Musharakah: Definition & Overview

KEY TAKEAWAYS

• Musharakah is a joint venture partnership that is common in Islamic finance.
• It works by having both the losses and profits shared between two partners. 
• This is necessary as Islamic law does not permit profits from interest. 
• A permanent musharakah is used for long-term financing.

What Is Musharakah?

Musharakah is a partnership or joint enterprise structure in Islamic finance. It is where partners share in the losses and profits of an enterprise. Islamic law, known as Sharia law, doesn’t permit profiting from interest in lending. 

Musharakah is a type of shirkah al-amwal, which means partnership. Literally translated, musharakah means “sharing”. 

Read on as we take a look at the Islamic business principle of Musharakah.

Concept of Musharakah

Musharakah allows for the project or business’s financier to get a return in the form of a portion of the actual profits. However, unlike a traditional creditor, the financier also shares in any losses that may occur, this is also on a pro-rata basis. 

Types of Musharakah

There are four main types of musharakah:

• Shirkah Al-’inan: This is where the partners are simply the agent and don’t serve as guarantors of other partners. 
• Shirkah Al-mufawadah: This is an equal, unrestricted, and unlimited partnership. All partners put in the same sum, have the same rights and share the same profit and loss. 
• Permanent Musharakah: There is no specific end date and this agreement will continue until the partners decide to discontinue the partnership. This is often used for long-term financing. 
• Diminishing Musharakah: One partner’s share is drawn down. This is while it is transferred to another partner. It continues until the entire sum is passed over and the whole balance is paid off. 

Importance of Musharakah

Musharakah plays an important role in financing business operations that are based on Islamic principles. If someone wants to start a business but has limited funds, then they can find a financier who is willing to share the profits and losses. This helps to negate the need for a traditional business loan. 

Musharakah are not legally binding agreements, therefore either side may end the arrangement at any time.

In the event of a default, the proceeds from the sale of the property are divided pro rata between the buyer and the lender. This contrasts with more conventional lending models, where the lender is the only party to profit from any foreclosure-related property sales.

Conditions for Musharakah

Musharakah is widely used to finance major purchases, extend credit, finance investment initiatives, and buy real estate. In real estate transactions, the partners ask a bank for an estimation of the worth of the property using imputed rent (the sum a partner might pay to live in the property in question). 

Based on the value assigned and the total of the partners’ various holdings, profits are distributed among the partners in predefined ratios. Everyone who invests money has a right to input on how the property is run. When employing musharakah to finance significant acquisitions, banks frequently use floating-rate loans with interest rates based on a company’s rate of return. That peg represents the earnings of a loan partner.

Summary

In Islamic finance, a musharakah is a joint venture or partnership structure where stakeholders split an enterprise’s revenues and losses. Islamic law forbids making money by lending interest. However, musharakah permits the financier of a project or business to get a return in the form of a percentage of the real earnings in accordance with a predetermined ratio.

Musharakah is a good way to circumnavigate Sharia law and allow businesses to make a shared profit. You can get both long and short-term financing capital to help grow or expand your business.