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Companies commonly raise capital on the basis of equity or debt. These approaches offer the advantages of general acceptance and a known legal framework to facilitate the transactions. However, both approaches have disadvantages:
| Disadvantages
of selling equity |
Disadvantages
of selling debt |
- Dilution of ownership and control
- Outside directors & shareholders may force decisions favoring short-term profits rather than long term competitive advantage
- Exposure to increasingly stringent corporate governance laws
- Reporting requirements force disclosure of
trade secrets
- Loss of entrepreneurial corporate culture
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- Repayment is required
- Creditors can force bankruptcy and gain control of the debtor
- Cost of capital not aligned with business performance
- Debt perceived by investors and others can limit strategic alternatives for growth
- Not acceptable to Muslim companies or investors
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Rather than equity or debt, companies and projects can also be financed based on their future revenues. Investors can purchase a sliver of the company’s future revenues, instead of a percentage of profits or promise of interest payments.
| Royalty
Entitlement (RE) approach
advantages for investor
|
Royalty
Entitlement (RE) approach
advantages for issuer
|
- The RE produces quarterly income payments.
- The RE can produce profits without a company going public or being bought.
- The RE shields the investor from the uncertainty of profits. The RE is based on REVENUE, not profit.
- The RE does not utilize debt or interest, and, therefore, is Shariah compliant and acceptable for Muslim investors.
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- The RE enables a company to raise capital without suffering dilution or incurring debt, based on anticipation of revenues.
- The RE does not involve voting rights, outside shareholders or directors.
- The RE, as a percentage of revenues, increases or declines with revenues.
- Shariah compliant method of financing a privately owned or family business.
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