How to Invest in Startups in a Shariah-Compliant Way?

Getting in early on the next big tech startup—think the next Apple, Amazon or Google—has a huge potential for creating wealth, so most investors think about investing in startups at one point or another. 

But as a Muslim investor, however, there’s an additional layer of Shariah you need to think about. 

Abu Bakr reported God’s Messenger as saying:

This usually holds Muslim investors back, as with limited knowledge, ensuring your startup investments strictly follow the Shariah can be hard. 

Read on to learn more about the different ways of investing in startups and have a clear understanding of Shariah risks for each type.

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Angel Investing

You may have heard about “angel investors” - these are wealthy individuals who put in their own money directly into early-stage startups. They don’t just provide funds, but also mentorship and their network to help these startups raise more funds and scale. 

Angel investing is one of the most popular ways of investing in startups. There are over 36,800 angel investors in the UK who have backed two or more startups in the past decade and they usually invest anywhere between £10,000 to £500,000 in a startup. 

For a Muslim investor interested in angel investing, the permissibility of this mainly depends on the nature of activities of a startup. After all, we have to be careful that our wealth isn’t tied up in anything impermissible like Riba (interest), gambling, alcohol or other prohibited activities. 

The good thing about angel investing is that you get to thoroughly examine each company before investing your money. But of course, proper due diligence, especially carefully vetting each opportunity through an Islamic lens takes serious time and effort.

Pros of angel investing:

• Potential for high returns: Opportunity to earn significant returns on the investments if the startups succeed.
  
  
• Early access to innovative ideas: Chance to be involved in the early stages of mission-driven companies solving for our community’s biggest challenges.
  
  
• Total control: Allows full control over selecting companies to invest in.
  
  
• Personal fulfilment: Leads to personal fulfilment as many investors enjoy the process of mentoring and supporting entrepreneurs.

Cons of angel investing:

• High risk: Carries the highest risks since most startups fail and there is a significant chance of losing the entire investment.
  
  
• Lack of liquidity: Illiquid investments which can take years to generate returns, making it difficult to access capital when needed.‍
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• Time and effort: Significant time and effort needed to research potential investments, conduct due diligence and provide ongoing support to portfolio companies. Especially as a Muslim since the companies need to be vetted for Shariah compliance.

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Venture Capital Funds

Venture capital serves as a cornerstone of the traditional startup ecosystem. A group of experienced investors, called venture capitalists, pool funds from institutional investors, pension funds or ultra-wealthy individuals together into an investment fund. They then find high-growth startups to invest from the fund as part of their portfolio.  

Venture capitalists typically invest in cycles of five to seven years and don't just provide capital; they actively mentor and advise the startups they invest in to help steer them towards profitability, often by taking a board seat at the startups they invest in. The goal is for these companies to grow rapidly so they can eventually exit, leading to a huge return. However, there’s no guarantee that every startup will succeed so they’re just looking for that one huge win to hit the jackpot. 

As a Muslim investor, investing in a venture capital fund is different from investing directly in a startup because, here, you are essentially investing in a portfolio of companies that the fund invests in. It is at a fund manager’s discretion to invest in the companies they like, which can be a bit tricky because some of these companies may not be Shariah-compliant, which would make the investment impermissible.

Pros of Venture investing:

• Diversified risk: A venture fund invests in a diverse portfolio of startups with each fund, reducing the overall risk exposure as compared to investing in just one startup.
  
  
• Expert screening: Managed by experienced investment teams that conduct thorough due diligence before investing.
  
  
• Value-add services: Provide portfolio companies with strategic guidance, operational support, industry network, talent recruitment assistance and other services.  

Cons of Venture investing:

• Lack of control: Investors have little to no say in which specific startups the fund invests in or key decisions around those investments.
  
  
• Shariah compliance risks: Venture funds often deal with preference shares, which grant investors priority in any event of liquidation. Shariah law advocates for equitable risk and reward sharing among all investors, so such deal structures are impermissible for Muslim investors.

• High minimum investment: Participating in venture capital funds often requires a high minimum investment, which may be out of reach for individual investors.‍
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• High fees: Typically charge management fees and carry fees, which can reduce investors' overall returns.
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• Market Volatility: Performance of venture capital investments can be highly sensitive to market conditions, economic cycles, and changes in investor sentiment, which can impact the timing and success of exits and the overall returns generated by the fund.

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Investing via Online Investment Platforms

The rise of investing via online platforms has truly democratised the venture investing landscape, opening up startup investing to the general public. The high-growth deals are no longer exclusive to high-net-worth individuals only.  

It is a way for startups to raise capital by pooling smaller investments from a large number of people, with relatively small amounts. This makes it easier to diversify across multiple startups and limit your overall risk exposure.

In 2023, the market size for this type of investment was $1.17 Billion, with projections indicating a twofold increase by 2030. In the UK, online platform investing ranks as the third largest source of financing for startups with notable success stories including Monzo, Revolut and Nutmeg. 

While this form of investment is permissible in Islam, similar to angel investing, the issue lies in choosing the right companies to invest in. Muslim investors need to thoroughly vet that a startup's business activities are permissible and free from any prohibited elements like riba (interest), gambling or exploitative deal structures.

Pros of online investment platforms:

• Diversification: Allows investors to spread their investment across multiple startups, thereby reducing the overall risk associated with any single investment.
  
  
• Access to early-stage opportunities: Access to investment opportunities in innovative, disruptive startups from the very beginning, when valuations and pricing are still low – opportunities traditionally reserved for high net worth investors. 
  
  
• Lower Minimum Investment: Lower minimum investment requirements compared to traditional investment avenues where the required minimums are tens- or even hundreds-of-thousands of dollars.
  
  
• Easy investment process: Investments can be easily made and managed through online platforms.
  

Cons of online investment platforms:

• Limited transparency: Investors may not have full access to information about the startups they are investing in, making it challenging to conduct thorough due diligence and assess the investment opportunity accurately. For Muslim investors, this is particularly problematic as it can be difficult to ascertain whether a startup is Shariah-compliant. 
  
  
• Regulatory risks: Investments through online platforms could potentially face changing regulations, restrictions or limitations down the road as it is still a nascent space.‍
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• Little to no control: Investors typically have little to no control or decision-making influence over startup’s management and strategic direction.

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Wahed Ventures vs. Other Investment Options: What Sets Us Apart?

At Wahed Ventures, our mission is clear: to create a truly inclusive and comprehensive platform for halal startup investing for Muslim investors like yourself. Think of us as the best of all worlds.

Operationally, we are similar to other online investment platforms; however, we proudly call ourselves a private placement platform because we provide our investors with private and exclusive opportunities that are not available elsewhere in the market. 

Like online investment platforms, we make it very easy for you to explore new deals, review details, invest with a simple click and monitor your portfolio—all from the convenience of your mobile phone. But unlike typical platforms, all of our startups are Shariah-compliant, so you can invest without worry and have peace of mind knowing that all returns you will be making are fully aligned with Shariah principles.

Similar to being an angel investor, with us, you can invest in the deals of your choice. But we take away the added pressure of due diligence off your shoulders, as we take care of that for you by scrutinising each deal with our Shariah lens.

Unlike a VC fund where you need to invest hundreds of thousands of dollars, our investment minimum is much lower, starting at just £500. With a low entry, you can build a diversified investment portfolio from day one to spread your risk across multiple startups. 

So essentially, we combine the accessibility of online investment platforms, the autonomy of angel investing, the rigour of VC funds’ due diligence and an uncompromising commitment to Shariah–all rolled into one platform.

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