in which the capital manager is responsible for managing the capital for a certain business and the profit is divided according to the agreed ratio.

In the context of business financing by private equity, private equity as shahibul mal channelled funds to the recipient of funds as mudharib to be managed in business activities with profit sharing as agreed in the financing contract. The DSN MUI fatwa that regulates mudharabah contracts are: 

Murabahah Contract 

Murabahah contract in Islamic finance terms is a contract in which the lender purchases an asset, goods, or services at the request of the applicant customer and sells it to the customer with an additional margin on the purchase price of the asset. In the case of private equity, private equity can provide stock or asset procurement financing to its financing recipients by buying the stock or asset and selling it to the financing recipient with a margin on a murabahah basis. The DSN MUI fatwa that regulates the murabahah contract is: 

Ijarah Muntahiyah bi At-tamlik contract 

Ijarah muntahiyah bi at-tamlik is a lease agreement used for financing where the lender leases an asset to the customer at his request, and the monthly rental price in the transaction seems to function as an installment from the customer to the lender for the asset that he will own with the transfer of ownership of the asset from the lender to him at the end of the lease period. In Islamic private equity, the ijarah muntahiyah bi at-tamlik contract can be used to finance business assets such as equipment or business property by private equity buying the asset and then leasing it to the financing recipient with an ijarah muntahiyah bi at-tamlik contract.  

The DSN MUI fatwa that regulates the ijarah muntahiyah bi at-tamlik contract is: 

Infographic – Private Equity

In the first part of this discussion, we have explained the contracts that can be used by Islamic private equity in raising funds from investors, and in the second part of the discussion, we explained the contracts used between private equity and the businesses that receive financing from them. May Allah ﷻ make access to Islamic financing easier for Muslim businesses. 

Wallahu a’lam 

References

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