the best source of corporate funding without falling into sharia violations

Borrowing in order to increase production capacity or pay the company's obligations and what is the difference between participation to obtain profit and between obtaining a return on the loaned money, is financial leasing or sale with re-lease one of the forms of loans and borrowing?

Ashraf Hagar - • Corporate finance management

In the Name of Allah, the Most Gracious, the Most Merciful,

peace and blessings be upon the prophet

“The best sharia-compliant source for corporate funding”

“From your experience over the past 25 years, what is the best source of corporate funding without doing anything that is deemed contradictory to Sharia? Do loans really ruin businesses?”


Decision makers in all companies always confront fateful decisions regarding borrowing, whether in order to increase the production capacity of their companies or to pay off obligations arising from losses incurred by the company due to a circumstance. A question then comes: is resorting to banks for borrowing is a good option or not? I am not exaggerating when saying that such decision frustrates the decision maker for months and even years, especially that many consider the deterioration and the downfall of companies accompanied by borrowing decisions, even if based on elaborate scientific studies that include all the scopes that would support the validity of the decision. Overwhelming circumstances always result in the demolition of all these studies that confirmed the feasibility of borrowing!!

These circumstances change all the studies referred to, not only at the level of companies but also at the level of countries as we always find countries that sign borrowing contracts- after conducting studies proving the feasibility of borrowing - exposed to "devastating circumstances that were never taken into account" and these loans turn into a scourge on the state and its decision-makers.

Adam Smith’s Invisible Hands

All of this does not diminish the importance of scientific studies, but just as the famous economist Adam Smith introduced the theory of the invisible hand (Wealth of Nations 1776). We should also admit that there is a hand that intervenes in the borrowing process and turns it into a circle of hell once the contract is signed, and it leads to the downfall of the entity and the decision-maker.

Anyone doubts this can refer to the crises that borrowing countries and companies face, as well as the crises that affect the people surrounding them, and it seems obvious that the issue goes beyond material reasons. As clarified, the decision-maker we are talking about spared no effort in addressing all the reasons that lead to the validity of the borrowing decision, and the financial markets usually support such decision saying all large companies resort to borrowing. The truth is that this information lacks accuracy. All large companies don’t borrow because they know its harmful consequences. However, small and medium-sized companies resort to it as the decision makers therein have not reached this clear vision yet.

The Sharia justification for the Invisible Hand theory

Based on the foregoing, carefully read the following Quranic verse (God has permitted trade, and has forbidden usury), and the punishment as mentioned in Quran is (then take notice of a war by God). It is what we referred to earlier by the term “overwhelming circumstances" that were not considered.

This leads us to the answer of the question, "Do loans destroy businesses?" Yes, they destroy companies and economic entities.

What is the ideal path of borrowing?

A question arises about the proper ways for borrowing as it is a need for companies that cannot be overlooked, and we’ll answer this question through the following axes:

1) the only borrowing that is allowed in Islam is qard hasan, benevolent loan “who is he that will give Allah qard hasan,” (Qur’an 57:11) and (Establish regular prayer and give regular charity and give Allah qard hasan.” (Qur’an 73:20). There are no other types or names for it.

2) Partnership is an alternative that is based on Sharia where the losses are borne if they occur under any circumstance.

What is the difference between partnership for obtaining profits versus getting returns on the borrowed money? If the results are the same?

This raises a popular topic for discussion, which is the difference between forming a partnership for obtaining profits and obtaining a return on the borrowed money, as the outcome is almost the same! It is the same intellectual approach adopted by the Jews in the past. Allah told us that they said, "selling is like usury" and the fact that selling is completely different from usury in terms of several things. Every seeker of truth can find, and this can be embodied in the following:

1) the person who sells is the trader, and the lender is any person engaged in the business of making loans.

The difference between the merchant and the lender

The merchant is completely different from the lender as he bears the risk. He simply gets goods or services and keeps them and then uses promotional strategies in order to sell these goods and services for a profit, and during this he bears a great risk as he might fail in selling his products, or he might get rid of them without profit or not selling them at all because there are no buyers, which is why the Sharia favored the merchant because he throws his loads on Allah and trust him. That is why Allah allows selling. However, the situation for the lender is the reverse. The lender never bears the risk. He never buys goods and services in advance, but he obtains a promise from those who want to get the good or service before he finances it. Always note that the lender does not bear the risk of purchasing goods or services as he may come across any of the following risks:

a. The inability to sell in the first place for reasons such as: the expiration of the products, their incompatibility with the public taste, or the end of the selling season.

b. Selling at a loss or with limited profitability due to market conditions.

Why did Allah prohibit financing activities in general?

All of the above clarifies why the Islamic Sharia does not allow any interest financing activity on earth, because they are not like merchants at all, they didn’t trust Allah and, consequently, do not throw their loads on him. They won’t buy products in the hope that someone will buy it, therefore, they always wait for the customer and then get his signature and even oblige him with Penalty clauses in case of non-execution after the lender has obtained the product. This explains to you the nature of the punishment that both the lender and the borrower receive as they both seek false security in other than what Allah has prescribed. To put it simply, the lender is looking for security from loss and the borrower is looking for savings in repaying amounts less than those that would have been paid to the partner, so Allah punishes both by throwing unexpected and difficult circumstances that turn this deal into a circle of hell.

Based on the foregoing, you should realize-God bless you- that the Prohibition of financing activities is a prohibition of the activity itself, and there is no room to compare it to, for example, the installment selling, which is one of the famous examples in modern life, and the truth is that the difference is great. Now, we need some reflection. Installment selling if done through the merchant will be halal, but if the same process is conducted through the lender will become haram! So, if a merchant offered a commodity for 100 cash and a year for 200, and a lender offered the same commodity for 100 cash and a year for 200 as well, the first transaction is halal and the second transaction is haram. It's the activity and not the financial transaction as the financial transaction is the same in both.

What are the cases of commodity intermediation whether real or unreal?

Such procedures do not change cases of mediation, whether real or unreal

In the case of real mediation, the contract is signed on a product that has material form- (taking into account that the borrower does not need the commodity, but uses it in order to say that the commodity is mediated).

Unreal cases of commodity intermediation are only documents that are issued to confirm that the lender purchased the commodity before selling it to the borrower. Obtaining a contract for the purchase after obtaining a promise from the buyer denies your merchant activity! You are not a merchant if you are not holding the responsibility of losses. Therefore, you can now understand that the issue is not in the name of the seller, is he a merchant? is his name a lender? or is the commodity brokered for unreal purposes? The transaction is valid only if you bear risks.

Is financial leasing or sale-leaseback a form of sham transaction?

Similarly, mixing up names is done to bring confusion among business owners, for example, the so called "financial leasing contract" is also a forbidden contract. Obviously, the contract name mixes the halal with haram. You will remain baffled, knowing that a lease contract is undoubtedly approved by Sharia, but a financial leasing contract is doubtful. If in need, you will be ready to accept it. In the financial leasing contract, the lessor buys the asset from the seller after taking a promise from "the lessee". The lender then resells it to the borrower in instalments. As it seems to the reader, the transaction as a whole is halal except for a promise of purchase.

A sale-leaseback contract is also an old trick that is intended to finance convincingly. The lender did not buy the premise from its owner until he checked that he would buy it back. Otherwise, he won't buy the premise at all. Thus, it is a financing transaction intended to circumvent legitimacy, and the person engaged in such process is not a merchant as explained above.

1) Your criteria in judging any transaction should be as follows, if the lender bears the possibility of loss that results from business circumstances (not from default or negligence), this is a valid transaction (halal). However, any contract that exempts the lender from loss is not valid (haram).

2) By the same token, the real estate financing contracts under which the state sells its units in cash to a bank and the bank then resells them is a valid transaction (halal) because the bank played the role of the merchant. The bank bought the units first, and the risk was transferred to it. Even though the bank resells them later to customers in installments, the transaction is valid. On the contrary, when a person buys a unit from the state through banking channels after obtaining the customer's commitment that he will pay installments to the bank, the transaction is not valid because the bank then played the role of the financier (prohibited as an activity).

3) Is the change in interest rates means that the lender is trading? indeed, anyone who is engaged in trade understands that it makes no sense to change ratios. Profits are calculated through the income statement, and the profit and loss are distributed according to their ownership percentages.

4) From the previous question you can establish a fundamental principle that the element of time is not present in the formula of the partner's profits.

So, if we assume that the equation of profit calculation is = capital value * Profit ratio of the income statement * time period the money remains in the company

Such equation is not approved by Sharia because Sharia forbids the existence of a time dimension in calculating profits. Undoubtedly, the entry of partners and a group of other partners must be separated by a financial centre that clarifies the dividend limits for their profits.

5) The lack of financial management will always lead you to fall into financial troubles and resort to borrowing funds that destroy the company.

6) In Sharia, to make money from money is forbidden – wealth can only be generated through legitimate trade and investment in assets.

Why decision-makers always prefer borrowing over partnership?

The answer is that the decision makers always find tons of advantages surrounding only the borrowing decision, such as:

1- The lender approves much lower return rate than that requested by the participant, and you can understand this from the following example. Imagine that the capital of an enterprise is 100 and would like to get another 100 to expand. There are two options, either to borrow or to find a partner, knowing that the ratio of net profit to its capital is mostly 20%. A lender would offer you the 100 for 15% or less of the capital (not from the earnings of the income statement, which may be more) while the partner would ask for 50% of the profits, which in this case will be 20% of his capital, if not more. Thus, the lender always asks for a lower percentage than it should be as he knows that you will fail to pay one day and these debts turns into assets as he wishes. This is expressed in Quran in the following verse (whatever riba you give so that it may increase in the wealth of the people, it does not increase with Allah) (30:39). The purpose of the lender is not to get a return, but to turn these funds into assets by seizing the borrower's assets when he fails to repay, which will inevitably happen!

2-The lender will not participate in making the decision and accordingly will never ask about the situation of the company and the market, or if the profits increased or decreased, which is a normal reaction because he receives his returns on the capital regardless of what may occur:

a. you earned more than the agreed rate of return

b. you incurred losses

So, what is the best source of corporate funding without doing anything that is deemed contradictory to Sharia?

Under modern conditions, the best financing options are:

1- Getting a partner through

a) using a specialized crowdfunding platform

b) presenting the company's documents to one of the investment funds interested in the sector

2- Launching the company on the stock exchange, whether the Nile Stock Exchange or the Egyptian exchange.

For any inquiries regarding the executive procedures, please feel free to call 0226909968

Ashraf Hagar

Chairman of ( Egyptian Certified Public Accountants )

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