sources of finance

Sources of FinancingPresented by Ndako Mijindadi at The Guild of Muslim Professionals Convention (2016)

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Outline

• Basics of Financing

• Sources of Finance

• Debt Financing

• Conventional

• Islamic

• Equity Financing

• Conventional

• Islamic

• Practical Tips for Sourcing Financing

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Overview

•Will you start a business without considering the source of your raw materials?

Considering the source of finance should be the 1st step

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For many individuals and businesses, financing is often the

missing link required to take them to the next level.

• What type of financing do we need

What

• At what point do we need each type of financing

When

• What is the capital raising process?

How

• Where do we get funds from?

Who

We need to understand:

Financing Basics

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Financing Basics

Back to the Basics

Parties There are typically two or more parties involved in a financing contract (financier and the financed)

Purpose The purpose of seeking finance can vary between short term to long term needs

Pricing Financing always almost comes at a cost which is considered the return on investment to the financier

Short Term

Medium Term

Long Term

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Individuals• Long Term

• Home Acquisition

• Short Term• Rent Payment• School Fees• Car Acquisition

Businesses• Long Term

• Business Capital• Property Acquisition• Business Expansion

• Short Term• Working Capital

Government • Long Term

• Infrastructure finance• Developmental

Finance

• Short Term• Overheads

Common Financing Needs include:

Financing Basics

Back to the Basics

Financing duration needs to match your objectives

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The 6 common sources of funds

Personal Funds

Family &Friends

Private Investors

GrantsBanks/ Fin. Institutions

Public

Financing Basics

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Personal savings is a goldmine!

• Most individuals or business have some avenue to save.

• In the time of need and shortfall of funds, the savings/earnings automatically become the first source of finance to take advantage of.

• This is usually the cheapest form of finance

• Savings can vary in the form of bank deposits, stocks, pooled investments etc

• This form of financing is mostly used by individuals and small businesses to finance short term needs such as asset acquisition

• Many companies also resort to retained earnings for expansion.

Financing Basics

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Sources of Personal Finance

SPEND

Financing Basics

5%Helping

Hand Account

55%Basic needs

accounts

10%Enjoyment

account

10%Educate yourself account

10%Saving to

Spend Account

10%Siddon

lookPassive income

Lotus Financial

Health Plan

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Sources of Funding

Forms of Finance

Debt Equity

There are two broad categories of financing that are not very well understood.

Not Yours Yours

Debt providers are different animals from equity providers

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Debt Finance

• Debt financing involves borrowing funds from creditors with the stipulation of repaying the borrowed funds plus interest at a specified future time.

• For the creditors the reward for providing the debt financing is the interest on the amount lent to the borrower.

• Debt financing may be secured or unsecured.

Sources of Funding

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Debt Finance

Medium-Long term

• Bonds• Debenture• Mortgage• Finance Lease

Short term

• Personal Loan• Bank loan• Overdraft• Credit Cards• Commercial Paper• Treasury Bills

Sources of Funding

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Murabaha (Cost Plus)

Qard Hassan/

Benevolent Loan

Sukuk

• In Islam, debt is generally discouraged

• However the shari’ah permits certain debt like contracts

• Unlike conventional finance, in Islamic finance any form of finance must be based on a tangible/valuable asset.

Islamic debt finance is not a “money for more money” contract

Islamic debt finance is underlined by Trade or Good will

• All activities underlying Islamic debt financing must be permissible

Islamic Debt Finance

Sources of Funding

NIFI

Supplier

Client

Cost plus mark up

1. The client approaches a NIFI and expresses intent to engage in a Murabaha transaction facilitated by the financier

2. Subject to the financier’s approval, the client signs a "Promise to Buy“ agreement

3. NIFI purchases the asset

4. NIFI sells to client at marked up price and client pays in full or in instalments as pre-agreed

Cost PriceAsset

Asset

Islamic Debt Finance - Murabaha

Sources of Funding

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Goods Purchase of Goods Receipt of Goods

Price & Mark Up Repayment

Quality and quantity must be clearly stated and agreed upon

Client should not have made purchase of the good prior to the murabaha agreement

Client can appoint an agent to receive the goods.

Must be clearly stated and agreed upon

Clearly stipulate• Amount of

each installment

• Timing of each installment

• Total duration of installments

Goods must be shari’ah compliant

Financier can appoint the client as an agent to purchase the goods on his behalf.

No portion of this is to be paid prior to the buyer taking delivery

Not to be resold prior to delivery

Supplier of goods must be a third party

Islamic Debt Finance - Murabaha

Sources of Funding

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• Sukuk are non-interest debt instruments, which are developed in accordance with Islamic tenets.

• They are otherwise known as the Islamic equivalent of a bond.

• The underlying activity financed must be Shari’ah permissible in both nature and use.

• Sukuk holders have recourse to the assets acquired with the sukuk proceeds in the event of the originator’s bankruptcy.

• Sukuk is mainly used as a form of financing by corporates and the government

Islamic Debt Finance - Sukuk

Sources of Funding

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Sukuk

• Sukuk represents ownership stakes in existing and/or to be built well defined assets.

• The underlying contract for a sukuk issuance is a permissible contract The sale of a sukuk represents a sale of a share of an asset

• The underlying assets financed by a Sukuk issuance must be Shari’ah permissible in both their nature and use

Conventional Bond

• Bonds represent pure debt obligations due from the issuer;

• The core relationship is a loan of money, which implies a contract whose subject is purely earning interest on principal

• The sale of a bond is basically the sale of a debt

• Bonds, can be issued to finance almost any purpose which is legal in its jurisdiction regardless of moral screen

Islamic Debt Finance - Sukuk

Sources of Funding

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Islamic Debt Financing- Sukuk in Practice

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Osun state issued the first sub-sovereign sukuk in 2013 to raise funds for the construction of schools

Model schools

Sources of Funding

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• A goodwill loan against which interest is not charged; where only the principal amount is to be returned in the future

• This is typically the type of funding obtainable from friends and family

Islamic Debt Financing- Qard Al Hassan

Initial Loan$10,000

Repayment $10,000

Time A-B

Sources of Funding

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Equity Financing

• Equity typically involves selling a stake in a business/project to raise additional funds/capital

• It is underlined by profit and loss sharing

• Equity finance is long term focused but through stock exchanges several investors/financiers can exit over a short period.

• Equity is the most expensive form of finance because the “shareholders” bear the underlining risks of the business.

• Equity finance is generally permissible by the shari’ah

Sources of Funding

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Venture Capital Angels

• High Net Worth Individuals or retired company executives

• Investors contribute experience, contacts and management knowledge

• Investor supervises management

• Usually for companies with high-growth potential

• Investor looks for exit plan (IPO)

• Investors should bring relevant experience

Equity Financing - Start Ups

Crowd Funding

• Raising many small amounts of money from a large number of people

• Typically happens via the Internet.

Sources of Funding

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Public Offerings Private Placement

• Shares are offered to a close knit of select individuals and institutions

Initial Public Offerings• Ordinary Shares• Preference SharesRights Issues

Sources of Funding

Equity Financing - Big Companies

Companies often employ the services of a professional financial adviser to help structure these equity capital raising deals

Advisers come in different shapes and sizes

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Musharakah (patnership ) Mudarabah

• Business partnership between two or more parties

• One party provides capital, while the other provides the investment management expertise

• Both share profit based on pre-agreed terms

• In the case of a loss, the investor bears any loss of capital while the Mudarib loses his time and effort

• Musharakah means a joint enterprise formed by the contribution of capital by multiple parties.

• Profit on the enterprise is shared on a pre- agreed ratio

• Losses are shared based on the percentage of capital contribution

Sources of Funding

Islamic Equity Finance

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1. NIFI and Client enter into Musharaka agreement and fix profit sharing ratio (PSR)

2. Client manages business

3. Profits are shared according to agreed ratio and losses are shared based on capital contribution

4. In the NIF industry, the musharakah contract is largely used for mortgages

Capital & Effort

ClientNon Interest

Financial Institution

Project/Asset Acquisition

Project Revenue

Capital & Effort

Musharaka contract

Islamic Equity Finance - Musharakah

Sources of Funding

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Sources of Funding

Partners Capital Business

Profit sharing Contract

Partners have the right to - Appoint agents & be appointedas agents- Right to sell the mutually owned property

Any form of liquid or illiquid asset

Not Debt

Quantifiable and specified amount

Permissible

Role of the partners to be duly specified

Based on ratio agreed

Not restricted to capital contribution basis

Not in absolute amount

Loss based on capital contribution

Clear and definite in language

Islamic Equity Finance- Musharakah

NIFI

Client Project

Project Revenue

CapitalManagement

Profit/LossProfit

1. NIFI & Client enter into Mudaraba agreement and fix profit sharing ratio (PSR)

2. Client manages business

3. Profit is shared according to PSR

4. Loss is absorbed by the NIFI

Islamic Equity Finance- Mudarabah

Sources of Funding

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Sources of Funding

Mudarabah & Musharaka Financing

Short/medium/long term financing

Project financing

Small and medium enterprises setup financing

Large Enterprise

Import Financing

Export financing (Pre-shipment financing)

Letter of Credit financing

Working capital financing

Islamic Equity Finance

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Sources of Funding

Other Islamic Finance Modes

Ijarah (Lease to own)

Istisna’(Construction Finance’)

Salam(Deferred Delivery)

is a contract in which advance payment is

made for goods to be delivered later on.

Mostly used to finance agricultural produce

A contract of exchange with deferred delivery,

applied to specified assets that are

manufactured on order

is a simple leasing contract where a party leases an asset for a specified rent and term. This may include an option to buy the asset at the end of the

lease

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The Big Decision- key things to consider

Practical Tips for Sourcing Finance

Debt

Equity

• Equity involves loss of control

• Less burden on company profits

• Funding stays in for a long term

• Both Parties share profit & Losses

• Control is retained

• More burden on company profits

• Default could result in losses of personal asset

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Type of business Size of business Urgency of financing need

Availability of collateral Stability of cashflows Business prospect and profitability analysis

The Big Decision- key things to consider


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Approaching a Financier

When a financier is asked by a customer for a credit facility, he will consider several factors;

Purpose• The purpose of the loan A loan request will be refused if the purpose of

the loan is not acceptable to the bank.Amount

• The customer must state exactly how much he wants to borrow. The banker must verify,Repayment

• How will the loan be repaid?

Term

• What would be the duration of the loan?

Security

• Does the loan require security?

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Approaching a Financier- Requirement Checklist

Asset Acquisition (Individual)

Application Letter

Pro-Forma Invoice (In the Name and Address of financier)

Referral letter from employer

Source of repaymentThree (3) months pay slip and last six (6) months bank statement. If from any other source please specify.

Minimum contribution of 20%

List and Details of Bank Borrowings

C V (with passport photograph)

Two Guarantors (Name, Phone Numbers, Details of Relationship and Address)

Completion of Know Your Customers Form (KYC)

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Approaching a Financier- Requirement Checklist

Asset Acquisition (corporate)

Application Letter Two Guarantors (Phone Numbers, Details of Relationship and Address)

Pro-Forma Invoice (In the Name and Address of financier)

Minimum of 20% contribution

Company Profile & Management Profile

Memorandum and Article of Association (Certified true copy)

Projected cash flow for the tenure of the lease

Certificate of Incorporation

One year historical cash flow of your company

Board resolution

Company last six months Bank statement

C0.7 (List of Directors)and C0.2 (List of Shareholders) - Certified true copy

Company last audited financial statement

Passport Photograph of all Guarantors with copy of means of identification e.g. Drivers License, International Passport or Office

List of bankers

10.Other bank borrowings

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When a financier is asked by a company for equity investment, he will consider several factors;

Entrepreneurial spirit

Competence

Commitment

Financial Discipline

Governance + Trust

Uniqueness of the idea

Workability

Profitability

Exit

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Rasul Allah (sallallaahu 'alayhi wa sallam) said, “If anyone continually asks forgiveness, Allah will

appoint for him a way out of every distress, relief from anxiety, and will provide for him from where he never realized.” (Abu Dawood, Book 20, Hadith

1873)

“Ask forgiveness of your Lord. Truly He is Oft-Forgiving. He will send rain to you in

abundance; increase you in wealth and children; grant you gardens and bestow on you

rivers.”’“ [Nuh (71):10-12]

Make Istighfar

Thank you for listening

sources of finance

Economy & Finance