Venture capital investment in Turkey: market and regulatory overview
A Q&A guide to venture capital law in Turkey.
The Q&A gives a high level overview of the venture capital market; tax incentives; fund structures; fund formation and regulation; investor protection; founder and employee incentivisation and exits.
To compare answers across multiple jurisdictions visit the Venture Capital Country Q&A Tool.
This Q&A is part of the global guide to venture capital. For a full list of jurisdictional Q&As visit www.practicallaw.com/venturecapital-mjg.
Venture capital and private equity
Venture capital is principally used as a subset of private equity. Both have the same purpose (to provide capital), but they differ from each other. The Capital Markets Board (CMB) of Turkey defines venture capital as an investment financing that enables early stage dynamic start-up enterprises to realise their investment opinions. Venture capital is provided to companies at early stage, whereas private equity funds are provided principally to growing companies for their further expansion and growth.
Sources of funding
Early stage companies can obtain funding from the following sources:
Funds of finance institutions (banks, insurance companies, and so on).
Other funding sources such as foundations, investment trusts and public authorities.
Types of company
Venture capital funds can invest in joint stock companies or limited liability companies (Communiqué on Venture Capital Investment Trusts). If the invested company is a limited liability company, it must be turned into a joint stock company within one year after the investment. Several factors play a role in the investment decisions of venture capital funds, such as the investee's sector and its growth potential. According to statistics, the manufacturing and service sectors attract the most venture capital investment, followed by logistics, telecommunications, trade and construction. Other popular sectors for investment are food and beverage products manufacturing, activities regarding medical and chemical products and computers, entertainment and arts, and textile.
Venture capital investments are principally made in start-up companies rather than established companies. The number of investees has increased since 2007. In 2012, there were about 150 investees in Turkey, mostly invested in Istanbul, Ankara and Izmir.
The Tax Process Law 2012 set out tax incentives for venture capital funds. These incentives may increase the number of venture capital investments.
The Communiqué on Venture Capital Investment Trusts of 9 October 2013 and Communiqué on Venture Capital Investment Funds of 2 January 2014 regulate the management, corporate structure and investment conditions for venture capital. The new investment incentives provided by the Council of Ministers' Resolution in 2012 may also increase venture capital investment depending on the investments' location and subject.
There have also been updates to the Commercial Code, particularly relating to corporate structure and corporate governance, which may positively affect venture capital funds in their investments.
Tax incentive schemes
Venture capital funds and investment trusts benefit from tax incentives under the Tax Process Law. The revenue of venture capital funds or investment trusts established in Turkey are exempted from corporate tax and the withholding tax rate is 0% (Tax Process Law). The position is the same under Article 5 of the Corporate Tax Law.
In addition, the state and various institutions provide general incentives for investors. These vary depending on the sector and location of the investment.
Generally, venture capital funds are structured in the form of limited partnerships consisting of limited partners and general partners. Venture capital firms are general partners and investors are limited partners. These partnerships last about ten years.
The investments' type and amount may depend on the total amount of the fund. In addition, a limited partnership may affect the investment's location and investment sectors. The partnership agreement includes the investment policy, and this agreement determines the sectors and locations of the investee.
The average life of a fund is three to ten years. Venture capital funds invest in one to three-year-old companies. Funds seek to exit their investments within three to five years, depending on the investment's standing and profitability.
A venture capital fund seeks:
Growth of the investee.
Profits from the transactions.
Fund regulation and licensing
Venture capital funds are regulated as investment trusts (Communiqué on Venture Capital Investment Trusts and the Capital Markets Law). Venture capital investment trusts must be established as joint stock companies (Communiqué on Venture Capital Investment Trusts). They are subject to the conditions imposed on joint stock companies under the Turkish Commercial Code, Capital Markets Law and Communiqué on Venture Capital Investment Trusts. Their minimum capital amount, corporate and management structure, and activities depend on the conditions stated by the Communiqué on Venture Capital Investment Trusts.
The Capital Markets Law and related legislation impose conditions relating to advertising. Advertisements and announcements about their companies and the companies in their portfolio must correspond with their real assets and financial data (Article 34, Communiqué on Venture Capital Investment Trusts).
The partnership agreement generally contains a number of provisions that address the relationship between the fund manager, the fund and the investor, including:
The fund manager's role.
The fees paid to the fund manager.
The decisions the fund manager can take.
Prohibitions of self dealing transactions.
The term of partnership.
Interests in investee companies
Valuing and investigating investee companies
Venture capital firms value the target company by considering certain factors, including the:
Target company's historical operating statistics, comparable company multiples of sales, current cash flow and expected future cash flow.
Outlook for the business sector in which the target company conducts business and its growth potential.
The principal legal documents used in a venture capital transaction are the:
Shareholders' agreement. The shareholders' agreement generally includes investment terms (that is, how the investment will be made, and so on), restrictive covenants and obligations regarding the company's management and governance.
Articles of association. The articles of association typically determine the rights attaching to shares, new share issues and transfers, the operation of the board, and general constitutional matters.
Protection of the fund as investor
Contractual protections are included in the shareholders' agreement, articles of association and service agreement. An investor may be entitled to (Turkish Commercial Code):
Certain capital/income rights (that is, dividends, liquidation dividends and pre-emption rights on transfer).
Managerial rights (that is, voting rights, the right to attend general meetings and the right to vote at general assembly).
Protections (for example, the right to ask for information about the financial statements of the company and the right to ask for an investigation).
Forms of equity interest
To invest in a company, a venture capital firm signs a shareholders' agreement with the target company. The shareholders' agreement determines the general rights and obligations of the venture capital fund and target company shareholders. In addition, the parties can extend the shareholders' agreement to include certain provisions regarding corporate governance, management, exit strategies, dividend policies, pre-emption rights, tag along and co-sale rights.
Share transfer restrictions
The investment documents usually contain the following restrictions on the transfer of shares by shareholders:
Pre-emption. The articles of association will contain pre-emption rights preventing shareholders from transferring their shares to third parties, unless they have first offered those shares to existing shareholders on the same terms.
Tag-along. The articles of association often prohibit share transfers to third parties that would result in a third party holding a controlling interest in the investee company, unless that third party has offered to acquire all shareholders' shares on the same terms.
Co-sale. This prevents a shareholder from transferring a proportion of his shareholding to a third party, unless all shareholders have been given the right to transfer a similar proportion of their shares to that buyer on the same terms.
The shareholders' agreement usually includes investors' pre-emption rights in relation to any further issues of shares by an investee company. In addition, the contract between the parties often contains a contractual restriction on the investee company issuing new shares without the investor's consent.
The venture capital's investment trust's articles of incorporation require the approval of the Capital Markets Board (CMB). Following that, the articles of incorporation are published in the Turkish Commercial Registry Journal. The trust must also prepare a prospectus to issue and offer shares to the public.
In addition, a stock exchange bulletin announces to investors:
Any important events relating to venture capital investment trusts.
Venture capital investment trusts' monthly portfolio tables, including their assets and net asset value per share.
Finally, venture capital investment trusts' annual and semi-annual financial statements must be audited by a certified external auditor.
A communiqué published by the Capital Markets Board (CMB) regulates the structure of the venture capital funds, but does not regulate who covers the costs of the venture capital fund. Therefore, the investor company usually covers the cost of the venture capital fund (although the parties can agree otherwise). As the investee is a start-up company, investors usually pay the cost of due diligence and legal fees.
Founder and employee incentivisation
Turkish legislation does not have good leaver and bad leaver provisions (that is, provisions relating to shareholders who have been directors or employees of a company but have left that employment). A shareholders' agreement can include these provisions. The provisions usually specify that the price which a bad leaver can demand for his shares is significantly less than that which a good leaver will be able to demand. Good leavers usually get market value, bad leavers often just get a nominal amount.
The following forms of exit are typically used to realise a venture capital fund's investment in an unsuccessful company:
Sales to specialist investors. In the case of financial distress, venture capital funds sell their shares to strategic investors who want to purchase distressed companies' shares at a lower price.
Solvent liquidation. Following debt discharging transactions, the company may be wound up under the solvent liquidation procedure. Once all debt is paid off, the remaining assets are distributed to the shareholders.
Insolvent liquidation. A company's assets are disposed of, for the purpose of immediate liquidation. However, there is a threat that the company is taken out of the venture capital fund's control.
Provided that the sale proceeds are reinvested into venture capital funds, these exit strategies have the advantage of obtaining cash quickly. This is essential to strengthen the financial statements of the funds after an unsuccessful investment, in order to reinvest in other investment opportunities.
The following forms of exit are typically used to realise a venture capital fund's investment in a successful company:
Trade sales. Trade sales may be significantly beneficial if a competitor is willing to purchase shares of the company at inflated prices. However, if the acquirer company is larger than the target company, the acquirer may seek to replace the management team and to transform the target company for their own business purposes.
Buyout. In the case of a buyout, venture capital funds can use the newly raised cash to take advantage of reinvestment opportunities in new companies. However, there is more uncertainty in comparison with trade sales.
Initial public offering (IPO). An IPO takes much longer than other exit strategies, as there are many transactions to complete and the real prices of the shares must be determined. The fundamental benefits of an IPO are:
the management does not lose control of the company; and
a partial refinancing of the company can be provided without a complete exit.
Shareholders, investors and creditors must be considered when determining an exit strategy. The exit strategy should be built into the agreement at the outset, as part of the overall negotiations. The exit strategy may include:
Tag along rights. This is an ultimate protection for minority shareholders in a company against major shareholders' sales decision. If majority shareholders decide to sell their shares to a third party, minority shareholders have the right to join the transaction and may sell their shares in the company.
Drag along rights. A right is given to majority shareholders to force the minority for the purpose of a sale.
Share transfer restrictions. This is a restriction on shareholders exiting without other shareholders.
Leaver provisions. These aim to prevent employee shareholders leaving before the exit is completely achieved.
Capital Markets Board of Turkey (CMB) (Sermaye Piyasası Kurulu)
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 equities and venture capitals, for example, CMB Regulations and Communiqués. It includes general information for foreign investors.
Banking Regulation and Supervision Agency (Bankacılık Düzenleme ve Denetleme Kurumu)
Description. This is the official website of the Banking Regulation and Supervision Agency, which is the regulatory and supervisory authority in the banking sector
Herdem Attorneys at Law
Professional qualifications. Turkey, Lawyer
Areas of practice. Private equity; venture capital; energy; banking; finance; aviation.
Languages. Turkish, English
Professional associations/memberships. Istanbul Bar Association, ABA.