If you’re venturing into the Gulf to raise money, you need to have at least a basic understanding of Islam and how it affects private equity investing. We recently came across a fund-raiser at a Gulf investment conference who was passing around a PPM that promised fixed rates of return on participation in its fund, a practice that is forbidden in Islamic risk capital. It was but one example of the ignorance that some general partners bring with them into the Gulf region that insures failure in advance.
Remember this above all else: Islam in the Gulf Region is not merely a religion, but the basis of the government, financial, regulatory and legal systems of the Gulf’s countries.
Firms and funds venturing into the area to raise money will encounter limited partners that are in many cases “Hallal” or “Shariah-compliant.”
The Koran incorporates tenets relating specifically to risk investing. Interpreting those 1,200-year-old tenets in the framework of modern investment allocation theory and practices is at times, challenging. It’s not likely that an Arab LP will require that your next fund is compliant with Islamic practices—most of the region’s key LPs are tolerant of non-believers. But as Islamic finance grows, it’s worthwhile to have a modest understanding of how religion and venture capital overlap.
Here are the cliff notes on being Shariah-compliant:
• Certain types of investments are prohibited: gambling, pornography and prostitution, weapons or defense industries, nuclear energy, areas of agriculture relating to certain foods, companies involved in unfair practices, pollution-producing industries and firms involved in destruction of the natural environment.
• Certain types of investing are encouraged: industries that promote good in the world and industries that promote well being in the communities in which limited partners LPs are based.
• Business partners must behave with fairness toward each other, fulfill their obligations and maintain the highest degree of integrity and morality in all business operations. They are obligated to consult one another on all important decisions.
• LP and GP interests must be aligned, and all aspects of business transactions must be fully disclosed to all parties, who must be fully “engaged” in the business.
• Limited partners cannot make investment decisions. The general partner must make all of those decisions. It is a division of power intended to insure that those running a business have complete control over its ability to succeed.
• LPs and GPs must share in both the risk and reward of investing. Taken literally, this aspect of Islamic finance means that all deals have built in joint and several liability.
• Interest may not be charged for the use of limited partners’ funds or in the transactions relating to their funds. “Usurious” practices are not allowed.
• GPs are not allowed to invest in companies with indebtedness over one-third of their balance sheet. Also, a portfolio company’s accounts receivable cannot exceed 50% of its assets. —Jerry Borrell