Private equity and venture capital regulations in Turkey
by Elvan Aziz and Burcu Döner, Paksoy & Co.
In the aftermath of the 2001 financial crisis, the past three years have been a period of remarkable economic growth and legal reforms for Turkey, which aim at encouraging investors by way of removing various barriers on private equity and venture capital, financing and procuring them a fertile ground for investment. Due to the government’s stable policy and economic reforms, an inflation figure of 46% and 25% in 2002 and 2003 respectively, has shown a considerable decrease by moving into a single digit number in the second quarter of 2004 and consumer tendency surveys indicate an increase in consumer confidence. In realisation of these economic and legal developments, the Turkish government works hand-in-hand with the business sector. One of these efforts was a round-table discussion called “The Investment Advisory Council” held in March 2004, which was encountered with participation of CEOs of a number of large multinationals,World Bank officials,Turkish ministers and aimed to gather recommendations for making Turkey a foreign investment friendly environment.These recommendations are crucial for the Turkish government, determined to establish an adequate infrastructure such as improvement of tax regime, incentive schemes, intellectual property laws and customs regulations for the benefit of local and foreign investors. This article aims to provide general information on legislation relating to Turkish venture capital and private equity. Special emphasis is given to the newly-enacted foreign direct investment legislation and corporate governance principles.
Venture capital
The venture capital fund market in Turkey is regulated through the regulations of the Turkish Capital Markets Board (the “CMB”).The governing legislation, which was initially introduced in 1993 to promote private equity investment in Turkey, enabled venture capital companies to be established in the form of a Venture Capital Investment Trust (the “VCIT”).The legislation has undergone substantial changes in 1998 and 2003 providing for more flexible investment opportunities. A VCIT needs to be established in the form of a joint stock corporation with initial capital of TL5 trillion (around US$3,350,000). Shareholders of a VCIT can be real persons or legal entities, provided that they have not been subject to any legal prosecution due to bankruptcy or any other disgraceful offence. Being exempt from corporate tax, a VCIT also enjoys tax benefits. A VCIT needs to apply to the CMB to become listed on the Istanbul Stock Exchange (the “ISE”) within three years following its incorporation.This requirement is not applicable to special type VCITs having a minimum initial capital of TL1 trillion (US$670,000), which can only issue shares to qualified investors such as local and international
institutions. A VCIT may purchase stocks and borrowing instruments issued by the entrepreneur companies, participate in the active management of such companies, issue borrowing instruments and invest in other VCITs.They can enter into options and futures contracts in order to realise these venture capital investments. Since 1993, only two VCITs have been established in Turkey;Vakif Risk Venture Capital Co. in 1996 and Is Risk Venture Capital in 2000.Vakif Risk Venture Capital Co.’s nearly 50% stakes are held by a leading Turkish commercial bank,Vakiflar Bankasi, and more than 50% of its shares are traded at the ISE. Is Risk Venture Capital, which is an indirect subsidiary of another leading Turkish bank called Is Bank, had fully completed its organisational structure and began operational work in assessing investment projects but have not yet being quoted at the ISE.The above stated VCITs plus other private equity companies form a financial fund of approximately US$250m-US$300m in Turkey.
Private equity
Turkey has a strong potential for investment due to its market size and access, skilled and cost-effective labour, competitive domestic firms and strategic location.
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Significant legislative reforms were introduced in 2003 in order to improve the investment climate in Turkey and facilitate the flow of private equity investments. New enactments, as will be explained briefly below, aim to eliminate red tape, introduce equal treatment to both domestic and foreign investors and protect foreign investors’ rights in a fashion that match international standards. Depending on the size and objective of the investment, private equity investments could be exercised in different types of transaction such as incorporation of a new company, M&A, asset sale, public offering, spin-off, privatisation and joint venture.These transactions are mainly governed by provisions of the Turkish Commercial Code and the Turkish Code of Obligations.The Capital Markets Law and relevant communiques of the CMB also apply to transactions involving publicly-held companies. In addition, pursuant to the Law Concerning Protection of Competition and relevant communiques of the Competition Authority, the transactions defined above, which constitute a merger or an acquisition, will be subject to the approval of the Competition Board in case the market share and/or turnover thresholds are met and change of control in management rights occurs as a result of such transaction.
With the enactment of the new law, foreign investors can freely transfer profits, dividends and the sale and liquidation proceeds as well as payments received in relation to licence, know-how, technical assistance, and management or franchise arrangements.
CMB legislation, Istanbul Stock Exchange and public offerings
The CMB is the independent public authority authorised for regulating and supervising the securities markets and institutions subject to capital markets law. It is also responsible for determining the operational principles of the capital markets and protecting the rights and interests of the investors. Capital markets law and its implementing regulations issued by the CMB regulate, among others, public offerings in Turkey and describe the offering structures to be adopted. Real persons and legal entities residing abroad can freely purchase and sell all sorts of securities and other capital market instruments in Turkey. Under the capital markets legislation, offering of securities is realised through approved brokerage firms and is subject to a prior registration with the CMB. In addition, mandatory offer is required if a party or parties acting together acquire, directly or indirectly, 25% or more of the capital, voting rights or take over management control of a listed company. In connection with a public offering application the CMB, among others, reviews the company’s corporate documents to determine whether there are any share transfer restrictions affecting the liquidity of the shares to be offered or any provisions contrary to rights of minority shareholders. After a detailed review and registration of shares, the financial and other information of the company are announced to the public through the publication of the prospectus. The board of the ISE, the only securities exchange in Turkey, is the authorised body responsible for issuance of approval regarding the listing of debt and equity securities on the ISE.The ISE has issued a number of regulations providing for the ISE rules concerning listing, trading, settlement and custodian services.The ISE reviews the application and issues its decision within 60 days following the submission of all required documents. In practice, listing applications are usually filed with the ISE at the same time the CMB application is made. As of December 31, 2003, 265 Turkish companies were listed on the ISE and a total of 272 classes of shares of those companies were regularly traded (13 of these companies and classes of shares are
New foreign direct investment legislation
The new Foreign Direct Investment Law, introduced in June 2003, adopts a new approach to foreign investments and simplifies the bureaucratic procedures by way of eliminating certain foreign investment specific permissions. In addition, amendments to the Turkish Commercial Code (the “TCC”) simplified the lengthy and complicated company formation process, which previously required more than 20 government agencies’ authorisations. Changes in the company formation procedures have been praised by the international community.The International Finance Corporation has stated that company formation procedure in Turkey has become one of the easiest in the world. The new enactment also introduced the “equality principle” for domestic and foreign companies. As a reflection of this equality principle, all companies established with foreign capital and under the rules of the TCC are regarded as local Turkish companies, and, therefore, entitled to and benefit from the same rights and exemptions that are granted to domestic companies engaged in the same field of activity.The foreign investors also are no longer required to obtain an initial permit from the Foreign Investment General Directorate or contribute a minimum share capital because of their foreign identity for establishing or participating in a company in Turkey.
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suspended for trading). As of the same date, the total market capitalisation of all companies with equity securities regularly traded on the ISE was TL97,291,118,462m (approximately US$65,000m). A disproportionately large percentage of the market capitalisation and trading value of the ISE is represented by a small number of listed companies. Combined market capitalisation of the 10 companies with the greatest market capitalisations whose shares regularly traded on the ISE was TL52,552,891,771m (US$35bn), which represented 54.0% of the market capitalisation of all companies regularly traded on the ISE as of such date.
Disclosure requirements
As an important element in protection of shareholder rights, key principles of disclosure and transparency are given mandatory force by the TCC and regulations of the CMB and the ISE.The CMB disclosure requirements were amended and broadened in July 2003. As a general rule, it is required that public companies disclose in writing any changes that may effect investors’ decisions, market value of the underlying securities and all situations relating to the company, its subsidiaries, managers, personnel or any third party having a direct or an indirect relationship with the company via the fastest means of communication, including use of electronic signature, and on the date such decisions or situations have been procured. More specifically, the CMB requires disclosure of change in financial matters and assets of the company, its shareholding structure and management, voting rights or other rights determined in articles of association of the company. However, as a matter of market practice, name, field of activity, nationality of all shareholders and beneficiary ownership status will be disclosed to the CMB and the ISE. In addition,Turkish companies listed on foreign stock exchanges are required to disclose the same information to Turkish investors, which they provide to foreign investors under the rules of such foreign stock exchanges.
Corporate governance
The primary sources of corporate governance regulations embedded in the TCC and regulations of the CMB and the ISE. Special corporate rulings are also applicable to certain sector companies, such as banks and insurance agents. In addition, the doctrine and case law also provide the necessary source of mandatory corporate governance rules and standards in Turkish law. In July 2003, the CMB issued corporate governance principles (the “CMB Principles”) with an aim to heighten the corporate governance standards of Turkish companies, particularly public ones.The
principles were modelled after the OECD Corporate Governance principles of 1999 and take into account other worldwide generally accepted or suggested corporate governance standards with a view to increasing corporate accountability, transparency, fairness and integrity. The CMB Principles were developed on the basis of a code of best practice rather than firm legal rules. Unlike the mandatory legislation, the CMB Principles are not binding and, therefore, applied by companies on a voluntary basis. However, some of the principles of the CMB are already given mandatory force by being included in the CMB legislation such as disclosure requirements, using of IFRS and formation of audit committee.The CMB, however, has created a “comply or explain” process, requiring reasons for non-compliance, in the absence of adherence by listed companies to the CMB Principles, to be provided in the company’s annual activity report together with explanations addressing or dealing with possible conflicts of interest. Level of such disclosure has been left to discretion of public companies for year 2003. However, the CMB is expected to introduce higher disclosure levels from 2004 onwards. The CMB Principles are divided into four sections, namely the shareholders, disclosure and transparency, other stakeholders such as employees, suppliers, customers and creditors, and board of directors.The CMB Principles provide for the role of stakeholders in corporate governance and encourage active co-operation between companies and stakeholders.They also provide detailed principles concerning shareholders and their rights, for example right to review company books and accounts, right to attend to general assemblies, minority rights, voting rights, equal treatment and financial rights. The CMB Principles also cover the board of directors, including the board’s role, composition, responsibilities and appointment and remuneration of its members, as well as the relationship between the shareholders and the directors. One of the novelties in the CMB Principles concerns independent directors and the differentiation between executive and nonexecutive directors, and that of the CEO and the chairman of the Board.The CMB Principles also propose that companies have a “corporate governance committee”, in addition to an “audit committee”. In order to promote application of corporate governance principles, the CMB is planning to form a separate index of ISE, which will be comprised of public companies complying with the corporate governance standards at a certain level assessment of which is to be made by corporate governance rating companies yet to be incorporated.
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Conclusion
Turkey is a potentially important place for equity deals due to its young and dynamic population, unique location bridging Europe and Asia which expands the potential market size as an export platform, entrepreneurial community, cost-effective labour force and assorted business sectors. Turkey has reached a stage where the issue of foreign capital in the form of private equity or venture capital, is considered as a top priority and the latest reforms are the initiation of a series of required course of action to improve the investment climate.Turkey’s overall economic growth and recent reform-related activities offer potential foreign investors liberal and flexible investment grounds. It is expected that Turkey will become one of the major countries in the area attracting foreign investment in coming years.
Authors: Elvan Aziz,Associate Burcu Doner,Associate Paksoy & Co. Beybi Giz Plaza, Meydan Sok. No:28 Kat:10 Daire:35-36 Maslak, 34398, Istanbul Turkey Tel: +90 212 290 2350 Fax: +90 212 290 2355 Email: eaziz@paksoy.av.tr bdoner@paksoy.av.tr Website:www.paksoy.av.tr
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