Tuesday, November 6, 2007

A Window of Opportunity for Islamic Financing

The definition of an entrepreneur is one that has in-principle a sound business “idea”, but without significant amount of money to convert that idea to a business venture. Financing such new venture is one of the major hurdles facing most entrepreneurs. The questions of how and when to raise money and from whom are frequent topics of concerns.
In order to raise money, the entrepreneur typically needs more than an idea. He/she will have to invest some money in the idea, such as doing a market study (also called feasibility study), in order to convince prospective providers of capital that the idea has strong potential.
At the initial stage when the business is in the start-up phase, the risk is at its highest. Therefore, equity capital is usually most appropriate, since it will assist the business to get “off the ground”. This is required to demonstrate commitment on the part of the entrepreneur.
The entrepreneur can obtain these “equity funds” by borrowing from family members, friends, and from a personal bank loan or even credit cards. It is expected the entrepreneur will exhaust his/her own funds before the business generates real cash from operations. Thus, he/she must approach outside sources for equity capital. This task will be easier and quicker to generate such capital, if the business does not require much capital (service industry).
One important source of equity capital is private wealthy investors. In order to approach these individuals, the entrepreneur will need a business plan which must be short and concise and attempts to stimulate interests among potential investors.
Another practical source is the Islamic finance companies who do not practice usury (borrowing/lending based on interest rate). These companies are cash rich, always searching for sound real investment ventures. Since they will be taking high risk (unlike murabaha), they seek a high rate of return on their investments; target returns of 30% — 40% are the norms. In exchange for this high return, these Islamic finance companies will often provide advice to the entrepreneur. They have experienced people in all areas of the business (unlike the bankers). They can often provide useful counsel on the problems a company may experience in the start-up phase.
Some Islamic finance companies will invest a mix of equity capital and interest-free debt. It is usual that those companies will have a priority claim on the assets of the business. The unique feature of these Islamic finance companies is that they could become equity-partners with the entrepreneur in his/her new business, besides getting back their original investment. Ultimately the goal of an entrepreneur is to convert his/her idea into a business venture that will generate cash value; he/she invests today in hoping to generate cash flows tomorrow. Therefore, the entrepreneur must understand and manage business and financing risks.
Any analysis of investment or financing decisions must focus on cash, after all as the saying goes “Cash is King”. Cash income is not the same as net profit or net income as reported in the financial statements. The income statement summarizes the matched revenues and expenses, while the cash flows statement focuses on cash inflow and cash outflow. Entrepreneur must measure profitability of the venture on the basis of his/her initial investment and future cash inflow (cash to be received in the future).
Most importantly, the entrepreneur must be aware of the four major stage of his/her investment. Initially, a small investment of say SR100,000 to SR1 million is needed to support an entrepreneur’s exploration of the idea and the writing of the feasibility study.
Once the company is ready to start operations, more significant funds are needed depending on the industry chosen. Islamic finance companies will assist the entrepreneur in recruiting affective management, establishing efficient management practices and providing access to suppliers, banks and potential customers.
Once the company has an organizational structure in place, a working product or service and may be some revenues, there will be a need of additional funds which will be used to establish the company’s first major marketing efforts and to enhance its product or service, or to expand it operations.
The last stage of financing is typically provided for working capital and fixed assets (plant and machinery) needs to support the growth of a company with active production and some profits.
For Arab society to prosper and function smoothly, the number of market-disciplined entrepreneurs must increase. A deeper sense of solidarity is required from the community so that instead of pursuing narrow selfish interests as practiced in the Arab world nowadays, they bring about common good more expeditiously and effectively.
These entrepreneurs must be the type who play by fair rules of the market place. They must not depend on special privileges and preferential treatment extend to them by government. They must have a deep sense of social responsibility which lead them to search for more ways by which they can do more for the society and contribute more to the common good of the country.
For Arab entrepreneur to succeed, he/she has to gain knowledge of the environment in which business is done, understand the conventions of commercial life, and has to be fluent with the methods of employing labor and capital. In this general context Islamic finance companies have a fundamental role to play in identifying, stipulating and encouraging entrepreneurs. Without them, all other financial activities by the Islamic finance companies are based on usury laws operating within the current world monetary system.

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