The heter iska is based on the distinction between a loan and an investment. A Jew may not accept interest on a loan to another Jew but may invest and share profits.
When borrowing money, the money belongs to the borrower, and any profit belongs to him. Sharing this profit with the lender violates the prohibition of ribbis. Conversely, invested funds belong to the investor, and profits are therefore his.
The key factor that determines whether money was given as a loan or an investment is ‘risk’. A loan must be repaid regardless of the borrower's investment outcome, so the lender's capital is not at risk. Investments involve risk, with no guarantee on the capital. The heter iska converts a loan into an investment by having the lender/investor assume risk but minimizes the risk he is undertaking by making several stipulations as follows:
The recipient (borrower) is not trusted to claim a loss in the principal unless he provides two valid witnesses to testify to this effect. Similarly, regarding profits, he is not trusted to claim that there were no profits unless he takes a serious oath to that effect. However, if the recipient agrees to pay as per the prior agreement made between the parties with the intention of reaching a 'compromise,' he is exempt from any oath or additional proof.
For the effort the recipient invests in managing the investors funds, the investor pays the recipient a small compensation for the effort, as agreed upon, such as one dollar.
This document is formulated in such a way that the investor becomes a partner in all of the recipient’s profit-generating assets, thereby entitling him to profits even if it is known that a specific investment made by the recipient did not yield a profit.