There is a close relationship between Islamic tenets of investing and private equity.
By its nature private equity is participatory and inevitably it must lead to the sharing of both risks and rewards.
As long as the company seeking the private equity infusion is not operating in a haram area of business such as pornography or liquor, or is not heavily indebted, then few forms of co-investing could be more pure from a Shariah compliance perspective.
The reality of the matter is that there is a close relationship between Islamic private equity and conventional private equity and therefore as private equity has grown in size across the globe then we might have expected its Islamic counterpart to have done the same.
Immediately prior to the financial crisis, conventional private equity had become the whipping boy of the financial world and there was much talk of the need for increased legislation and greater transparency in the industry. Too many people were making enormous amounts of money out of private equity transactions that were, in essence, being fuelled by excessive cheap debt.
Islamic private equity never fell into quite the same trap, largely because of the prohibitions inherent in the Islamic financial system against too much debt.
The Shariah requirement that transactions have a productive activity underpinning them, and that financial flows and assets remain correlated, meant that debt simply never had the chance to balloon out of control in the Islamic sphere to the same extent that it did in the conventional market.
Size of the market
Industry estimates suggest that the global private equity market is worth around $2,200bn at present although the volume of transactions completed in the first quarter of 2009 is miniscule. According to Greenpark Capital, a specialist secondary investor in private equity, deals closed in the first quarter of 2009 amounted only to $2bn. A market with too many sellers and too few buyers inevitably means depressed asset prices.
Figures for the Islamic private equity industry are much harder to come by, but estimates from Yasaar Media research suggest that the industry is approaching $3bn in funds raised and deals done, much of it in the Mena region. This is a far cry from the $40bn that pundits suggested was the kind of level that the industry would reach by 2011. For an overall Islamic finance industry, whose size is estimated at around $800bn, it is not hard to see that private equity does not play a very significant part yet.
Before the credit crisis some observers had postulated that there were not enough potential Shariah compliant target portfolio companies around to be able to soak up the Islamic private equity funds available. Remember that at this time there seemed to be money for even the most speculative of investments, redolent of the dot.com boom where there was too much money chasing too few opportunities.
The picture that has emerged since the collapse of Lehman Brothers is still far from clear but there is now much less of a mismatch between the financial heft of investors and potential Shariah compliant private equity targets and the undeniable conclusion is that the Islamic private equity sector is particularly well placed for expansion at present.
The Islamic private equity model is very similar to the classic Mudarabah model with the alliance of general partner and limited partner being a straightforward example of what a Mudarabah is supposed to be.