Islamic venture capital's guidelines and future

By Paul McNamara, Yasaar Media

During her keynote address at the Islamic Venture Capital & Private Equity Conference 2008 launching these guidelines YBhg Dato Dr Nik Ramlah Nik Mahmood, managing director, Securities Commission Malaysia said, 'Venture capital brings profound impact to the economy. It bridges the financing gap where direct bank lending or financing through the debt or equity market is difficult to obtain.

'The unique nature of the venture capital model, which is based on active management, leads to improved corporate governance and an overall alignment of stakeholder interests with that of the management. This then creates significant value above and beyond the use of financial engineering. New companies and industries spawned by venture capitalists for example Apple Computer, Federal Express, Google, IBM have irreversibly changed the way we live and work today'.

Search for 'mega brands'

The clear intention was to promote an Islamic venture capital industry whose aim was not
simply to nurture small businesses but rather to be the catalyst behind the next wave of 'mega brands' too, in the mould of Apple and Google.

Such thinking is certainly ambitious, but judging by the way the balance of global financial and economic power is currently shifting away from the traditional centres of London and New York it may contain an element of realism.

Dato Mahmood then went on to say: 'With the rapid expansion and innovation of Islamic capital market products such as Sukuk, Islamic unit trust funds, Islamic REITs, Islamic ETF and Shariah-compliant listed securities, it is now timely for us to encourage and facilitate the growth of Islamic venture capital as another available asset class in Malaysia's broad range of Islamic products. The development of Islamic venture capital will offer the opportunity for Islamic investors to diversify their portfolios.

'Also, the fact that venture capital does not have perfect correlation with other asset classes such as listed securities allows more opportunity for investors to enhance their
portfolio returns'.

Naturally Dato Mahmood was focused principally on Malaysia but the general concept remains the same for the industry wherever it is based. The speech by Dato Mahmood was by way of a precursor to the publishing of the Guidelines whose two core requirements for Shariah compliant venture capital were identified as being:
- The appointment of a Shariah adviser who provides continuous guidance in ensuring
that amongst others, the proposed investment contract and instrument structures
are Shariah compliant (our emphasis)
- The core activities of the investee company must be Shariah compliant

Dato was clear that these guidelines were absolutely necessary for Malaysia if it was to stand a chance of attracting funds from the GCC, highly enriched with a vastly inflated oil price at the time. Wealth, and therefore venture capital interest, was blossoming in the Middle East and Malaysia did not want to lose out as a recipient of some of these funds.

A new industry

Shortly after this announcement, in July 2008, the first Islamic venture capital Musharaka
Fund was introduced by Malaysia Venture Capital Management with the fund managed by Musharaka Venture Management. Malaysia Venture Capital Management is the venture capital subsidiary of the Ministry of Finance in Malaysia. Apparently the fund drew interest from Swiss and Middle Eastern investors.

Malaysia Venture Capital Management allocated $ 8.3m for the fund while unnamed investors invested $1.83m. Malaysia Venture Capital Management will continue its efforts to attract participation from local and regional investors and hopes to increase the fund size in 2009. The Musharaka Fund aims to invest in at least four technology-based companies.

As its name suggests the Gulf Venture Capital Association (GVCA) is a body whose remit is to encourage the growth and prosperity of the venture capital industry in the GCC and the greater Middle East. While its remit is not solely confined to Islamic venture capital there are clear areas where the GVCA and Islamic venture capital intersect.

The original intention of the GVCA was never simply to be a body which promoted venture capital, however, but was seen as a counterpart to the Arabian Knowledge Economy Association (AKEA) whose remit was to increase entrepreneurial skills and awareness amongst young up-and-coming businessmen and women in the Arab world. Indeed the president of AKEA, Abdullah Al-Subyani, is also president of the GVCA.

The reality of the industry, however, is that the association focuses most of its attention
on private equity and not on venture capital.

The annual report produced by the GVCA from 2007 only makes passing reference to venture capital and even then only as a virtual footnote which reads, 'Venture capital funds raised money in 2005 and 2006, but lost their appeal in 2007. Venture capital funds still have to ascertain their viability in the Mena region in terms of availability of quality deal flow and realization of successful exits'.

The 2008 report from the GVCA said, 'Venture capital funds remain largely unattractive in the Mena region, with only three venture capital funds raised in 2008. The venture capital model has remained unproven in the region, despite many attempts by individuals and governments to adapt the western model to the Middle East'.


Perhaps what the industry needs more than anything else is a catalogue of success stories
that will pique the interest of wealthy investors with a penchant for backing small business. The success story that Abraaj Capital, a Dubai-based conventional private equity house, had with its investment in Aramex bred dozens of imitators across the GCC.

A similar success story in the Islamic venture capital field could prove to be just the fillip that the industry needs to spawn dozens of funds from the private sector looking for the next big Shariah compliant thing.

It seems a safe bet that successful Islamic venture capital investing in the future will be the speciality of Islamic investment banks rather than specially focused Islamic venture capital firms.

The rationale here is that, as we have already observed, the quantum of individual venture capital investments tends to be small and therefore may not be lucrative enough in the short term to finance all but the most boutique of firms.

Bahrain's Venture Capital Bank (VCBank) is an example of a specialist Islamic investment bank launched with the aim of capitalising on this niche, although VCBank's remit is wider than simply venture investing.

Established in October 2005 the bank also looks at private equity and real estate, while also trying to secure financial advisory mandates. In the current climate its business plan seems to be succeeding and for the year ended 31 December 2008 the bank achieved net profit of $47m, which showed 47 % growth compared to 2007 and a 27 % return on equity. The bank is also increasing paid-up capital from $165m to $250m.

VCBank launched its first fund, the $250m Mena Small & Medium Enterprises Fund in December 2006 and has so far invested in Challenger Limited, an oil drilling company in North Africa.

The future of Islamic venture capital

Early signs would suggest that the industry is likely to flourish in Malaysia before anywhere else, in large part because of the initiatives of the government.

What seems beyond doubt is that the industry at present is tiny, certainly smaller than $100m, and probably worth less than half of that. When the global recession is over, Islamic venture investing could easily be one of the fastest growing sectors of the industry, if for no other reason than it is coming off a very low base.