Private equity in Turkey: market and regulatory overview
A Q&A guide to private equity law in Turkey.
The Q&A gives a high level overview of the key practical issues including the level of activity and recent trends in the market; investment incentives for institutional and private investors; the mechanics involved in establishing a private equity fund; equity and debt finance issues in a private equity transaction; issues surrounding buyouts and the relationship between the portfolio company's managers and the private equity funds; management incentives; and exit routes from investments. Details on national private equity and venture capital associations are also included.
To compare answers across multiple jurisdictions visit the Private Equity Country Q&A Tool.
This Q&A is part of the global guide to private equity. For a full list of jurisdictional Q&As visit www.practicallaw.com/privateequity-mjg.
Companies that invest in the private equity market bear high risks but also the possibility of high returns. Usually, private equity companies exit after about three to seven years. However, Turkish private equity companies tend to invest for longer periods.
Private equity capital is also preferred for buyouts, which gives the investor company the opportunity to take control of the investee company.
Growth capital options are more popular than buyouts in the Turkish private equity market, but some companies have started doing buyouts too.
In general, Turkish companies still use traditional sources such as:
Mezzanine finance. This is a very new type of fundraising in Turkey and is expected to be more common in future years.
In Turkey, funds are typically invested in companies that are already established and have gone through the "start-up" level, but need financing. The manufacturing and service sectors attract the most investors, followed by logistics, telecommunications, trade and the construction sectors. In recent years, the retail sector has also started to attract private equity companies.
Generally, Turkish private companies engage in management and leveraged buyouts rather than other transactions. Since Turkish private equity companies tend to invest for longer than three to six years, management buyouts are more popular than other types of transaction.
Private equity investors exit by selling to a strategic buyer either through:
Public offering on the stock market.
A shareholders' agreement commonly includes:
The concepts of drag-along and tag-along are not well known in Turkey. Companies usually tend to exit after more than seven years. However, as long as the logic and benefit of the private equity is realised, the number of short term exits will rise in the following years.
On 1 July 2012, a new Commercial Code entered into force with the aim of modernising Turkish commercial market and company law. The Code is likely to have a positive effect on private equity investments, which will give a new impulse to the market.
The Code introduces new concepts and modernises provisions relating to:
Incorporation of a company.
Auditing and execution.
Joint stock and limited liability companies have been forced to make several fundamental changes.
Tax incentive schemes
There are no specific incentives regarding private equity investors. However, under Turkish tax legislation, private equity companies do not pay:
Corporate tax on income or capital gains provided that a minimum of 50% of the portfolio value is invested in Turkish companies. If it is not, companies have a one-year recovery period to invest up to the required rate.
Withholding tax on dividend distribution.
At whom directed
Private equity funds and private equity companies can benefit from these incentives if they meet the qualifications under Turkish legislation (see Question 6).
Any private equity investment trust or private equity company established in Turkey can benefit from these incentives.
There is no restriction on domestic, foreign and offshore companies investing in Turkey. However, foreign private equity trusts cannot benefit from the tax incentives mentioned in Question 5. Private equity trusts usually take the form of a joint venture.
For private equity funds, a fund must have a leading investor who holds at least 25% of the share capital and meets the qualifications set out in the communiqués published by the Capital Markets Board (CMB). For example, private equity companies must take the form of joint stock companies and obtain approval from the CMB before an IPO.
Under Turkish tax legislation and communiqués published by the Capital Market Board, private equity companies are exempt from several taxes and have several tax incentives if they are established in Turkey (see Question 5).
Fund regulation and licensing
Private equity funds are regulated by the Turkish Capital Markets Law as a subset of investment companies. They are defined as joint stock companies with fixed or variable capital established to issue shares in respect of portfolios comprised of:
Capital market instruments.
Venture capital investments.
Private equity funds must be incorporated as or transformed into joint stock companies with registered capital. An establishment permit must be obtained from the Capital Markets Board (CMB).
The Communiqué on Venture Capital Investment Trusts regulates the management and structure of private equity funds. Advertisements and announcements concerning the company and its portfolio must correspond with its real financial situation and the publicly available data on the company.
There are no exemptions to the regulatory procedure referred to above.
The Communiqué on Venture Capital Investment Trusts regulates the restrictions on the shareholders and managers of private equity investment trusts and funds. A leader shareholder must fulfil conditions such as:
Honesty and reputation.
Not being insolvent.
A minimum of five years' experience in law, finance, banking, industry or trade.
Assets of a minimum of TRY10 million.
The same conditions (apart from the minimum assets condition) also apply for general managers.
Restrictions for investors are not regulated by the Communiqué on Venture Capital Investment Trusts. Qualified investors (as defined by the Communiqué) must fulfil the requirements of the Communiqué on Angel Investments, including the condition that assets must be worth a minimum of TRY1 million.
There are no statutory or other maximum or minimum investment periods in private equity funds. The minimum rate of private equity investments must be 51% of their portfolio value. The maximum rate of investment in capital market instruments is 10% of their portfolio value.
In the event that a private equity investment trust invests through giving loans or security, its minimum rate for an investee must be 25% of the investment amount for the related investee. They can invest in the off board shares of the investee for a minimum amount of 25% of the assets of the private equity investment trust.
The relationship between the investor and the fund is governed by rules under the Turkish law on corporate management:
The founders and portfolio managers must look after investors' interests by managing the fund's assets. The management must act in accordance with the management principles regulated by the law.
Private equity investment trusts must provide the documents regarding their articles of association, investments and board resolutions to the Capital Markets Board (CMB).
Private equity investment trusts are subject to the governance principles in the Capital Markets Law. For example, certain financial information regarding the investee and portfolio must be announced in the KAP (Public Disclosure Platform).
The portfolio manager must be independent of the private equity investment trust (Capital Markets Law).
Interests in portfolio companies
Most common form
Generally, private equity funds take common stocks instead of debt interest. The risk with common stocks is that the investor does not have control over decisions regarding:
Other investment instruments are:
Preferred stock. The main difference between common stock and preferred stock is that the holders of common stock do not have decision-making powers.
Warrant. Warrants are available only for a specific time-period and lose their worth if they are not sold.
Convertible debt. The price of convertible debt is less than that of common stocks.
Equity line of credit.
Sale of restricted shares. Restricted shares can only be transferred under certain conditions.
There is no general restriction on the transfer of equity and/or debt interests in companies incorporated in Turkey. However, the transfer of debt or equity interests may be restricted by a company's articles of association or by the Turkish Commercial Code. In joint stock companies, the transfer of unpaid registered stock is subject to the company's approval. The transfer of registered stock which is not quoted on the stock exchange may be restricted for a valid reason (for example, the financial interests of the company). If the company has set a limit on the transfer of quoted stocks, transfers exceeding this limit may be restricted.
Tax payable in the context of share transfer includes corporate tax, income tax and VAT. Revenue arising from the transfer of stocks is subject to income tax unless the shares are retained for a minimum of two years. The transfer of printed shares is not subject to VAT.
Buyouts through capital injection are increasingly common. The main aim of a buyout is to acquire control of a related company that cannot fulfil its potential.
Buyouts that are performed by auction generally involve high amounts. Small and medium-sized deals are usually conducted directly with the assignor and assignee in accordance with the Turkish Commercial Code and the Capital Markets Law. Auctions are subject to general principles such as the announcement of an auction and corresponding applications within certain time limits.
Turkish legislation does not specifically regulate private equity buyouts. The general rules of the Turkish Commercial Code apply.
The following principal documents are produced in a buyout:
Share purchase agreement.
Employment agreements with the acquired company.
Interim financial statement.
Annual financial statements.
Financial audit report.
Annual activity reports.
The required documents may differ from the above depending on the buyout process.
Private equity funds commonly request contractual protection from sellers such as:
Proper due diligence process.
With regard to buyer protection, the Turkish Commercial Code and Capital Market Law regulate the principles providing transparency.
Joint stock companies must publish certain information regarding their company management and financial status on their websites (Turkish Commercial Code). Corporate governance principles are determined by the Capital Market Board (CMB) and may differ for public companies, for example:
Essential transactions such as the merger and acquisition resolutions of public companies are subject to authorisation by the CMB.
Public companies must declare the purchase of capital market instruments to the CMB.
The shareholders' meeting must be announced through the Public Disclosure Platform.
The duties stated below apply to portfolio company managers even in circumstances where the duties are not included in the contract (Turkish Commercial Code):
Managers must not:
compete with the company;
contract with the company; and
contract debts with the company.
consider the obligation of confidentiality; and
provide information and accounts to the company.
Management buyouts (MBOs) are not common in Turkey. The duties set out in Question 20 also apply to an MBO.
In addition to the typical employment terms of title, term, compensation (including incentive compensation), benefits, termination and severance, the most important employment terms imposed on management by a private equity sponsor are:
Private equity investors often acquire a controlling stake in the portfolio company. In general, management control over the activities of portfolio companies is defined in the shareholders' agreement. This includes:
Certain management decisions.
Rules relating to appointments (including the voting system and whether a veto right is granted to the investor or not).
In addition, private equity investors have:
The right to attend general meetings.
Voting rights. The most common measures are the requirement for a majority vote of the board and special quorum for certain topics.
To examine the state of the company, private equity funds also usually ask for information regarding a company's books, records and financial statements. This often includes information on the company's performance against projections and the likely achievement of banking covenants.
The percentage of finance typically provided by debt depends on a variety of factors such as:
Size of the transaction.
Risk profile of the transaction.
Income tax considerations.
Term loans and working capital facilities are the most common form of debt financing, but there is no typical percentage.
Debt providers typically protect their investments by obtaining security interests in the borrower's assets and guarantees from the borrower's subsidiaries, secured by the relevant subsidiaries' assets. There are several types of security such as:
Assignment of receivables.
Mortgages over real property.
Guarantees (for example, guarantees provided by parent companies).
Contractual and structural mechanisms
Contractual mechanisms to protect the investments of debt providers can be provided by senior facility agreements or mezzanine loan agreements which are executed between the debt provider and the parent company. Contractual subordination between the senior lenders and mezzanine lenders is provided in these agreements by accession of subsidiaries to the agreement through a statement.
Structural mechanisms for protection of debt providers can be provided by the creation of structural subordination between different debt providers. A structural subordination can ensure operating companies have priority over holding companies with regard to payment under the loan agreement. For this reason, a lender generally provides loans to operating companies rather than holding companies.
A joint stock company cannot support any third party acquirer of its shares by providing an advance, a loan or security (Article 380, Turkish Commercial Code).
Shareholders cannot acquire any loan from joint stock companies or limited liability companies unless to further the aims of the business (Turkish Commercial Code). The board of directors and related third parties are also within the scope of this law.
Certain transactions are exempted where (Article 380, Turkish Commercial Code):
A bank or financial institution performs a transaction that is pursuant to the nature of its business.
The company provides the loan and security under a share purchase transaction made by the company's employees, sister or parent companies' employees.
Portfolio company management
Under the Turkish tax law provisions, private equity investment trusts are exempt from corporate tax on income or capital gains (see Question 5).
Dividends can be paid to shareholders if there are no negative results carried forward. An allocation of 5% of the profits of the financial year must be made to create a legal reserve until the reserves reach at least 20% of the share capital. Other payments to the shareholders can only be made if the company does not become insolvent as a result of those payments.
Anti-corruption or anti-bribery protections can be included in the investment documents if the parties consider it necessary. Any director who becomes involved in corruption or bribery crimes is subject to the provisions of the Turkish Criminal Code. Directors are liable for:
Breach of faith: penalties range from a term of six months' to seven years' imprisonment.
Aggravated fraud: penalties range from a term of two years' to seven years' imprisonment.
Forms of exit
The forms of exit typically used to realise a private equity fund's investment in a successful company are:
Trade sales. This is mostly applied through an M&A transaction to a strategic buyer. This exit strategy is highly popular as trade buyers who are involved in the same industry and who have common business interests are driven to pay higher prices.
IPO. An IPO enables a company's shares to be listed on the stock market for the first time. In Turkey, IPO exits are not as preferred as strategic sales.
In 2013, there were 15 exit transactions in the Turkish private equity market.
Advantages and disadvantages
The advantages of trade sales include:
A premium is paid by acquirers after the higher valuation of the portfolio company.
In comparison with the IPO process below, it is less costly and also convenient to proceed.
M&A exit requires only one investor's support, whereas an IPO must convince the whole market.
Immediate and complete exit.
The disadvantages of trade sales include:
Potential conflict among the management which could also affect its independence.
Difficulty in forecasting buyers' behaviour.
The advantages of an IPO include:
The prestige of being a publicly-traded company.
A public float can increase the liquidity of the portfolio company.
It can provide investors with higher returns as a consequence of the difference between book value and the market value of the portfolio company.
The disadvantages of an IPO include:
More complicated bureaucratic procedure may dissuade investors by creating concerns over the general efficiency of Turkish legal procedure.
The disclosure of the company's financial statements for the purpose of transparency can cause pressure on the company's financial management strategies.
Forms of exit
Secondary buyout. In the event of a secondary buyout, the private equity fund sells its shares to another private equity investor.
Leveraged recapitalisation. This is a partial exit strategy where private equity funds acquire cash by re-leveraging the company in the case of selling and completely exit from the portfolio company.
Advantages and disadvantages
In respect of secondary buyouts, one advantage is that private equity funds tend to engage in short-term buyout transactions that allows them to adopt their strategy to macroeconomic circumstances. It also benefits from a faster exit strategy compared to an IPO or trade sale.
The advantage of leveraged recapitalisation is that the management of the company remains under the control of the private equity company.
A disadvantage arises in the case of an over-leveraged capitalisation where the company is likely to face a risk of bankruptcy by defaulting on its debt.
Private equity/venture capital associations
Capital Markets Board of Turkey (CMB)
Status. The CMB is the regulatory and supervisory authority in charge of the securities markets in Turkey.
Principal activities. This is a governmental website which contains official information and directives. The CMB's principal activity is to oversee the smooth functioning of the capital markets.
Capital Markets Board of Turkey
Description. The CMB is the regulatory and supervisory authority in charge of the securities markets in Turkey. The website contains official information in Turkish and English on private equity and venture capital (for example, CMB Regulations and Communiqués). It includes general information for foreign investors.
Herdem Attorneys at Law
Professional qualifications. Turkey
Areas of practice. Private equity; venture capital; energy; banking; finance; aviation.
Languages. Turkish, English
Professional associations/memberships. Istanbul Bar Association