Sources of financing (including Islamic finance)

Choosing the right financing mix depends largely on a company’s stage of growth, its credit worthiness, and whether it is “quoted” (listed on a public stock exchange) or “unquoted” (private). Here is a breakdown of the primary sources of financing.

Quoted Companies (Publicly Listed)

These companies have access to public capital markets, allowing them to raise vast amounts of money from institutional and retail investors.

• Public Equity (IPO/SEO): Issuing new shares to the public. This includes the Initial Public Offering (IPO) or Secondary Equity Offerings (SEO) for companies already on the exchange.
• Corporate Bonds: Issuing debt securities to investors. These are traded on markets and usually carry a fixed interest rate (coupon).
• Rights Issues: Offering existing shareholders the opportunity to buy additional shares, usually at a discount, to raise quick capital.
• Commercial Paper: Short-term, unsecured promissory notes used to fund accounts receivable and inventories.

Unquoted Companies (Private)

Private companies rely more on specialized investors and traditional banking relationships since they cannot “tap” the public markets.

• Venture Capital (VC): Funding provided to startups and small businesses with high growth potential in exchange for equity.
• Private Equity (PE): Usually involves larger, more established private firms. PE firms buy stakes to restructure or expand the business.
• Angel Investors: High-net-worth individuals who provide capital for a business start-up, usually in exchange for convertible debt or ownership equity.
• Bank Loans & Overdrafts: Traditional debt financing. This is the “bread and butter” for most small-to-medium enterprises (SMEs).
• Crowdfunding: Raising small amounts of money from a large number of people, typically via internet platforms (can be equity-based or reward-based).
• Owner’s Investment: Personal savings or “Friends and Family” rounds.

Universal Sources (Both Quoted & Unquoted)

Regardless of listing status, these internal and external methods are common to almost all businesses.

• Retained Earnings: Using the company’s own profits to reinvest in growth rather than paying them out as dividends.
• Asset-Based Lending: Using company assets (like machinery, property, or inventory) as collateral for a loan.
• Trade Credit: Buying goods or services now and paying the supplier later (typically 30, 60, or 90 days).
• Leasing/Hire Purchase: Obtaining equipment or vehicles without paying the full cost upfront.

Government & Grant Funding

Grants are unique because they typically do not have to be paid back and do not require giving up equity. However, they are usually “earmarked” for specific purposes.

Islamic finance operates on a fundamentally different philosophy than conventional finance. The core principle is that money has no intrinsic value; it is simply a medium of exchange. Therefore, making money from money (interest) is prohibited.

Instead, Islamic financing is based on risk-sharing and asset-backed transactions.

Core Principles (The “No-Go” Zone)

To be Sharia-compliant, financing must avoid three specific elements:

1. Riba (Usury/Interest): Charging or paying interest is strictly forbidden.
2. Gharar (Uncertainty): Contracts must have full disclosure; “excessive uncertainty” or gambling-like risks are prohibited.
3. Haram Industries: No financing for businesses involving alcohol, gambling, pork, tobacco, or weapons.
   
   

Primary Islamic Financing Structures

Since lenders cannot charge interest, they instead become “partners” or “traders.” Here are the most common methods used by companies:

Murabaha (Cost-Plus Financing)

This is the most common alternative to a standard business loan.

• How it works: Instead of lending you money to buy an asset (like a machine), the bank buys the asset itself.

• The Profit: The bank sells the asset to you at a marked-up price, which you pay back in installments.
• Why it’s compliant: The profit is tied to a physical commodity trade, not a “rent” on money.

Musharaka (Joint Venture Partnership)

This is a form of equity financing.

• How it works: The bank and the company both contribute capital to a project or business.
• The Profit: Profits are shared according to a pre-agreed ratio.
• The Risk: Critically, losses must be shared strictly according to the amount of capital each party contributed.

Mudaraba (Profit-Sharing)

Similar to a Venture Capital arrangement.

• How it works: One party provides the capital (the Rab-ul-mal) and the other provides the expertise and management (the Mudarib).
• The Profit: Profits are shared at a fixed ratio.
• The Risk: If the project fails, the financier loses their money, and the manager loses their time and effort. The manager is not liable for financial losses unless they were negligent.

Ijara (Leasing)

This is the Islamic equivalent of an operating lease.

• How it works: The bank buys an asset and leases it to the company for a fee.
• Ijara wa Iqtina: A “lease-to-own” version where the company eventually buys the asset from the bank at the end of the term.

Sukuk (Islamic Bonds)

For quoted or large-scale companies, Sukuk are the alternative to conventional bonds.

• The Difference: While a conventional bond is a debt obligation (the issuer owes you money + interest), a Sukuk represents partial ownership in a tangible asset or project.
• The Return: Investors earn a share of the profit generated by that specific asset, rather than interest.
  

Unquoted companies frequently use Murabaha (for equipment) or Musharaka (for startup capital), while Quoted companies or governments often issue Sukuk to raise billions on international markets.

Key Difference: The Cost of Capital

• A fundamental concept in finance is that the “Cost of Equity” is generally higher than the “Cost of Debt.” For a company deciding between these sources, the Weighted Average Cost of Capital (WACC) is an important metric.
• Choosing the right source of financing at the right time for the right amount and cost, will make a huge difference to a company, its growth and profitability prospects in the long run.