Musharakah is a type of Shirkah al-Amwal which literally means sharing. In the context of business, it refers to a joint enterprise in which parties share the profit and loss of the enterprise. It plays a vital role in financing business operations based on Islamic principles, which prohibit making a profit on interest from loans. Musharakah may sometimes include Shirkah al-Amal, where a joint partnership is formed to render some services without requiring any capital investment.
Musharakah allows each party involved in a business to share in the profits and risks. Instead of charging interest as a creditor, the financier will achieve a return in the form of a portion of the actual profits earned, according to a predetermined ratio. However, unlike a traditional creditor, the financier will also share in any losses. The relationship established between parties, in Musharakah, is by a mutual contract; hence, all the necessary ingredients of a valid contract must be present. However, there are number of conditions that apply specifically to the contract of Musharakah.
In fact, the capital to be invested in a joint venture can be unequal between the partners and should preferably be in cash. If it were to be based on commodities or other Shari’ah-compliant assets, the market value prevalent at the time of the contract would have to be appropriately valued with the mutual consent of all the partners in order to determine the share of each of them. The commodity should be compensable by similar commodities or assets in quality or quantity, in case it could be destroyed. Otherwise, its price should be paid. The capital may also be in the form of equal units or shares representing currency. And if partnership capital involves a variety of currencies, it must be translated into the currency of the enterprise at the current rate. Finally, Debts or receivables alone cannot form part of the capital until they are received, although, they may become part of the capital contribution where they become inseparable from the other assets of the business.
Moreover, the proportion of profit to be distributed among the partners must be determined and agreed upon at the time of the contract. Otherwise the contract wouldn’t be valid. And it is necessary that each partner’s share in the profit is exactly equal to the proportion of initial investment into the partnership. The ratio of profit distribution may vary, however, for non-active partners, who only contribute capital. A party that has no capital invested in an enterprise does not have to share its loss. The partnership would also be invalid if a partner were to receive regular payments of a fixed, pre-determined amount as a percentage of its investment. In addition, a person can become a partner in a running business having fixed assets by investing capital in cash or kind; it is also allowed to merge various partnership businesses. Valuation of the fixed assets will be based on their fair value agreed upon by the partners.
Further, Musharakah is not a binding contract and any partner may unilaterally terminate it unless provided otherwise in the contract. It is agreed upon by the Muslim jurists that a partnership is terminated if one of the partners terminates the partnership or if one of the partners dies or becomes insane. If the remaining partners want to continue the business under any of these cases, it is possible with mutual agreement. The remaining partners would have to purchase the share of the out-going partner.
Difference between Musharakah and Mudarabah
Mudarabah is a special kind of partnership where one partner (rabbulmal) provides the capital to the other (mudarib) for investment in a commercial enterprise. A Mudarabah arrangement differs from the Musharakah in the following major ways:
The investment in Musharakah comes from all the partners, while in Mudarabah; investment is the sole responsibility of rabbulmal.
In Musharakah, all the partners can participate in the management of the business; while in Mudarabah, rabbulmal has no right to participate in the management which is carried out by the mudarib only.
In Musharakah all the partners share the loss to the extent of the ratio of their investment while in Mudarabah the loss, if any, is suffered by the rabbulmal only, because the mudarib does not invest anything. His loss is restricted to the fact that his labour has gone in vain.
The liability of the partners in Musharakah is normally unlimited. Therefore, if the business goes in liquidation, and if all the partners have agreed that no partner shall incur any debt during the course of business, then the exceeding liabilities would be borne by that partner alone who has incurred a debt on the business in violation of the condition. Contrary to this is the case of Mudarabah where the liability of rabbulmal is limited to his investment, unless he has permitted the mudarib to incur debts on his behalf.
In Musharakah, as soon as the partners put their capital in a joint pool, all the assets of the Musharakah become jointly owned by all of them according to the proportion of their respective investment. Therefore, each one of them can benefit from the appreciation in the value of the assets, even if profit has not accrued through sales. In the case of Mudarabah, all the goods purchased by the mudarib are solely owned by the rabbulmal, and the mudarib can earn his share in the profit only in case he sells the goods profitably.