Despite the economic turmoil that has affected Turkey this year – a sharp decline in the value of the lira which has fallen more than 30% against the US dollar and an inflation rate above 20% – Turkey remains attractive for private equity (“PE”) firms seeking to raise funds for investment. Big names, such as the Dubai-based Abraaj Group and Turkven Private Equity, believe that Turkey continues to offer opportunities. Although Turkish PE hit a ten-year low in 2018, according to PitchBook, Abraaj has made ten separate PE investments in the country over the last few years while Turkven has invested $1.5bn in various projects.
Alongside Actera Group, Turkey’s other large buyout fund, Turkven is also planning to raise new dollar-denominated Turkey funds that guard against a further fall in the lira: Actera is aiming to raise up to $1.3bn and Turkven towards the $1bn mark. The current uncertainty could potentially work to their advantage if they choose the right time to re-enter the market when Turkish assets offer sufficient value.
So what do investors need to consider from a legal perspective when looking at buying opportunities in Turkey?
The most frequent method of investment for PE transactions in Turkey is for the PE investor to establish a Special Purpose Vehicle (“SPV”) in a jurisdiction that is tax efficient, often offshore. The then acquire shares in Turkish companies directly or through a local SPV established by the offshore PE fund in Turkey.
In Turkey, the Capital Markets Law (“CML”) and the Capital Markets Board (“CMB”) are supplemented by secondary regulations relating to capital markets institutions and instruments. The CMB issued two important communiqués: the Communiqué on Venture Capital Investment Companies (“VCIC” Communiqué) relating to the establishment and operation of venture capital investment companies (“VCICs”), and the Communiqué on Venture Capital Investment Funds (“VCIF” Communiqué), which enables the establishment of venture capital investment funds (“VCIFs”) in Turkey.
The CMB is the principal regulatory authority responsible for PE transactions undertaken by VCICs. The VCIC Communiqué offers detailed information for VCICs under the control of the CMB, including the incorporation phase, the realisation of investments, as well as dissolution. CMB involvement is needed for the approval of applications made by a VCIC or through notifications submitted to the CMB with respect to its ongoing activities.
Most VCIC sponsors are legal entities owned by large Turkish companies, or individual shareholders in those companies, while offshore PE funds are principally sponsored by foreign investors, often supported by the International Finance Corporation and the European Investment Bank. The sale process depends on the exit route: either an initial public offering (“IPO”) or a private sale chosen by the VCIC, or offshore PE fund.
The CML, the VCIC and VCIF Communiqués are the primary pieces of Turkish legislation. The VCIC Communiqué outlines a framework based on three pillars: venture capital investments, scope of activities of VCICs and investment restrictions. VCICs invest in venture enterprises, defined as ‘companies that are incorporated, or to be incorporated, in Turkey, and that have growth potential and are in need of funding’.
These investments are often conducted through shareholders’ agreements between the VCIC and existing shareholders of a venture enterprise, which must include references to the VCIC’s management, and to the rights and obligations of the venture enterprises and the VCIC. They may also regulate exit rights, rights of first refusal, tag-along and drag-along rights, and dividend distribution policies. VCICs must be domiciled in Turkey, while no such restriction applies to sponsors of VCICs, although they still have to demonstrate financial capacity and previous relevant experience. No such requirements are made of offshore PE funds and their sponsors since they are not subject to CMB regulations.
The Turkish Commercial Code (“TCC”) imposes duties on VCICs and sponsors. It regulates the activities of a group of corporations and dominant companies that indirectly manage such groups: a dominant company cannot misuse dominance over a subsidiary to its detriment. VCICs can appoint board members of portfolio companies; sponsors cannot prevent this. Venture enterprises are primarily incorporated as joint stock corporations (“JSCs”). Overall, the TCC is the primary legislation governing their obligations with specific rules on their management and representation, such as duty of care, non-compete and confidentiality.
The VCIC Communiqué requires that before an IPO, sale, or private placement, the transfer of VCIC shares of 10 per cent or more, or the transfer of privileged shares in VCICs, are subject to CMB approval. Should VCIC sponsors wish to transfer their shares in the VCIC beforehand, CMB consent is also required. In exits, withdrawal of funds through dividend distribution by the portfolio company is the most common method, although there can be problems with timing issues in relation to fiscal year rules. For sponsors seeking irregular withdrawals from their investments, the VCIC has to decrease its share capital and distribute the proceeds to shareholders.
In order to overcome this, companies with variable share capital, introduced under the CML, are useful tools for PE investment. Like the VCIC structure, they offer a more flexible capital adjustments mechanism. In 2015, the CMB issued the Communiqué on Securities Investment Companies (the SIC Communiqué) under which the regulatory framework for companies with variable share capital was first stipulated in Turkish Law.
VCIFs have no legal personality: their assets are separate from those of their incorporators, portfolio custodian and portfolio manager. The fund information documents are its by-laws which regulate the VCIF’s custody and management – they can only be amended with CMB approval. The VCIF Communiqué regulates investments using restrictions similar to those applied by the VCIC Communiqué. It includes the principles regarding incorporation and the issuance and sale of participation shares in VCIFs, which can be incorporated by portfolio management companies or venture capital portfolio management companies. The term needs to be stated in the VCIF’s by-laws and issuance certificates.
The Turkish PE sector is well-regulated to accommodate future foreign investment. It is anticipated that momentum will reappear once stability returns to the domestic economy. Turkey will therefore remain as a major hub for local and international PE funds seeking future investment opportunities.