The origin of the Venture Capital operation and practice are believed to have been derived from the Islamic world, using the concept of mudharabah by the Arab traders. This concept was then formalized by Muslim jurists and embodied in Islamic law, known as Islamic transactions or fiqh muamalat. The mudharabah concept then developed and spread to other parts of the world as Islam spread. This was obvious in the Ottoman State, where there were manufacturing and trading of fabrics, production of pillows and shoes that were funded in the form of venture capital (Cizacka, 1996). It then spread to Italy and other parts of Europe in the 15th century (Cizacka, 1995). The practice of Venture Capital (VC) using the concept of mudharabah had tremendously increased the number of entrepreneurs in Europe at that time.
Islamic Venture Capital (Islamic VC) is generally structured based on the concept of risk-sharing. Mudharabah and musharakah are deemed as the most common form of Islamic VC. This is because of the following reasons as listed by Cizacka (2011):
1. VC is identical to mudharabah, and the practice is part of the Prophet’s sunnah.
2. Unlike a loan or a credit transaction, there is neither interest nor collateral in a venture capital transaction. Finance is simply provided in return for shares. This is equity finance.
3. Since the entire system is based upon equity finance, there are no loans and where there is no loan, there is definitely no riba. If a third-party guarantee is provided in order to encourage the public, only the principal is guaranteed by the state.
4. VC is a profit-and-loss sharing system. Profit-and-loss sharing takes place in accordance with Islamic rules. Profit in a venture capital company is shared according to mutual agreement. This mutual agreement is expressed in the amount of shares the VC company obtains from the entrepreneur. Loss goes entirely to the venture capitalist financier. This is without any doubt mudharabah.
5. A VC company is established just like a classical Islamic shirkat, that is, as a partnership for limited duration, usually ten years.
6. Risks are truly shared and the venture capitalist does not demand collateral from the entrepreneur.
There are a number of models that can be used for an Islamic VC, such as mudharabah, the different forms of contractual musharakah, and hybrid forms of these contracts, like the Two-Tier Mudharabah Model (TTMM) or musharakah mutanaqisah (diminishing partnership) (Iqbal and Molyneux, 2005). The table below presents the different models that can be used for venture capital financing and their compliance in terms of Shariah.
