<p>Sharia compliant companies raise capital from a number of sources such as common  stocks, Sukuk and funds. Different securities are expected to generate different  returns. Fund raising by a company in a Sharia compliant environment may take  different forms such as borrowing, issuance of shares or issuance of  Sukuk.<br /><br />As a general rule, Sharia law allows investment in common stocks  (company shares) as long as those companies do not engage in &lsquo;Haram&rsquo; activities  such as lending, gambling or the production of alcohol, tobacco, weaponry or  pornography. Investment in companies may be through participation in initial  public offerings, rights issue or by direct investment (private equity). Islamic  scholars have made some concessions on permissible companies, as most use debt  either to address liquidity shortages (they borrow) or to invest excess cash  (interest-bearing instruments). One set of filters excludes companies that hold  interest-bearing debt, receive interest or other impure income or trade debts  for more than their face values. A further distillation of the aforementioned  screens would exclude companies whose debt/total asset ratio equals or exceeds  33%; companies with "impure plus non-operating interest income" revenue equal to  or greater than 5% or companies whose accounts receivable/total assets equal or  exceed 45% or more.<br /><br />Sukuk refer to certificates or financial securities  that represent a proportional or undivided interest in an asset or pool of  assets and the claim embodied in Sukuk is not simply claim to a cash flow but an  ownership claim. This differentiates Sukuk from conventional bonds as the latter  proceed over interest bearing securities, whereas Sukuk are basically investment  certificates consisting of ownership claims in a pool of assets.&nbsp;The aim is to  sell the assets and recover its value from subscription, in which case the  holders of the certificates become owners of the assets. Sukuk may be divided  into two types: Sukuk that yield pre-determined returns and Sukuk based on  profit and loss sharing.&nbsp; Sukuk al-ijarah is a prime example of certificates  that yield pre-determined returns.&nbsp;<br /><br />Having stated the above, a variety of  factors may impact a company&rsquo;s decision as to which capital raising strategies  to execute and when. The choices often have to be made and evaluated by a  company before deciding on the most suitable method of fund raising. For  example; a company, ABC Corporation, intends to raise Sharia compliant capital  to build a power plant in Kuwait. Some of the considerations as to which of the  two methods to raise capital is suitable for ABC Corporation are examined  below.<br /><br />The raising of capital through common stocks is done either  through an initial public offering, if ABC Corporation is not a publically  listed company, or through a secondary offering. This method has a number of  advantages to ABC Corporation represented by features which appeal to investors,  hence, will enhance the attractiveness of potential for subscription by the  investors. Some of the factors are listed below:<br /><br />(i)&nbsp;common stock has the  potential for delivering very large gains as compared to Sukuk. Annual  returns-on-investment (ROI) of over 100% have been experienced;<br /><br />(ii)&nbsp;the  potential loss from stock purchased with cash is limited to the total amount of  the initial investment. This is considerably better than that of some leveraged  transactions, where the maximum loss can well exceed the total of the funds  invested;<br /><br />(iii)&nbsp;stocks offer limited legal liability. Passive  stockholders (those who take no active part in the running of the company) are  protected against any liability stemming from the company&rsquo;s actions beyond their  financial investment in the company;<br /><br />(iv)&nbsp;most stocks are very liquid; in  other words, they can be bought and sold quickly at a fair  price;<br /><br />(v)&nbsp;although past performance is not a guarantee of future  performance, stocks have historically offered very high returns in relation to  other investments. <br />&nbsp;<br />In other words, stocks offer two ways for the  investors to benefit, by capital gains and dividends. Each share of stock  represents partial ownership in a company. If the company becomes more valuable,  so will the ownership interest represented by each share of stock. This  appreciation of the stock&rsquo;s value is known as a capital gain. In addition, if  the company earns more profits than it needs to support its maintenance and  growth, it may elect to distribute the excess to its owners, the shareholders,  which are the dividends.<br /><br />However, while there are numerous advantages to  investors making investments on common stocks appealing, common stocks, like all  investments, have some distinct disadvantages which make it not appealing to  investors, hence, reducing the attractiveness of the stock to investors to  participate, including:<br /><br />(i)&nbsp;since common stock represents ownership of a  business, investors are the last to get paid, like all other owners. A company  must first pay its employees, suppliers, creditors, maintain its facilities and  pay its taxes. Any money left over can then be distributed among its investors;</p>
<p>(ii)&nbsp;while shareholders are company owners, they do not enjoy all of the  rights and privileges that the owners of privately held companies do. For  example, they cannot normally walk in and demand to review in detail the  company&rsquo;s books;</p>
<p>(iii)&nbsp;investors in a company may not know all that there is to know about the  company. This limited information can sometimes cause investment decision-making  to be difficult;</p>
<p>(iv)&nbsp;stock prices tend to be volatile. Prices can be erratic, rising and  declining quickly. Such declines often cause investors to panic and sell, which  actually only serves to lock in their losses; and</p>
<p>(v)&nbsp;stock values can sometimes change for no apparent reason, which can be  quite frustrating for the investor who is trying to anticipate the stock&rsquo;s  behavior based on the actual performance of the company.<br />&nbsp;<br />On the other  hand, ABC Corporation may want to consider Sukuk as a means of fund raising due  to the following features of Sukuk issuance:</p>
<p>(i)&nbsp;able to mitigate liquidity of illiquid assets and untapped  assets;<br />(ii)&nbsp;reduce the cost of funding, in addition, having the cost of  funding linked to market rates is attractive in uncertain times;</p>
<p>(iii)&nbsp;decrease funding risks by diversifying the sources of funds;</p>
<p>(iv)&nbsp;takes assets of the balance sheet without the loss of use;</p>
<p>(v)&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; ability to attract more investors since investors are able to make  their investment decisions almost independently of the credit standing of the  issuer and instead, focus on the degree of protection provided by the SPV to  meet the investment target. <br />&nbsp;<br />However, the disadvantages of ABC  Corporation issuing Sukuk are as follows:</p>
<p>(i)&nbsp;including the widening of credit spreads, which make it less  cost-effective if ABC Corporation has ratings below &lsquo;AA&rsquo; to issue the Sukuk;</p>
<p>(ii)&nbsp;the costs of structuring and issuing Sukuk remain high relative to  conventional bank loans and bond issuance. Legal and accounting fees contribute  to this higher cost structure, as does uncertainty regarding the perceived risk  associated with these instruments. Moreover, the lack of standard structures,  perceived differences in approach to sharia compliance and a relatively illiquid  secondary market may, in our view, discourage investors&rsquo; appetite for Sukuk;</p>
<p>(iii)&nbsp;investors&rsquo; interest in Sukuk has been dampened by increased market  risks, as for example, the requirement to mark-to-market (usually at a loss) the  bonds which are within the investors&rsquo; portfolio;</p>
<p>(iv)&nbsp;&nbsp;there is a lot of controversy surrounding the structure of the Sukuk.  Some companies want to avoid the controversy as they are not keen on disguising  the features of conventional bonds and making them appear as Sukuk. However, if  ABC Corporation wants a bond that is truly asset-backed, maybe it will then  issue Sukuk; and</p>
<p>(v)&nbsp;&nbsp;investors are often faced with the risk that there will be no assurance  that a secondary market for Sukuk will develop, or if a secondary market does  develop, that it will provide the Sukukholders with liquidity of investment or  that it will continue for the life of the Sukuk. The market value of the Sukuk  may fluctuate, consequently, any sale of Sukuk by Sukukholders in any secondary  market that may develop, could be at a discount from the original purchase price  of such Sukuk and accordingly, an investor in the Sukuk must be prepared to hold  the Sukuk until the Sukuk has been redeemed, or all amounts then due have been  paid in full.<br />&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; <br />Considering the above factors, the primary selection  as to whether ABC Corporation should issue common stock or Sukuk lie in the fact  that companies which want to grow through expansion or acquisition often issue  stock rather than Sukuk, because Sukuk essentially raises a debt obligation and  money has to be paid back. There is a limit as to how many Sukuk can be issued  before the burden of repayment of principal and profit on a company&rsquo;s debt  becomes too great and further offerings become impractical. By offering common  stock instead, a company will raise money from the public without taking on more  debt. However, if a company such as ABC Corporation which plans to undertake  specific project financing may consider issuing Sukuk if it has specific revenue  generating assets which can be offered as the underlying assets for the Sukuk.  In such a case, only the specific assets will be affected and not the entire  assets and revenue of a company. In the case of ABC Corporation, the power plant  project can be structured in such a way so as to contribute as the underlying  asset for the Sukuk (eg through istisna&rsquo; or ijara for the land plot where the  power plant is to be constructed) without affecting its other assets.</p>