To jump-start the skidding Islamic private equity
It is generally well accepted that the principles on which private equity and venture capital are built are Islamic in nature — they are based on risk sharing and the lack of guaranteed financial result.
According to Eurekahedge Islamic Funds Database, the first Islamic private equity funds have existed since 2002. Between 2002 and 2007, their number was multiplied by a factor of near to seven from 22 to 153 (‘the golden age of Islamic private equity’!) 14 years later the number of Islamic private equity funds stands at 918. We should be seeing a flurry of weekly business deals. We should but we are not.
The number 918 itself is misleading, as it includes obsolete funds and funds that ‘may’ consider Shariah compliant investments. The actual number of Islamic private equity funds is under 50.
Why did that seemingly spectacular boom failed to go on? In my humble opinion there are several particular reasons and a fundamental one.
The particular reasons for the relative protraction of the industry:
1. The insufficient number of targets. I elaborate on this thesis below;
2. Competition with more experienced conventional private equity funds;
3. Additional costs of operations due to the necessity to carry Shariah Boards;
4. The need for higher profitability may go against Shariah-based social goals;
5. Emerging competition with SPACs which are under increased pressure to invest/acquire companies due to the short life span ‘until investment’ (generally no longer than 24 months).
The fundamental reason for the lack of Islamic private equity boom is the lack of Islamic private equity infrastructure. Private equity finances some of the later stages of the business development of a company. The stages after are IPOs, trade sales, or with no adverse conditions, the company may become a ‘cash cow’ for its shareholders.
Diagram 1: Islamic company life cycle funding
Source: the author
But in order to flourish, the Islamic private equity needs a constant supply of private companies large enough to absorb relatively large investments. And there are just not enough of them in the Shariah compliant universe.
There are a plenty of entrepreneurs with brilliant ideas who end up spending their money and being forced to shut down their businesses. Too few government grants, almost no Waqf grants make the ‘company funnel’ even more narrow. Having too few Shariah compliant business angels translate into having too few venture capital-ready companies.
And so on, a large incoming pour at the upper end of the Islamic business funnel turns into a few drops at the end.
To fix the Islamic private equity we need to address the lack Islamic funding infrastructure. By the way, did you know that the Yale University endowment (a structure built largely on Waqf principles) invests 38% of its assets into the venture capital and private equity funds?