SPECIAL COMMENT: Islamic Venture Capital - A Distinguishing Factor

By Rushdi Siddiqui, Global Head of Islamic Finance, Thomson Reuters

Failure is a mark of success in venture capital, hence, it is an option with beneficial learning consequences.

Today, Islamic venture capital is a feel-good theory presented at (not many) conferences about the lofty goals of this niche market with the focus on the formalism of structuring and screening. Its impact investing, yet we seem to see it as a cost (at best) and a write-off (at worst).

The Islamic world defined capitalism in 8th/9th century, but today’s Muslim country’s who have planted the Islamic finance hub flag are missing an important element. The interplay between risk capital and innovative ideas cannot be emphasized enough for local country development and diversification.

The Chairman of Malaysia’s Securities Commission, Zarinah Anwar, stated in a keynote speech in 2007, ‘…how can Malaysia distinguish itself in the emerging market VC [venture capital] pool? Our belief is that Islamic VC provides that distinguishing factor.’ Obviously, the industry needs to catch-up to the vision of the Chairman.

To date Islamic finance has missed two important opportunities: addressing the ‘have nots’ (micro-finance), and deploying the funds of the ‘haves’ into Islamic VC funds. Yes, VC is labor intensive requiring specialized skills, entails active risk capital as part of portfolio, and a long term play, much like Sukuk in hold to maturity portfolio or lock up periods in real estate and private equity.

Ok, but nothing ventured, nothing gained and continued reliance and commentary on the gaps in Islamic finance.

Walk the Talk
However, its time for Islamic finance to ‘walk the talk’ of venture capital. Others have written more eloquently on the Shariah modes of contract of Islamic VC, preferred share issues, etc., my interest is macro (industrial policy like) and multiplier impact (knowledge base economy) of Islamic VC in Muslim countries.

It’s an asset class whose time needs to arrive. It’s the authenticity that Islamic finance needs as its the pre-condition foundation for innovation. Young tech [Muslim] graduates in OIC countries have typically opted for working in multi-national corporations and government jobs, and rarely do we hear about friends/colleagues considering ‘garage souk’ start-ups.

Islamic VC is not about sending Muslim (country) money to western market VC based funds as passive investors in selected sectors and (hoped for return) profits are remitted to the Muslim country funds. Yes, VC does not exist in Muslim countries, but this ‘cycle of portfolio only returns’ has to stop somewhere and sometime.

[There are 42 stock exchanges in the 57 Muslim (OIC) countries, and, possibly with exception to Malaysia and Saudi Arabia, most of Muslim money in Islamic equity funds is in blue-chip equities in G-20 countries, hence, portfolio returns and very little commitment to local capital market development. Lets hope Islamic VC, once it starts to take off, has learned a lesson from Islamic equity funds.]

Today, funds are invested in Islamic private equity/real estate funds, and, much like VC, it is locked for a medium period of time, say, 5-10 years. However, the distinction between Islamic VC and interest in latter funds, I suspect, is Realty/PE are established companies (customers and cash flows) play where the manager has access to deal flows. Islamic VC is not and does not.

OIC Tech Parks
Islamic VC in Muslim countries is not about setting up technology parks with names linked to ‘Silicon Valley,’ without a supportive infrastructure, hence, becoming a real estate tenant occupation play. Furthermore, with the focus on crowded ICT and the ‘hot’ social media, it becomes another offering into the sea of offering, hence, it does not stand out.

For example, Google’s recent announcement in Egypt, called Ebda2, is supported with seed money and mentoring to take advantage of the entrepreneurial energy and opportunity fanning across Egypt, if not the Maghreb. The dynamics of the Muslim world entails the need to look beyond and addition to the next Twitter, Facebook, Youtube, and so on.

Yes, ICT/social media is needed, but are they vital for GDP diversification and growth and pursuit of knowledge based economies? Is it better to focus on areas, akin to industrial policy, that have similar impact of diversification, growth and development?

If the leading Muslim countries, like Malaysia, Turkey, UAE, etc., are to increase the per capita income by 30-50% by 2020, diversify their economies from commodities, contribute to capital market development, reduce and reverse capital and brain drain, move away from pep talks and motivational speeches, and so on, then outside the box thinking is the need of the hour as the hour of the day is continually passing us by.

A VC eco system needs to be the collective mantra of the leaders and the led. Issues on risk (less than some of the white elephants projects), return (knowledge based economy) and reward (first Islamic VC hub) are acknowledged and need to measurable and manageable. However, they must also be realistic, the Muslim world will not build a ‘silicon valley’ by simply calling Silicon Valley, Alley or Oasis.

Indicator of Innovation
Patents are an indicator for innovation and knowledge based economy. A 2006 article in Dinarstandards, Intellectual Property Gaining Protection in the Muslim World, shows how Malaysia heads the list of OIC countries (Table 1) with 547 patents (granted in the US) during the 27 year period. Putting it in prospective, Japan had 547,865 patents granted out of total 3,101,719 during the same time period, and OIC countries (totaling 1,542) had a meager 0.05%. What can Islamic finance do to start closing the gap?

US Patents Granted to OIC Based Inventors

PATENTS 1977-2004

Malaysia 547

Saudi Arabia 212

Indonesia 162

Turkey 144

Kuwait 78

Egypt 69

UAE 42

Lebanon 42

Iran 32

Morocco 30

Nigeria 29

Pakistan 26

Jordan 20

Kazakhstan 16

Syria 14

Source: www.uspto.gov
State of Islamic VC

But, where is Islamic venture capital in the Muslim world? There are Islamic VC associations (Gulf Venture Capital Association or Malaysian Venture Capital and Private Equity Association (GVCA)), VC Funds (Musharaka Venture Management Sdn Bhd), and venture capital bank (VC Bank), etc. But results are under-whelming:

1. How many dedicated conferences or sessions have been on Islamic VC?

2. How many high profile funds and investments have been announced in pure-play Islamic VC investments.

3. How many articles, beyond academic or modes of Islamic contracts, in mainstream western media on Islamic VC on the internet?

VC Eco-System
To address the criticism of the present Islamic investing business model, exporting capital and importing returns, Islamic VC needs to be linked with public/private partnership to establish a framework for a knowledge based OIC country economy. For example, in Malaysia, we have the Bio-technology Park (Iskandor Malaysia) and Senai Hi-Tech Park (in Johor), and they are work in progress and may eventually become case studies for other Muslim countries.

At the KL International Venture Capital Symposium, I have been asked to present on the Islamic VC Eco-System in Muslim countries. The approach is to link Islamic VC to investing in companies or technology transfer to address some of the major illnesses in OIC countries as part of medical tourism and housed in technology parks while working with research universities. An integrated holistic play will have more traction than a vertical silo approach.

Yesterday’s AIDs awareness is today’s non-communicable diseases (NCD), obesity and diabetes (Type 2) contributing to heart disease and stroke. For example, the sedentary lifestyle and nutritional transition has made the Gulf region the fastest ‘NCD hub’ in the world, and there are massive costs for cash strapped governments, and, therefore, interesting opportunities (in the billions) for Malaysia.

As Islamic finance moves beyond the pre-dominant risk averse Murabaha, it must think about financing ventures beyond their depositors, investors and shareholders to health of mankind.

An opportunity exists for Islamic banks seeking to deploy some of their excessive liquidity, some exposure to venture capital, to finance some of the major concerns in the GCC: healthcare, desert farming with minimal water, alternative energy, carbon emissions, etc. Its about finding & financing tomorrow’s technology that have application today in the region.

Yes, some ventures will not be successful, but the risk is only financial, not like today’s provisioning to realty estate exposure. Some ventures will be successful, and the upside is knowledge based contribution and its attribution to Islamic finance. Thus, Islamic finance can actually lead conventional finance in Saudi, Qatar, UAE or Malaysia (for the Muslim world) for venture capital.