Policy #2.2: Enter Partnerships

Entrepreneurs who want to expand their business must do so through partnerships, i.e. they must partner with real, live human beings and not through entities invented by state law.  A partnership is an agreement between two or more specific parties, i.e. one party can't sell their stake to another party without getting permission from the existing partners. Consequently, no longer can companies issue stocks (or other equity instruments) on a public exchange to obtain capital. Such a rule would also apply to private corporations.

This policy is explored in two posts. The first post explored the impact of public companies on the economy. This second post explores the partnership structure as an alternative to stock-based companies. 

Part 2: Partnerships as an Antidote to Corporate Power

The Islamic approach to partnerships: The evidence for partnerships is that Prophet Muhammad (saw) in the following hadith did not object to the use of the partnership structure when they were asking about buying merchandise using a mixture of cash and credit:

“I and my partner bought something in cash and credit. Al-Bara ibn 'Azib came to us so we asked him about this. He said: My partner, Zaid ibn Al-Arqam, and I did the same and we asked the Prophet (saw) about this. He (saw) said: 'That which is in cash you take, and that which is in credit you return it back'.” [Bukhari]

In another hadith, Prophet Muhammad (saw): “The Supreme said I am the third of the two partners as long as one of them does not betray his companion. If he betrayed, I would withdraw from them.” [Daraqutni]

Both of these evidences show that partnerships are allowed in Islam. 

The types of partnerships include:

  • Al-'Inan or "equal" where partners contribute both capital and labour.
  • Al-Abdan (bodies) where the two or more people partner on their labour.
  • Al-Mudharaba (two or more) where one or more parties contribute with one or more parties that contribute just their labour.
  • Al-Wujooh (faces) where there are partners in labour or capital, but there is also a partner in trust, i.e. in the matters of trading, overall business operations, paying one's debts/bills, etc.  
  • Al-Mufawadha (negotiation) where two partners share in all the types of companies mentioned before, like a combination between the companies of 'Inan, Abdan, Mudharaba, and Wujooh.

The key, however, is understanding how the partnership rules prevent the problems with public/private corporations. One of the pillars of contracts (partnership, marriage, etc.) is that when two parties enter a contract that they have a valid "offer and acceptance" (in Arabic "ijab and qabool"). When party A offers partnership to party B, it is only an agreement between A and B. Party B cannot just sell his share to Party C without first asking Party A. In a sense, business partnership contracts should be similar to the way that (normal) marriage contracts work:  Billy who is married to Sally can't sell his contract to Jack without first divorcing Sally - who then subsequently must agree to marry Jack. The key is that a partnership contract exists between specific parties defined in the initial agreement. In contrast, when a company does an initial public offering anyone can be a partner and they are permitted to sell their stake to whomever they want. 

Other rules include:

  • Control is defined by the number of bodies, not amount of money: Unlike corporations, the more shares you have doesn't give you a greater say. In the Mudharaba contract, the capital owner has all the money and the labour has none - but both have the same say. It is left to them to negotiate based on their respective positions as to how they will share the profits. That is, it is still possible for the partner-in-capital to demand more than half of the profits if the partner-in-labour agrees. 
  • The loss is absorbed by the capital in the company. Abdurrazzaq narrated in Al-Jami' from 'Ali (ra): “The loss (al-wadhi'a) is upon the capital and the profit is according to what they stipulated.” Consequently, the labourer will lose their effort but won't be personally liable for the loss. 
  • Partners can't take a salary. The partner-in-labour (badan) can't mitigate the downside risk by taking a salary; they must only take a share of the profits. This combined with the previous requirement aligns the interest of the partner-in-labour with the success of the overall businesses. 
  • No limited liability. Islam is premised on personal accountability for one's actions in this life and the next. Consequently, the corporate structure (which limits such liability) is completely alien to Islam. Each partner is accountable and responsible for the actions of their company. This is not just debts but also any harm that a person may have done to their employees, customers or others impacted by their business (aka negative externalities).  

How will such partnerships dismantle corporate power? The amazing thing about partnership structures is that they simultaneously give an avenue for entrepreneurs to grow their wealth and at the same time it puts natural limits on how they can grow their wealth. What is meant by natural is that there is no arbitrary limit as to how big the company can be in terms of "dollars" (e.g. amount of assets held, annual revenues it can earn, etc). Instead the size of the company is limited by how well the partners can come to an agreement on working together and agreeing on how to move forward.  

How do such rules ensure that companies don't dominate the economy?

It should come as no surprise that today the partners-in-capital dominate the negotiation when dealing with the entrepreneur or company-founder.  In fact, 4 out of 5 company founders are forced out of their own company by the owners of capital

The ease of organizing and dissolving partnerships enables companies to break up if the partners disagree on how to run the company. Any partner, labour or capital, can simply exit the company. This will force the remaining partners to either buy the exiting partner or dissolve the company and divide up the assets as per the agreement.

In other words, what limits the size of partnerships - and the ability of owners-in-capital from overwhelming such structures -  is that the partners have equal footing when it comes to establishing the company, regardless of how much money they have invested in the company. 

Digger deeper into the mechanics of start-ups, we can see how such rules empower the "penniless entrepreneur". The reality of successful entrepreneurs is that they are driven by passion. Even more interesting is that this passion may lead the founders of companies to "make decisions that conflict with the wealth-maximization principle". This can lead to conflict with the partners-in- capital who are likely to be more focused on their "return on investment" (ROI). More generally, when people get together it is inevitable for differences of opinion to emerge between them. For example, the partner-in-labour (e.g. the founder) may want to sell the company for less than the other partners or the founders have differences that emerge over time, such as change in life plans, how much they want to focus on the business, etc. As venture capitalist Mark Suster notes in the video, he has to act "as a marriage counselor with startups who don't get along". In reality, some of these disputes will require a judge to settle the differences that could force the dissolution of the company or set the price at which one partner can buy out the other. This feature highlights two key points:

  • Partnership structures enable a more entrepreneurial economy: In contrast to the current Capitalist approach to investing, this approach to partnerships would elevate the status of the founder (i.e. the entrepreneur) who can't be pushed out of their own company. Investors will have to work with entrepreneurs on a more level playing field as they will fear the founder will simply pull the plug or find other investors to replace them (keeping in mind there is no other way to invest since there are no treasury bills and no stock markets). This doesn't mean that entrepreneurs have unlimited leeway as they will still need to work with partners-in-capital if they want to expand, it just means they have more options on how they want to shape their business. 
  • Empowering skilled employees to go out on their own:  In well-established industries (retail, service, etc.) employees move from unskilled workers to skilled workers. At this point, the worker will have the option to keep working as an employee or start theirs own business. For example, if his current employer wants to keep him, then she may have to make him a partner or let him go and find other investors to start his own business, depending on how valuable he is to the current business operations. 

Regardless of the scenario, the point is capital doesn't rule the day. The partner-in-labour can retain their agency and determine the direction of their involvement in the company. 

It should also be noted that the death of one of the partners requires the contract to be re-written. That is, the heirs of the deceased partner do not automatically become partners as the surviving partners must have a valid "offer and acceptance" with the children of the deceased who themselves may unable to agree and want to liquidate the business and "cash out". This emphasizes the original point where if a structure, theoretically, includes say 10,000+ people, it becomes structurally unstable as it constantly requires reorganizations when one of the partners dies or one of the partners decides to leave. In other words, Islam makes it hard for people to assemble mega-companies that dominate the economy and concentrate wealth in the hands of the few. 

What's implicit in the above discussion is that it's a good thing that companies can't live forever - in contrast to what we're taught in school about corporations having unlimited life. The ability for people to reorganize their companies enables for companies to be smaller. This prevents businesses from taking over not just business but politics as well and enables such structures to enable distribution of wealth instead of concentration of wealth. 

In summary, the partnership rules in Islam make the human element indispensable and ensure that business remains a tool within the hands of people and not make people tools for business.