What is a “Heter iska”?
A heter iska restructuring a loan so that it becomes an investment instead of a loan
Instead of having a lender and borrower, creditor and debtor, there is an investor and receiver
The standard heter iska creates an arrangement of half loan and half Investment.
“Heter iska” translates literally as “business permit.” It’s a term used in Jewish religious law that essentially means “iska loophole.”
Without loans, commerce can’t function—and without interest, lenders can’t function. But Torah law prohibits interest—so what do you do? Here comes the heter iska.
The heter iska legally redefines loans as investments: Since they’re not “loans,” you can “earn profit” by agreeing on a percentage of eventual profits from your “investment.” (There are several ways of structuring a heter iska, and indeed different situations may call for different types of heter iska.)
The standard Heter Iska (in contrast to the advance banking-friendly Heter Iska) works as follows:
Investment, not interest: With a heter iska, I don’t “loan,” say, $100,000 to you—I simultaneously business-loan $50,000 to you and invest $50,000 in a business run by you.
Principal protected by testimony impracticality: In a heter iska, both parties agree to produce two witnesses to back any claim. So if you’ll claim that you lost any part of my $50,000 investment in your business, you’ll need to produce two people knowing every little bit of your business—which is way too tedious and impractical. So, I’m guaranteed that you’ll grow, or at least protect, my $50,000 investment in your business—because it’ll be really hard for you to produce two expert witnesses on your business.
Religious principles guarantee growth: We legally agree that you’ll pay me set earnings from my $50,000 “investment.” One year passes. The business grows. You pay me my set earnings. And I trust you to never undercut me: You’re a faith-based Jew, and you’ll never swear (and on a sacred Torah scroll before an Orthodox court!) that the business didn’t earn enough for my set earnings when there’s any chance that it did. That’d be false testimony—and you don’t want that on your soul!
Can’t work for free! If you’re working as managing partner of my investment, it’s your work that’s earning me my profit in the deal—which I wouldn’t have without you. Since that would constitute interest in its own right (I’m getting back something that wasn’t there before, right?), I negate that by symbolically paying you for your investment management services—even if it’s just a dollar. It’s small—but without it, the whole heter iska process is legally not valid.