From: THE PROHIBITION OF RIBBIT IN THE MODERN WORLD
WHAT IS THE HETER ISKA?
Halakha makes use of "evasions" of the law in various different realms. The idea of the heter iska arose already in the seventeenth century, and expanded to enormous proportions over the last hundred years, despite its inherent halakhic difficulties.
How does heter iska work? In a heter iska, the "lender" and the "borrower" turn into "investor" (=capitalist) and "businessman." Thus, it is noted that all the documents mentioning the terms "borrower" and "lender" actually mean "investor" and "businessman." The investor gives money to the business, and the businessman is supposed to invest the money in a business that yields profits. The profit and loss derived from the money is divided equally between the investor and the businessman, except for the small salary that the businessman takes for his work. The important point in the agreement is that the investor cannot know exactly how much the businessman profits from the business, and so the parties agree among themselves that the businessman is required to prove the truth of the figures presented by him. If the businessman is unable to prove to the investor how much money he earned, he must pay him demei hitpashrut, at the rate of interest. Practically speaking, the businessman (i.e., the borrower) is unable to prove how much his business profited or lost, and therefore he must pay the investor (the lender) the agreed upon demei hitpashrut.