The contractual Musharakah (Inan) has an agreed tenor with a fixed maturity date. But it is not necessary that the partners have to wait until such a long stop date to wind up the Musharakah agreement. Today, we shall discuss the Shariah compliant approaches for one of the partners to exit the Musharakah. Subsequent articles shall address the termination of the Musharakah.
There are options for partners to either enter into a fixed, term-based agreement to ensure achieving the joint venture objectives. This is a sort of ‘lock-in’ arrangement. Then, there is flexibility to exit at any time provided the continuing partner is given the first right of refusal to purchase the exiting partner’s share in the Musharakah entity. If the continuing partner does not have the appetite to acquire the retiring partner’s equity, a newcomer shall do so provided the continuing partner provides the assent to the newcomer’s inclusion.
The most excruciating aspect in such a situation is the question of the valuation of the exiting partner’s equity. Understandably, the partner who is saying goodbye would like to get a maximum price for selling his share whereas the continuing partner would want to get maximum mileage, considering it an opportunity. The same human logic applies on both parties in case of a new entrant. Finally, an agreed price is paid to the exiting partner and the business continues unabated.
This rudimentary approach is applied mostly in SMEs; however, a proficient methodology governs the sale and purchase of equity in larger privately held businesses which includes all-encompassing due diligence which includes the cashflow trail, health of receivables, financial track record analysis for three to five years, product scrutiny, staff turnaround ratio and other important aspects and the third-party professional evaluation of the business based on which the price of the equity on sale is determined. While the equity acquisition in SMEs is swift, it could take months for mid-cap and larger enterprises to complete the process.
We are discussing the sale of private equity in a Musharakah entity and hence it is implied that the entire process shall be Shariah compliant. A separate discussion shall take place on the sale and purchase of listed equity in this space on the same discussion on Musharakah.
An aspect which has been the subject of discussion in the industry for some time is related to the large club or consortium financing or Sukuk deals based on the Musharakah structure where typically a promise is obtained from the managing partner (obligor) to purchase the financiers’ share of the Musharakah capital upon the occurrence of an event of default by the obligor.
The question that arises is on the value of the ‘promise to purchase’ (or ‘purchase undertaking’ as the market knows it) when it is needed to be called for in the case of default by the obligor. The renowned Shariah scholars are of the opinion that the amount stated in it must not be a face value but the market value, agreed value or the fair value. Unlike Ijarah where the mention of the face value is permitted in the purchase undertaking granted by the lessee to the lessor owing to the subject matter being a tangible asset, Mudarabah and Musharakah transactions cannot pinpoint the value of the equity in future since it keeps changing based on the market situation.
In addition to ascertaining the equity price to be paid to the exiting partner, it is also important to square up the ‘on-account’ profit payment position of such a partner (if any). The ‘on account’ profit payment is a Shariah compliant methodology which entitles the partners to draw a certain amount from time to time during the financial year as if they are distributing the Musharakah profit.
At the end of the year when the balance sheet is drawn and profit and loss is determined, the actual profit emerges and its distribution takes place based on a pre-agreed sharing ratio. If the ‘on-account’ profit amount withdrawn by the Musharakah partners during the year exceeds that of their entitlement to the actual profit, the partners shall return such excess.
However, if the ‘on-account’ profit withdrawals were lower than the actual profit distribution, the adjustment shall take place and the partners shall be entitled to receive the residual profit amount after squaring up the ‘on-account’ ledger.
It is important to ensure that all documentation for the sale of equity by the retiring partner in a contractual Musharakah transaction must be in compliance with the Shariah principles so as to eliminate any room for exploitation by any party. The partners may spare a little time to educate themselves from widely available material on Musharakah or seek guidance from any Shariah scholar who is serving the industry.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Next Week: We shall continue our discussion on the contractual partnership for the next few weeks.