ABSTRACT
The biggest obstacle to realize a business idea or grow a current innovative business is undercapitalization. Many radiant business ideas cannot succeed without a capital support. In this direction, private equity investment funds (“PEIFs”) have emerged as an alternative remedy for the small sized companies searching for a source for their capital requirements. As a consequence, PEIFs have become highly mentioned investment vehicles worldwide in the early 2000s. However, the utilization filed of PEIFs has increased in Turkey with the Communiqué on Principles of Venture Capital Investment Funds (“Communique”) numbered III-52.4 and dated July 01, 2014 which has specified the framework of the establishment and operation of PEIFs.
I. INTRODUCTION
Nowadays, private equity funds which have emerged as an alternative investment instrument intended for the companies underperforming but having high growth potential, or for the enterprises that cannot be established due to financial difficulties, especially in developing countries, have also achieved remarkable development in Turkey in recent years. Banks as traditional financial institutions provide credit at a considerably high interest rate which constitutes an obstacle to the establishment and operation of small or medium-sized enterprises with high growth potentials. Hence, the importance of private equity funds has grown rapidly not only in Turkey but throughout the world. Many successful companies of today all around the World such as Apple, were established with private equity funds, and the first regulation relating to the system of private equity companies had been made in 1993, and finalized with the regulations made in 1998, 2003, 2004 and 2014. Today, annual private equity investments are around 100 million dollars in Turkey1.
In this article, the information regarding the features of private equity funds, the authorizations and responsibilities of PEIF founders, management, custodianship and representation of PEIFs and the establishment and termination procedures in Turkey will be discussed.
II. NATURE OF PRIVATE EQUITY INVESTMENT FUNDS
A. Overview
Private Equity is a type of finance instrument for the purpose of investing in companies with high growth potentials for a specific period of time and acquiring ownership of the company’s shares2. Private equity investors raise funds and generally invest in underperforming companies that have the potential for high growth. Such companies which are funded by private equity investors are defined as Private Equity Companies (“PMC”).
1. Key Characteristic Features of Private Equity Investment Funds
According to the Communiqué,3 PEIFs do not have a legal personality, but instead they are described as an ‘asset pool’ established for a specific period of time whichtakes place in the fund’s charter (“Fund’s Charter”) of PEIFs and the Issuance Certificate (“IC”). Besides, according to the Communiqué, participation units stated in the Issuance Certificate can only be sold to qualified investors (“QIs”)4.
PEIFs are established with money and/or capital stocks collected from QIs in return of participation unit. Only Private Equity Portfolio Management Companies (“PEPMCs”) or Portfolio Management Companies (“PMC”) holding an operating license provided by the Capital Markets Board (“CMB”) are entitled to manage PEIFs on account of the participants and in accordance with fiduciary ownership principle in line with the Fund’s Charter.
2. Key Economic Terms of PEIFs
PEIFs present different key economic incentives for both founders of PEIFs (“Founder”) and QIs. While theaim of the founders is receiving management and performance fees, QIs aim receiving high rates of return on their invested capitals5.
According to the PEIF Communique, PEIFs can only engage in the works with the purpose of the management of portfolios comprised of the specific assets and transactions listed in the PEIF Communique.
3. The Asset of PEIFs
Fund assets are hold separate from the assets of the founder of PEIFs, the custodian (“Custodian”) and the portfolio manager. Besides, the assets of PEIFs cannot be designated as collateral or be pledged except for the purposes of borrowing loans and conducting hedging purposed derivative instrument transactions, provided that such transactions are conducted on account of PEIFs, and that the Fund’s Charter and the IC include provisions to this effect. The assets of PEIFs shall not be disposed of, even in the event assignment of management or supervision of the Founder and QIs for any purposes or whatsoever. Furthermore, it cannot be attached, made subject to interim injunction or be included in a bankruptcy estate for the purpose of collecting public receivables 6.
4. PEIFs Information Documents
a. Fund’s charter; is an adhesion agreement which is signed by and between the unit holders of PEIF on one side and the Founder, the Custodian and the portfolio manager on the other side; and which is about management of PEIF portfolio and functioning of PEIFs according to fiduciary ownership principles, and the Custodian of the assets, and management thereof in accordance with the provisions pertaining to attorney agreement.
b. The IC; is a document consists of information about the nature and sales conditions of PEIFs.
c. Investor information form; is a brief form showing the structure, investment strategy and risks of PEIFs.
III. AUTHORITIES AND RESPONSIBILITIES OF THE FOUNDERS
Founders are responsible for representation, management and supervision of the management of the PEIF and may also engage in activities in accordance with the provisions of Fund’s Charter and the IC, in such a manner to protect the rights of the PEIF unit holders.
On the other hand, Founders are authorized to dispose of and use the rights related to the assets of the PEIF on its own behalf and in the account of the PEIF in accordance with the applicable legislation, the Fund’s Charter and the IC.
Founders may delegate PEPMCs or PMCs, which are officially authorized by the CMB with an operating license, in order to get the portfolio management service within a portfolio management agreement. However, responsibilities of the Founders cannot be eliminatedby transferring the management of PEIFs to PEPMCs or PMCs. Founders may also assign third parties who are non-founder personnel as an agent through a decision of the Board of Directors for the purpose of using the shareholding rights specified in the Turkish Commercial Code regarding private equity investments of PEIFs, and the managerial rights arising from the shareholding contracts specified in the PEIF Communiqué.
IV. MANAGEMENT, CUSTODIANSHIP AND REPRESENTATION OF THE PEIFS
1. Management of PEIFs
Founders or delegated portfolio managers shall manage the PEIF assets in accordance with management principles specified in the law, the PEIF Communiqué, Fund’s Charter and the IC within the framework of regulations in the Communiqué on Portfolio Management so as to observe the benefits and interests of the investor.
2. Custodianship of PEIFs
Assets portfolio of PEIFs must be entrusted within the framework of the Communiqué on Portfolio Depositary Service and Providers of Such Service (III-56.1) 7. Additionally, the information, documents and records proving the existence of assets, which are not eligible for custodianship, either physically or on records, and the ownership of PEIFs on such assets are also held with the custodian.
3. Representation of PEIFs
PEIFs are represented by the board of directors of the Founder in respect of all activities related to the PEIFs.
V. ESTABLISHMENT OF PEIFS
A. Overview
For the establishment of PEIFs, Founders shall apply to the CMB with the draft of the Fund’s Charter and a standard form. In order to obtain the establishment license, a custodianship agreement should also be signed between the Founder and the Custodian.
1. Issuance of PEIF Units
PEIF units do not have nominal values and its value is calculated by dividing the net PEIF assets value by the number of PEIF units. The value of PEIF units must be calculated and notified to QIs accordingly at least once a year.
In order to initiate the issuance process, the Founder shall apply to the CMB by submitting an IC and other documents which can be requested by the CMB.
The IC is examined within twenty business days within the framework of the information and documents submitted to the CMB. The issuance of the IC strictly depends on the approval of the CMB. The approved IC is registered at the trade registry. Following the approval of the IC by the CMB, IC is offered to the investors through distribution channels declared in the IC from the starting date of the sales stated in the IC and under the principles set down in the Fund’s Charter, IC and, if any, investor information form.
2. Sales, Redemption and Transfer of the IC
The PEIF units shall be sold through complete payment of the PEIF unit value in cash or in transfer of the participation units that correspond to the value of the PEIF unit. The transfer of the PEIF units can only occur among QIs and the redemption of the PEIF units shall be realized through converting the investors’ PEIF units into cash under the principles stated in the IC. Entrance and exit commission may be charged on the sales of the PEIF units to QIs and on the redemption of units by QIs provided that it is specified in the Fund’s Charter and the IC. The collected commissions shall be recorded as revenue to the PEIFs.
The Founder must sell and redeem the PEIF units on the account of the PEIFs. The PEIF Communiqué permits the Founder to take PEIF units, including the qualified PEIF units, into its own portfolio, up to 20% of total number of units of the PEIFs. The underlying reason of this permission is that it is considered as an attractive marketing element since QIs would believe it better aligns the interests of the Founder with its own and the presumption of the QI that the Founder would not take excessive risks.
3. Marketing of the PEIF Units
Marketing and distribution of PEIF units may not only be conducted by the Founder, but also by the PMCs and investment companies holing the relevant authority through their personnel who have the relevant knowledge about the risks that these funds may involve, under an agreement signed with the Founder.
Public marketing of funds is strictly prohibited by the PEIF Communique except for the promotions addressed to QIs.
VI. PRINCIPLES ON VENTURE COMPANIES AND VENTURE CAPITAL INVESTMENTS
A. Overview
PEIFs can only invest in joint-stock and limited liability companies. A venture company, which is a limited liability company as of the date of investment, is required to complete its process of conversion into a joint-stock company within one year following the first investment date.
1. Investment Limitations on Venture Capital Investments
PEIFs shall ensure the following investment limits regarding management of venture capital investments in the PEIF portfolio:
a. At least 80% of PEIF net assets value is required to be composed of one or more venture capital investments.
b. If the amount of direct investments made by the PEIF in venture companies satisfying the qualifications listed in SME Regulation in an accounting period exceeds 10% of the fund’s total value, then the specified investment limit shall be applied as 51%.
In incidental cases such as redeem of fund units, or collection of dividends and interests from venture capital investments, or increase of the value of investments other than venture capital investments which may in turn lead to breach of the investment limits, providing that an application is filed to the CMB for granting of a period of time, and such application is deemed appropriate by the CMB, the founder and if any, portfolio manager may be granted a time of one year starting from the end of the subject accounting period in order to ensure compliance with the investment limits. If the said minimum investment limit cannot be complied with by the end of the granted time period by the CMB, the fund’s investment activities shall be terminated, and the fund rules shall be removed by the Founder from the trade registry within no later than two years following the end of the said period.
Moreover, if the minimum investment limits set forth in the PEIF Communique cannot be complied with due to full disinvestment of venture capital investments or the bankruptcy of venture companies, provided that an application is filed to the Board for granting of a period of time, and that such application is deemed appropriate by the Board, the Founder and if any, portfolio manager may be granted a time of two years starting from the end of the accounting period of said disinvestment in order to ensure compliance with the minimum investment limits.
2. Shareholders’ Agreement
Venture capital investments that the fund will make to the venture companies, granting a right of partnership in venture companies shall be made within the framework of a shareholders’ agreement which shall be signed between the PEIF on one side and the existing partners of venture companies holding the management control therein on the other side.
Shareholders’ agreement shall contain provisions regarding rights and obligations of the PEIF and existing partners of the venture companies, the principles relating to management of the venture company in particular.
3. PEIF Commitments
The Founder requests the QIs to make resource commitments to the PEIF to pay at once or at different times. The total amount of PEIF resource commitments to be collected from the QIs is minimum 5.000.000 Turkish Liras and it shall be stated in the IC. The PEIF resource commitments are required to be collected within one year following the commence date of sales of PEIF unitsto the investor. The collected PEIF commitments are required to be invested within the limitations specified in PEIF Communiqué within this period stated in the IC. However in any case, this period cannot exceed one year.
An investor agreement (“IA”) enters into by and between the PEIF and the QIs about the principles of payment of PEIF commitments. That agreement contains provisions on payment schedule of PEIF commitments, its lower and upper limits, and measures that may be taken by the Founder in case the PEIF commitments are not fulfilled. The Board of Directors of the Founder make the commitment calls on the QIs within the periods to be specified in the IA.
4. Prohibited Investments
According to the PEIF Communiqué, prohibited investments for PEIFs to engage in are as follows:
a. Investment in gold, other precious metals and other commodities and futures contracts based on them,
b. Margin trading, short sales and borrowing transactions with regard to capital market instruments,
c. Despite PEIFs can be part of derivate instruments in order to be protected against the risks such as currency, interest rate and market risks provided that they are specifically permitted in their Fund’s Charter, the total exposure in derivative instruments shall not exceed 20% of the total value of the PEIF.
VII. LIMITATIONS AND OBLIGATIONS
1. Limitations on Credit Transactions and Repo Transactions
In order to provide financing or to meet the costs related to portfolio, the PEIFs may borrow up to 50% of their net assets value calculated as of the last accounting period. In the case of borrowing, the information regarding the amount, interest rate, borrowing date, credit institution, and repayment date shall be notified to the CMB and to the PEIF unit holders via the most convenient communication instrument within 30 (thirty) days following the end of the relevant accounting period.
PEIFs can make repo transactions up to 10% of current market value of assets that may be subject to repo transactions, executed both in the exchange and in the overthe-counter market. Takasbank Money Market transactions may also be effected for borrowing purposes.
2. Obligations to Give Information of PEIFs
a. Periodic reports
PEIFs are obliged to prepare periodic reports and financial statements and submit the reports to the CMB. The relevant reports provided to the CMB and the investors are subjected to the regulations regarding the principles on financial reporting of investment funds 8.
b. Disclosure obligation
The founder and if any, the portfolio manager shall provide the unit holders via the most convenient communication instrument with information about venture capital investments, which also includes information regarding the relations of the persons involved in fund management with the these investments, within 15 days following the date of investment.
3. Supervision of PEIFs
All accounts and transactions of the Founder, the PEPMC and the PMC in relation to PEIFs are subject to the supervision of the CMB.
VIII. TERMINATION AND LIQUIDATION OF PEIFS
APEIF terminates at the end of the period specified in its Fund’s Charter. However, the Founder may make an application to the CMB for an extension of the term within the scope of the provisions regarding making changes in the Fund’s Charter provided that a relevant provision in the Fund’s Charter exists.
IX. CONCLUSION
PEIFs are Private Equity investment instruments which are regulated under Turkish capital markets legislation. Establishment of PEIFs in Turkey is a new concept while foreign funds have also been investing in Turkish Private Equity Companies. Key economic incentives such as tax advantages, deregulation trends in Private Equity investments and other investor friendly policies of Turkey have made positive contributions to the Private Equity investments in recent years. In the days ahead, rising trends in the Turkish Private Equity investment sector is expected to continue its growth.
BIBLIOGRAPHY
“Girişim Sermayesi Yatırım Ortaklığı Sistemi”, http://www.yoikk.gov.tr/upload/komiteler/kobi/gsyo.pdf, Last Access: 04.11.2016
“Sermaye Piyasası Kurulu”, http://www.spk.gov.tr/indexcont.aspx?action=showpag e&menuid=16&pid=5, Last Access: 04.11.2016
Mustafa İnanç, “Vergi Mükelleflerine Yeni Bir Teşvik Unsuru: Girişim Sermayesi Fonu”, Mali Çözüm Dergisi, V.113, 2012
FOOTNOTE
1 “Girişim Sermayesi Yatırım Ortaklığı Sistemi”, http://www.yoikk.gov.tr/upload/komiteler/kobi/gsyo. pdf, Last access:04.11.2016
2 “Sermaye Piyasası Kurulu”, http://www.spk.gov. tr/indexcont.aspx?action=showpage&menuid=16&p id=5, Last access: 04.11.2016
3 It entered into force on the date of July 01, 2014 and published in the Official Gazette (OG) numbered 28870 and dated January 02, 2014
4 Under the Guidelines on Individual Participation Equity ; QIs are defined as a person who owns at least TRY 1,000,000 worth of financial assets or satisfies the criteria of “angel investor”.
5 Mustafa İnanç, “Vergi Mükelleflerine Yeni Bir Teşvik Unsuru: Girişim Sermayesi Fonu”, Mali Çözüm Dergisi, V.113, 2012, p.195.
6 “PEIF Communiqué” published in Official Gazette (OG) numbered 28870 and dated 02.01.2014.
7 OG, dated 02.07.2013, numbered 28695
8 OG, dated 30.12.2013, numbered 28867.
