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.

Contents

Market overview

1. How do private equity funds typically obtain their funding?

Generally, private equity funds obtain their funding from:

  • Investors with high purchasing power.

  • Insurance companies.

  • Banks.

Turkish private equity funds often obtain their funding from sources such as the:

  • International Corporate Finance Group.

  • European Investment Bank.

 
2. What are the current major trends in the private equity market?

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.

 
3. What has been the level of private equity activity in recent years?

Fundraising

In general, Turkish companies still use traditional sources such as:

  • Capital markets.

  • Loans.

  • Corporate bonds.

  • Mezzanine finance. This is a very new type of fundraising in Turkey and is expected to be more common in future years.

Investment

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.

Transactions

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.

Exits

Private equity investors exit by selling to a strategic buyer either through:

  • Public offering on the stock market.

  • Trade sale.

A shareholders' agreement commonly includes:

  • Exit opportunities.

  • Pre-emption rights.

  • Drag-along rights.

  • Tag-along rights.

  • Profit share.

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.

 

Reform

4. What recent reforms or proposals for reform affect private equity in your jurisdiction?

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:

  • Corporate governance.

  • Incorporation of a company.

  • Auditing and execution.

Joint stock and limited liability companies have been forced to make several fundamental changes.

 

Tax incentive schemes

5. What tax incentive or other schemes exist to encourage investment in unlisted companies? At whom are the incentives or schemes directed? What conditions must be met?

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).

Conditions

Any private equity investment trust or private equity company established in Turkey can benefit from these incentives.

 

Fund structuring

6. What legal structure(s) are most commonly used as a vehicle for private equity funds in your jurisdiction?

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.

 
7. Are these structures subject to entity level taxation, tax exempt or tax transparent (flow through structures) for domestic and foreign investors?

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).

 
8. What (if any) structures commonly used for private equity funds in other jurisdictions are regarded in your jurisdiction as being tax inefficient (whether by not being recognised as tax transparent or otherwise)? What alternative structures are typically used in these circumstances?

Generally, private equity funds are not tax transparent in Turkey. Ordinary partnerships which are tax transparent (adi ortaklık) can be a solution in these cases.

 

Investment objectives

9. What are the most common investment objectives of private equity funds?

The most common investment objective of a private equity fund is to increase the value of a company and then exit from it. To achieve this, private equity companies evaluate all relevant elements such as:

  • Return.

  • Sales.

  • Performance of the investee company.

  • Management.

 

Fund regulation and licensing

10. Do a private equity fund's promoter, principals and manager require authorisation or other licences?

Under Turkish law, promoters, managers and principals do not require authorisation or other licences.

 
11. Are private equity funds regulated as investment companies or otherwise and, if so, what are the consequences? Are there any exemptions?

Regulation

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.

  • Real estate.

  • Venture capital investments.

  • Other assets.

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.

Exemptions

There are no exemptions to the regulatory procedure referred to above.

 
12. Are there any restrictions on investors in private equity funds?

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.

 
13. Are there any statutory or other maximum or minimum investment periods, amounts or transfers of investments in private equity funds?

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.

 

Investor protection

14. How is the relationship between the investor and the fund governed? What protections do investors in the fund typically seek?

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

15. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio company? Are there any restrictions on the issue or transfer of shares by law? Do any withholding taxes or capital gains taxes apply?

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:

  • Dividends.

  • Voting power.

Other forms

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.

Restrictions

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.

Taxes

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

16. Is it common for buyouts of private companies to take place by auction? If so, which legislation and rules apply?

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.

 
17. Are buyouts of listed companies (public-to-private transactions) common? If so, which legislation and rules apply?

The buyout of listed companies is not common. Principles concerning acquisitions contained in the Turkish Commercial Code and Capital Market Law are applied to the buyouts of listed companies. In addition, the Privatisation Law applies to auctions of buyouts of public enterprises.

 

Principal documentation

18. What are the principal documents produced in a buyout?

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.

  • Shareholders' agreement.

  • Interim financial statement.

  • Buyout report.

  • Annual financial statements.

  • Financial audit report.

  • Annual activity reports.

The required documents may differ from the above depending on the buyout process.

 

Buyer protection

19. What forms of contractual buyer protection do private equity funds commonly request from sellers and/or management? Are these contractual protections different for buyouts of listed companies (public-to-private transactions)?

Private equity funds commonly request contractual protection from sellers such as:

  • Business warranties.

  • 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.

 
20. What non-contractual duties do the portfolio company managers owe and to whom?

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.

  • Managers must:

    • act diligently;

    • consider the obligation of confidentiality; and

    • provide information and accounts to the company.

 
21. What terms of employment are typically imposed on management by the private equity investor in an MBO?

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:

  • Non-competition.

  • Non-solicitation.

  • Confidentiality.

 
22. What measures are commonly used to give a private equity fund a level of management control over the activities of the portfolio company? Are such protections more likely to be given in the shareholders' agreement or company governance documents?

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.

  • Financing 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.

 

Debt financing

23. What percentage of finance is typically provided by debt and what form does that debt financing usually take?

The percentage of finance typically provided by debt depends on a variety of factors such as:

  • Size of the transaction.

  • Market conditions.

  • 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.

 

Lender protection

24. What forms of protection do debt providers typically use to protect their investments?

Security

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:

  • Share pledges.

  • Assignment of receivables.

  • Bank guarantees.

  • 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.

 

Financial assistance

25. Are there rules preventing a company from giving financial assistance for the purpose of assisting a purchase of shares in the company? If so, how does this affect the ability of a target company in a buyout to give security to lenders? Are there exemptions and, if so, which are most commonly used in the context of private equity transactions?

Rules

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.

Exemptions

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.

 

Insolvent liquidation

26. What is the order of priority on insolvent liquidation?

In the case of an insolvent liquidation, certain types of debts have priority in the following order (Turkish Bankruptcy Law):

  • Commodity and real property debts.

  • Employee claims.

  • Custody debts.

  • Unsecured debts.

 

Equity appreciation

27. Can a debt holder achieve equity appreciation through conversion features such as rights, warrants or options?

Debt holders can achieve equity appreciation if they hold convertible securities such as rights, warrants or options, but this is not common.

 

Portfolio company management

28. What management incentives are most commonly used to encourage portfolio company management to produce healthy income returns and facilitate a successful exit from a private equity transaction?

Management incentives are not specifically provided under Turkish law. However, common management incentives are to give managers:

  • A combination of shares and options.

  • Performance-based bonuses (based on earnings before interest, taxes, depreciation and amortisation (EBITDA)).

 
29. Are any tax reliefs or incentives available to portfolio company managers investing in their company?

Under the Turkish tax law provisions, private equity investment trusts are exempt from corporate tax on income or capital gains (see Question 5).

 
30. Are there any restrictions on dividends, interest payments and other payments by a portfolio company to its investors?

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.

 
31. What anti-corruption/anti-bribery protections are typically included in investment documents? What local law penalties apply to fund executives who are directors if the portfolio company or its agents are found guilty under applicable anti-corruption or anti-bribery laws?

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.

 

Exit strategies

32. What forms of exit are typically used to realise a private equity fund's investment in a successful company? What are the relative advantages and disadvantages of each?

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.

 
33. What forms of exit are typically used to end the private equity fund's investment in an unsuccessful/distressed company? What are the relative advantages and disadvantages of each?

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)

W www.cmb.gov.tr (in English) (www.spk.gov.tr in Turkish)

Status. The CMB is the regulatory and supervisory authority in charge of the securities markets in Turkey.

Membership. N/A.

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.



Online resources

Capital Markets Board of Turkey

W www.cmb.gov.tr (in English) (www.spk.gov.tr in Turkish)

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.



Contributor profile

Safak Herdem

Herdem Attorneys at Law

T +90 212 319 7703
F +90 212 319 7600
E safak.herdem@herdem.av.tr
W www.herdem.av.tr

Professional qualifications. Turkey

Areas of practice. Private equity; venture capital; energy; banking; finance; aviation.

Languages. Turkish, English

Professional associations/memberships. Istanbul Bar Association


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