Islamic Private Equity

VENTURE CAPITAL AND PRIVATE EQUITY Topic: ISLAMIC PRIVATE EQUITY Hochschule Heilbronn International Business & Intercultural Studies Permitted to: Prof. Ted Azarmi Author: Sinan Kücükzeybek 177875 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a LIST OF CONTENTS LIST OF CONTENTS ..................................................................................................... 2 LIST OF FIGURES ......................................................................................................... 2 INTRODUCTION ............................................................................................................... 3 ABOUT CONVENTIONAL PRIVATE EQUITY ................................................................... 4 HOW PRIVATE EQUITY FINANCING WORKS ................................................................. 5 DEFINITION OF ISLAMIC PRIVATE EQUITY ................................................................... 5 ISLAMIC PRIVATE EQUITY – WHAT IS NEW? ................................................................ 6 ORGANIZATION OF A PRIVATE EQUITY FUND ............................................................. 7 ROLE OF THE SHARI’AH SUPERVISORY BOARD (SSB) ............................................... 8 SHARI’AH AND ECONOMIC CRITERIA...........................................................................10 TARGET COMPANIES .....................................................................................................12 DIFFERENT FINANCING METHODS...............................................................................12 VARIED AND DIFFERENT RISKS ...................................................................................14 RELATIONSHIP BETWEEN LP AND GP .........................................................................15 LIQUIDITY MANAGEMENT ..............................................................................................15 LEGAL CHALLENGES OF ISLAMIC PRIVATE EQUITY ..................................................16 CONCLUSION ..................................................................................................................16 LIST OF REFERENCE .....................................................................................................17 BIBLIOGRAPHY............................................................................................................17 LIST OF FIGURES FIGURE 1: THE NUMBER OF ISLAMIC PE FUNDS BETWEEN 2002 AND 2007 ................ 6 FIGURE 2: HOW IPE FUND IS ORGANIZED ....................................................................... 7 FIGURE 3 THE PRINCIPLES OF ISLAMIC PRIVATE EQUITY ............................................ 8 FIGURE 4: SHARI'AH COMPLIANT INVESTMENT PROCESS ............................................ 9 FIGURE 5: SECTOR FOCUS OF ISLAMIC PRIVATE EQUITY 1997-2006..........................11 2 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a [Bis-millahir-rahmanir-rahim] “In the Name of Allah, the Most Gracious, the Most Merciful” INTRODUCTION Start up a business requires capital, and getting it at the right time is very important. There are several alternatives to fund the start up. To name a few would be: Owner’s capital, equity partner, debt finance, et cetera. In addition, it can be diversified in many options giving the entrepreneur options to choose among. This study highlights the shapes of business financing by Islamic Private Equity (IPE) which comes under equity partner as well as debt financing. In the early 1980s, in Asia the modern Islamic Banking was increasing in importance and at the turn of the millennium it becomes to a global business.1 “IPE market has grown dramatically over the last few years.” Meanwhile the assets of Islamic banks have grown to US$ 700 billion to US$ 750 billion. Despite that the global market volume of about 350 Islamic banks and securities2 lays globally less than one per cent, but today more than 350 Islamic institutions are operating in 90 countries all over the world. We face to some similarities between venture capital (VC) and some traditional methods in Islamic financing. Like for example the active participation, the close partnership, and the quick exit of the private equity (PE) fund but even so they display different features which would be mentioned later. It is hard to appropriate the starting point of IPE, but it has its origins in the early 14th century, in the medieval Islamic societies, partnership arrangements were similar to those practiced in conventional PE. Indeed, financial transactions existed back then but without institutions exclusively devoted to banking or PE financing.3 The first VC activity started in 1946 when the American Research and Development Corporation (ARDC) established by General Doriot. Later, the number of PE investments and the volume 1 Cf. Mahlknecht, Islamic Finance, 2008 Such as Arcapita, Gulf Finance House and Unicorn Investment Bank 3 Cf. Chatti & Yousfi, 2010, and Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 2 3 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a of raised funds have increased significantly. In fact, “the amount of money raised by PE investors has sometimes exceeded capital issued through Initial Public Offering (IPO).”4 In the 1970s, in Silicon Valley, Intel and Microsoft were amongst the most famous projects financed through VC.5 Without the contribution of VCs they wouldn’t have seen the light of day nor at least achieved such a spectacular rate of development until today.6 ABOUT CONVENTIONAL PRIVATE EQUITY According to Lerner, a VC or PE is a “collective investment scheme or reserve capital used for making investments in various equities, and to a lesser extent debt securities according to one of the investment strategies associated with private equity firm.”7 In fact, PE may be defined as a partnership with non-listed companies. The objective of PE financing is to raise capital to invest in many types of firms in all stages (creation, development, buyout, recession…). Such firms as innovative or start-up firms, firms operating in the middle market, firms in financial distress, or public firms that want to go private through buyout financing. Professional intermediaries are providing PE financing with the aim to exit quickly the target company and thereby to maximize their profit. In the main, the PE fund keeps the project in his portfolio for a period of time between 2 and 8 years. Consequently, the entrepreneur’s project cannot be funded for a longer period than the money provided by the Limited Partners (LP). Generally, the investors aim to get their money back and invest in a new deal. The PE fund can exit project by three ways: First: By an Initial Public Offering (IPO) for the more successful projects, called high-flyers. Second: Trade sale, and third: Withdrawal which happens before the end of the first year. The fund is proving its ability to filter good projects from bad ones. Withdrawal as exit strategy is the last way to earn money by selling the hold shares. Third parties are acquiring the shares thus investors will be allowed to realize capital gains. At microeconomic level, PE financing accelerates the growth of Small and medium enterprises (SMEs) by sharing experience and skills, and benefits from PE fund’s professional network of knowledge, know-how and address book/contacts. Whereas the entrepreneur is wealth-constrained and have no collateral to get credit financing, 4 Cf. Chatti & Yousfi, 2010, and Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] Cf. www.theglobaljournals.com/ijar/file.php?val=MjkzOA== [Accessed on 24.01.2014] 6 Cf. Chatti & Yousfi, 2010 7 Cf. Chatti & Yousfi, 2010 5 4 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a and very often have no business experience to manage alone the project, because it is often a first experience. Investors usually accept financing projects with long-term growth potential. Such as firms which are often in the research and development stage that are trying to grow quickly in order to reach the commercialization stage.8 HOW PRIVATE EQUITY FINANCING WORKS As previously mentioned, in PE funds investors have usually an active participation, in contrast with passive financiers. Such investors could be professional (retired) managers who are very often experienced in business, in contrast to entrepreneurs. Such investors are able to use PE securities9, and monitoring and other related elements to solve agency conflicts. Such PE securities may be convertible preferred stocks, and subordinated and convertible debt. Finally, we can say: If the project doesn’t perform as well as originally provided, then PE funds issues convertible debt in exchange for shares and control which diminish the entrepreneur’s profit.10 The close partnership between the entrepreneur and the PE investors bases on confidence. Many proposals were rejected by an often very severe initial review, and the residual proposals are subject to a second review. If it belongs to the surviving ones, the PE investors interview key staff of the firms and even some customers, suppliers and creditors. This means a real dynamic intervention by investors for the company which will benefit from financial resources, complementary skills and some modern and effective modes of management and governance.11 DEFINITION OF ISLAMIC PRIVATE EQUITY According to Sheikh Taqi Usmani12, IPE funds are financed by high net worth individuals or business families, corporations and institutional investors. They diversify their portfolios and raise capital in exchange for high returns. In fact, there are savings of hundreds of millions of Muslims (for example, farmers and artisans) still refuse to deposit their savings in conventional banks. These incredible huge savings are captured in the last years by IPE funds. Such IPE funds provide financing 8 Cf. Chatti & Yousfi, 2010 PE securities and monitoring are mean to decrease agency costs. 10 Cf. Chatti & Yousfi, 2010 11 Cf. Chatti & Yousfi, 2010 12 Muhammad Taqi Usmani is an eminent Hanafi Islamic scholar from Pakistan. He is an expert in Islamic Ju isp ude e, e o o i s a d hadith. He has also held a u e of positio s o the “ha i’ah Boa ds of prestigious Islamic institutions, and is one of the most influential Islamic authors. 9 5 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a to a larger range of investments than would be accessible as a single investor. In addition, these investors have lower risks when they are operating as an IPE fund. In contrast with conventional PE funds, IPE funds invest in companies that are making halal13 profit.14 ISLAMIC PRIVATE EQUITY – WHAT IS NEW? One development worth mentioning here is the unbelievable growth of PE based on Shari’ah principles in the Middle East. While the first Islamic Banks were established in the 1970s, the first IPE funds appear only in the last decade. According to Eurekahedge Islamic Funds Database, the first IPE funds have existed since 2002. To meet the growing demand of Muslims and recently non-Muslims all over the world, the Islamic finance industry has grown appreciably over recent years (see Figure 1), not only in terms of the market volume but also in terms of the creation of innovative and sophisticated financial products which are Shari’ah compliant.15 “Nowadays, many conventional banks operate Islamic Windows in order to attract both Muslim and non-Muslim clients who are more and more cautious particularly after the financial subprime crisis. This shows the attractiveness and the increasing interest for Islamic PE industry.” 16 In fact, it has the aim to avoid interest-bearing instruments. Based on this idea, widely varied product structures were developed in recent years that range from redesign of financial derivatives and securitization to well-structured financial products. 17 Figure 1: The number of Islamic PE funds between 2002 and 2007 (source: Eurekahedge Islamic Funds Database 2008) 13 Halal: strictly conforming to the precepts of “ha i’ah. Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 15 nd Cf. Iqbal and Mirakhor, An Introduction to Islamic Finance Theory and Practice, 2 Edition (Wiley 2011) 16 Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 17 Cf. Mahlknecht, Islamic Finance Einführung in Theorie und Praxis, (Wiley 2009) 14 6 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a The amount of deposits is around US$ 350 billion while the amount of raised funds managed by IPE funds varies between US$ 500 and US$ 1200 billion.18 It was noticed that US$ 300 billion are invested in the Gulf Cooperation Council (GCC) countries.19 GCC consists of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. Indeed, a number of Islamic banks are often investing in growing unlisted companies to generate high yields. Actually, in recent years they have generated high yields in some business lines. (See table 1) ORGANIZATION OF A PRIVATE EQUITY FUND We learned that PE firms are structured as partnerships with two key components: 1. The General Partners (GP) which is responsible as a management team for the target company and, ultimately, the exit strategy. 2. The Limited Partners (LP) who are providing the fund and allow the GP to draw down of funds as required for investments that meet an agreed profile. By comparison, IPE appears more restrictive than conventional PE. In fact, there could be investments which are not in compliance with Shari’ah principles (haram investments) including no investment in interest-bearing instruments.20 In contrast with conventional PE fund, the IPE fund (IPEF) must ask for the approval of Islamic authorities before making any investment decision (see Figure 2). Figure 2: How IPE Fund is organized - source: Wouters (2008) Indeed, they operate in the following way: 1. The Shari’ah committee also called the Shari’ah Supervision Board (SSB) sets the Shari’ah policy of the fund. It recruits a Shari’ah Compliance Officer (SCO) to supervise target companies. 2. Investors raise funds for a fixed period of time to finance the selected IPE fund. 3. The management 18 Cf. www.theglobaljournals.com/ijar/file.php?val=MjkzOA== [Accessed on 24.01.2014] Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 20 Cf. Chatti & Yousfi, 2010, and Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 19 7 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a team (MT) of the selected fund invests only in the more profitable target companies. 4. The SSB checks whether the project is Shari’ah compliant or not. 5. MT and SCO control target firms and report irregularities to the SSB. 6. MT has to disclose information about the progress of target companies to investors. 7. The IPE fund exits the target company at a fixed date and it shares the losses and profits with the entrepreneur. ROLE OF THE SHARI’AH SUPERVISORY BOARD (SSB) The executive committee of the fund selects the target companies. This function is delegated by the LPs, to keep their interest, because often they do not have business experience. As mentioned above, in Islamic finance, alongside to the traditional executive committee, there is a Shari’ah committee which approves the decisions of the executive committee. They retain and select only Shari’ah compliant projects which are making only halal profits. Figure 3 and 4 set out the principles of Islamic Private Equity and the Shari’ah compliant investment process. Figure 3 The Principles of Islamic Private Equity - source: Abraaj Capital Analysis (2006) The Shari’ah committee comprises at least three religious scholars who are not only experts in the Islamic religion and its applications but also in financial law. 21 The SC or SSB must approve whether the selected projects are in accordance with the principles of Shari’ah or not. They must interpret the Qur’an22, the Sunna23 and the Hadith24 which are the source of Islamic law. 21 Cf. Chatti & Yousfi (2010), Cf. Wouters (2008), and Cf. Iqbal and Mirakhor (2011) The Qu ’a is the hol ook hi h o tai s the e t al eligious te t of the Isla . 23 This is the se o d sou e of the Isla faith a d efe s to the P ophet’s a ts a d o ds hi h a e elated to his practice of faith. It explains and transmits the Qu ’a . 24 These refer to traditions or stories of the Prophet. In contrast with the Sunna, which was practiced, the Hadith are records of what was practiced. However, they have become a controversy between Islamic groups since there are a number of interpretations of them. 22 8 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a In addition, they must interpret ijma25, Qiyas26 and Ijtihad27 which are used to provide interpretation and therefore “facilitate future development and implementation of the Islamic judicial system.” Also the must review all the stages of the investments to ensure that they are Shari’ah compliant. At the end of the year, they will check the financed firms whether they are still active in accordance with the Shari’ah. “Some projects can become ineligible when new elements occur such as research and development activities that can be useful to the weapons industry.” A SCO has to supervise all aspects of the business, such as portfolio management, trading practices, operational matters and so on, whether the firm is operating in accordance with the Shari’ah law. He has to report irregularities to the SSB. “In addition, SCO provides Shari’ah expertise on documentation, structuring and investment instruments.”28 (See Figure 4) Figure 4: Shari'ah compliant investment process - source: 2nd Islamic Venture Capital & Private Equity Conference (2009) 25 This is the consensus of the Islamic community. This is a deductive analogy by which a jurist applies to a new case. Cf. precedence. 27 This is independent judgment provided by scholars of Islamic law for which clear principles and procedures are stipulated in the Qu ’a and Sunna. 28 Cf. Chatti & Yousfi (2010), and Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 26 9 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a Table 1 illustrates how high are receivable ratio of some Islamic benchmarks. Some activities are not completely forbidden, but should be avoided because they may prove difficult situations, e.g. the hotel industry. In some countries, they are accepted otherwise not permitted in other countries. In the hotel industry and supermarket chains there is the danger of derivation of marginal returns from some haram activities.29 Table 1: Financial screening ratios - source: Wouters (2008) SHARI’AH AND ECONOMIC CRITERIA The business in which an IPE fund cannot raise capital varies from one country to another, from one region to another and even from one SSB to another. There is no unified disclosure code. But the following list summarizes some industries which are known clearly not Shari’ah compliant:        Any transaction related to pork products and blood Drugs, tobacco products, alcoholic beverages and in general any activity related to intoxicant products Adult Entertainment / Pornography or obscenity in any form Gambling, casinos, lotteries Any activity related to the arms’ industry Trading on human cloning, human fetuses. Some non-compliant financial activities based on interest, speculation and insurance In general, IPE funds only finance such companies under the condition that the haram30 income does not exceed five per cent and sometimes 15 per cent of the whole gross income. Figure 5 illustrates sector focus of Islamic Private Equity funds 29 30 Cf. Chatti & Yousfi (2010) P ofits hi h a e ot i o plia e ith the “ha i’ah la 10 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a from 1997 to 2006. Many Islamic scholars consider additional financial criteria when they have to finance publicly listed companies. Total debt: If total interest-based debt divided by assets exceeds (or is equal to) 33 per cent, the IPE cannot raise capital for the firm or the project. Total interest-bearing securities and cash: If the ratio of total cash and interest-bearing securities to assets is higher than 33 per cent, the investment cannot get IPE financing. Accounts receivable: If the ratio of accounts receivable against total assets is higher than 33 per cent. Threshold haram income: Any haram income of a non-compliant company that does not exceed five per cent of the whole gross income is considered marginal or accidental. Such moneys originate from haram income should be isolated and given to charity. 31 Figure 5: Sector focus of Islamic Private Equity 1997-2006 - source: Zawya/KPMG (2006) Even if the target firm satisfies some of the key performance indicators, it does not automatically become in line with Shari’ah law. In fact, the essential criterion for IPE financing is the entrepreneur since the mutual trust and the chances of success depend on it. “The evaluation of the promoter overrides the development plan and sometimes even the outlook of the market and the products.” In fact, Mudaraba32 financing is made without banking collateral thus to give a critical importance to human factors is needed. Primarily it depends on the qualities of promoter, his competency, honesty, integrity and personality. 31 Cf. Chatti & Yousfi (2010) Only IPE fund carries the financial risk, appropriate an agreed profit sharing were applied between IPE fund and entrepreneur. Thus entrepreneur gets compensation for his efforts. 32 11 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a TARGET COMPANIES As mentioned previously, an IPE fund prefers companies with high potential growth. To make a company favorable for Islamic investment, its debt level must be very low or zero. Generally, real estate projects and infrastructure were preferred by Islamic investors (see Figure 3). In addition, other funds are specialized in VC and in the technology sector. For example Injazat Technology Fund raised about US$ 50 million in Dubai 2001. It describes itself as the first Shari’ah-compliant VC fund, dedicated to technology, media and telecommunications in the MENA region.33 Capital investors are looking for projects that are in conformity with the Shari’ah, economically practicable and able to provide financial returns better than other asset classes. Besides financial and religious criteria, target companies must also fulfil economic conditions, even though these may not provide by Shari’ah. The projects will be selected by their both economic and social aims. Economic aims:    To satisfy the demand and the financial operations of Muslims today in the coverage of the principles and precepts of the Shari’ah. To invest the capital of Muslims into projects those are generating helal profits. To establish subsidiaries of Islamic banks in both Muslim and non-Muslim countries by the implementation of innovative and varied activities. Social aims:   To promote and consolidate co-operation amongst Muslims. To promote social development through almsgiving (Zakat34) and the creation of funds employed in charitable works. DIFFERENT FINANCING METHODS Besides the similarities between conventional and Islamic PE, there are some differences between them (see Table 2). In fact, Islamic PE financing is based on the Profit and Loss Sharing (PLS) principle. There are three modes of financing: First, Mudarabah in which the IPE fund is not only a banker who lends money. If a project 33 MENA means Middle East and North Africa Zakat institutionalizes the systematic giving of certain percentage (nearly 2. pe e t of o e’s ealth each year to benefit the poor. It does not include charitable gifts given out of individual generosity and is not a replacement for taxes, but is seen as a form of compulsory worship, purification and redistribution. As it necessitates a regular reassessment of net wealth, Zakat is thought to help concentrate the mind in e ou agi g o plia e ith “ha i’ah i all fi a ial deali gs Ala , 200 . 34 12 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a is successful the entrepreneur and the IPE fund share profits, otherwise they share losses. Exceptionally, the entrepreneur is misbehaving and is responsible for the project’s failure. In that case the entrepreneur will be charged for the losses. Table 2: Conventional versus Islamic Private Equity - source: Abraaj Capital Analysis (2006) In Mudarabah, the IPE fund raises financing, and the entrepreneur brings skills and know-how to the project. Furthermore, the entrepreneur has all the control rights, thus the IPE fund cannot participate actively to the management. However, it will monitor the project through a system of regular reporting: at least once every three months, the target company has to disclose commercial, human and financial information. The content is set at the date of the signature of financial contracts. In Conclusion, we can say that the IPE is considered as an alert partner. Profits are shared thusly: A successful project makes the entrepreneur is paid for their efforts and know-how while the IPE fund gets the earnings of their capital. “Otherwise, losses are borne solely by the capital provider and the entrepreneur losses time and energy.”35 Finally, we can say that the Mudarabah financing is very close to the VC’s financing that used to finance innovative SMEs and start-ups. Second, Musharaka all parties must contribute jointly to the funding of the target. Consequently, they are involved actively in the project. Losses are shared between them according to their financial contribution or on pre-agreed ratios. Unlike Mudarabah, IPE fund is present in the board of directors. The Musharaka principle is similar to non-venture private equity (buyout, development, etc.) in conventional PE. But in latter case the project’s level of debt is significantly high, so the project must be very profitable to cover the principal of loan and the interests. Third, Wakalah financing mode enables to authorize one party to assign the power and rights to act in favor of the other one, based on agreed terms and conditions. “On the contrary, conventional PE is based on effective control and active monitoring.” 36 35 36 Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] Cf. www.worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 13 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a VARIED AND DIFFERENT RISKS Both Islamic PE fund and the conventional one are exposed to significant and negative fluctuations of prices and therefore to the market risk, as well as default and liquidity risks and adverse selection problems of targets. However, to overcome these risks, there are different approaches. In conventional PE, future contracts decrease the exposure to market risk. But this led to speculation which is prohibited in IPE financing. In addition, Islamic PE does not allow forward sale of goods we do not own at the date (t=0). Thus, futures contracts such as options and futures are not coincide with IPE financing. But there is different variation of these contracts. “Despite the fact that these products are largely inspired by conventional ones, they do not offer the same guarantees particularly in terms of coverage of risks.” These products should protect both the entrepreneur and the PE fund on basis of the Profit and Loss Sharing (PLS) principle. As a result that some projects are prohibited for IPE fund, diversification among sectors and activities is not always possible. In fact, the IPE fund faces therefore higher risk than their conventional counterpart. For instance, the entrepreneur bears lower risks than in interest based financing system and does not provide collateral and guarantees. As a consequence, “Islamic PE funds are more selective than conventional one.”37 They are exposed to a different structure of risks because of the high number of agreements to ensure transparency. It takes time and need the participation of many contractors. “This poses new legal risk particularly for Islamic PE operating in conventional systems or conventional PE operating in Islamic countries.” This explains why the average financing cost in Islamic banks is higher than in conventional one. Eventually, Islamic PE fund is also subject to liquidity risk in the sense they must hold shares for a fixed period of time (5 years in average). They cannot immediately convert their shares into cash. But they can sign a diminishing Musharaka contract which is a special kind of Musharaka contract. It enables IPE fund to sell gradually their shares to the entrepreneur. Therefore, the money invested is recovered and the fund will not be constrained to wait for the exit date to get their capital back.38 37 38 Cf. www. worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] Cf. www. worldfinancialreview.com/?p=1256 [Accessed on 24.01.2014] 14 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a “The risk of bankruptcy is the most important risk that could be faced by the IPE fund.” If the project failures, the fund may lose the monies initially raised. Furthermore, according to the PLS principle, IPE operators cannot claim the restitution of funds. Second, the IPE fund selects target companies operating in both home countries and foreign countries. Consequently, they are exposed to foreign exchange risk. Ultimately, the IPE fund may face excessive risks like that “the entrepreneur may behave in an opportunistic manner to get non-transferable and private benefit particularly under asymmetric information.”39 RELATIONSHIP BETWEEN LP AND GP A not too broad management team is premised and it should be ready to make the projects profitable. “The managed portfolio should be within the scope of the managerial expertise as well as skills of the team.” First, the GP identifies firms that meet Islamic PE fund’s investment strategy particularly those that match the return on investment (ROI) criterion. Second, the management team should be able to create value and to make the business as profitable as possible. Consequently, the members of the management team should have a range of skills and experience in business. Eventually, they schedule the exit strategy since it is the ultimate way to ensure gains. According to the structure of IPE fund the GP benefits from profit share or management fee that may be dependent on a mixture of performance-based criteria and a fixed fee. LIQUIDITY MANAGEMENT At the beginning of the investment there must remain about 20 per cent of the raised capital in the fund for some period of time (one or two years). It is kept liquid to finance short-term strategies in case that the target company still needs to be financed. However, the money cannot be deposited in interest-bearing banks since interest is one form of Riba40. But they can be used to finance some Shari’ah compliant projects such as commodity. “In fact, customers may ask their bank to buy 39 40 Chatti & Yousfi (2010) Means haram profit because of interest gains 15 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a specific assets and, in turn, the bank sells them on a deferred sales basis. The difference between the acquisition and sale prices is the bank’s profit.” 41 LEGAL CHALLENGES OF ISLAMIC PRIVATE EQUITY There are some restrictions in the form and the content of the legal documents to make them Shari’ah confirm. “One example is the guarantee used to fix the exit price and exclude the risks of losses” that is contrary to the Shari’ah. At the exit date, the value of the target company is set by the fair market value, in contrast with conventional PE where this value may be fixed at the date of signature of financial contracts (required future value). In capital development and Leverage Buyout, even IPE funds use debt, but leverage must be structured in a specific way to be accepted by SSB. In conclusion, companies with high level of debt should restructure their capital such that total debt does not exceed 33 per cent of the capital (see table 1). CONCLUSION According to many professionals, Islamic Private Equity is a booming industry and strives to meet the demand of both Muslims and non-Muslims all over the world. The lack of liquidity in the West, the recent oil boom, and the rapid rise of credit demand are few of many reasons that lead to the development of Islamic Private Equity. It has proven as a sustained concentration of capital that performed very well in the recent crisis. To conclude, there are still some difficulties in implementing IPE particularly in non- Muslim countries because of restrictive regulations in accordance to Shari’ah principles. 41 Chatti & Yousfi (2010) 16 Te pape fo Ve tu e Capital a d P i ate E uit Finance Project WS2013/14 “e i a LIST OF REFERENCE Financial Times at www.ft.com/intl/islamic-finance-dec2011 [Accessed on 18.01.2014] Global Islamic Finance Magazine at www.globalislamicfinancemagazine.com/ [Accessed on 18.01.2014] Indian Journal of Applied Research at www.theglobaljournals.com/ijar/file.php?val=MjkzOA== [Accessed on 18.01.2014] Islamic Finance Wikipedia at wiki.islamicfinance.de/index.php/Main_Page [Accessed on 18.01.2014] Islamic Private Equity – Opportunities in Islamic Finance (Mohamed Ali Chatti & Ouidad Yousfi, 2010) at http://mpra.ub.unimuenchen.de/28705/1/MPRA_paper_28705.pdf [Accessed on 10.01.2014] QFinance the Ultimate Financial Resource at www.qfinance.com/home [Accessed on 18.01.2014] The World Financial Review at www.worldfinancialreview.com/?p=1256 [Accessed on 18.01.2014] BIBLIOGRAPHY An Introduction to Islamic Finance – Theory and Practice (2nd Edition, Iqbal & Mirakhor 2011) Islamic Finance – Einführung in Theorie und Praxis (Mahlknecht 2009) Islamic Finance – Islam-gerechte Finanzanlagen und Finanzierungen (Gassner 2010) Islamic Retail Banking and Finance (Sohail Jaffer 2006) 17