ABSTRACT
Given the difficulties early-stage ventures face in accessing financing through traditional methods, the need for entrepreneurs to raise funds for their projects or newly established venture capital firms is met by alternative financing methods. This study evaluates venture capital and angel investing, two alternative sources of funding, and discusses crowdfunding, which reaches out to huge numbers of potential investors through the internet. Equity-based crowdfunding, which enables investors to acquire shares in the funded company, will be analysed in the light of capital market regulations.
I. INTRODUCTION
Entrepreneurs aim to create new products or services, linking, at an early stage, their projects or firms with technological developments. Within this process, one of the biggest obstacles encountered by venture capital firms attempting to develop an idea or a prototype is access to funding. Where bank loans, a traditional financing method, are difficult to get due to lack of collateral or their high cost, with the effects of the economic crises experienced, entrepreneurs must look for alternative sources of finance.
As a result of the aforementioned alternative financing need, various financing methods have been used. One method of alternative financing is FFF (family, friends, fools), in which the entrepreneur funds a venture through contacts within their own immediate environment or from the “fools” they manage to persuade1. In general, this method is used in the early stages of a project. As the venture matures, angel investors and venture capitalists may be approached2.
Crowdfunding is an alternative method of financing. In this method, a distinction is made regarding whether it is financial or not and legal regulations are stipulated in financial or in other words, equity-based crowdfunding.
This study evaluates in detail the concept of crowdfunding and its legal framework with reference to venture capital and angel investment, which are financing options for venture capital firms.
II. VENTURE CAPITAL (RISK CAPITAL)
The venture capital model provides corporate finance, without a requirement for interest, to venture capital firms which have the potential to grow but for which an entrepreneur does not have insufficient equity to develop and realise the venture. The main feature of this model is that it depends on shares and is a medium-term solution3.
Venture capital kicks in where an entrepreneur has the technical expertise to develop a product or an idea but does not have the financial resources or management skills to put the project into practice. Venture capital investors invest in high-risk projects expecting high-income results from the entrepreneur4. The aim is to realise profit by disposing of the shares they hold when they increase in value as the venture succeeds in the medium term. Venture capitalists often acquire shares but leave control of the company with the entrepreneur, either by not taking a majority of shares or by granting privileged shares to the entrepreneur. In this way they are able to provide finances and expertise to support the company, giving the entrepreneur with a promising idea the opportunity to grow, and to make a profit by disposing of those shares in the medium term. Generally, as in Turkey, such funding is established as a venture capital investment fund. In Turkey, the legal framework for this is set out in the Communique on Principles of Venture Capital and Private Equity Investment Companies5 (“Communique on Venture Capital”) issued by the Capital Markets Board (“Board”). The procedures and principles regarding "venture capital and private equity investment company" are regulated by this Communique on Venture Capital.
Turkish capital market legislation states that the closest institution to venture capital is the venture capital and private equity investment company6. In addition, in the Capital Market Law numbered 6362 (“Law”), the concept of venture capital is broadly regulated to include both the ideas and the growth investments of 3-10-year companies targeting a growth strategy7.
III. ANGEL INVESTING
“Angel investors” are another financing resource available to venture capital firms8. They have a certain level of financial power and experience and are able to transfer those resources to their preferred venture capital firms9.
An angel investor can be someone from the entrepreneur’s family or social circle or someone unrelated to the entrepreneur. The prominent feature of angel investors is that they were once entrepreneurs or had this quality and want to take advantage of the high-risk investment opportunities offered by entrepreneurs10. Angel investors becomes involved in the management of venture capital firms by acquiring shares in return for the financial support and experience they provide. One of the features that makes such risks attractive to angel investors is the expectation of a high return, which is the result of the high risk inherent in venture capital firms, a risk traditional capital markets are not prepared to take. Once the venture becomes successful, guided by the angel investor’s investment and experience, the angel investor then disposes of the shares taking their return on their investment. That promise of rapid growth brings with its great risks so it is very difficult to dispose of any shares in the short-term. The investor’s expectation is that their risky investment will lead to rapid growth of the venture, when it can dispose of its shares with high profit margins11.
In Turkish law, "Individual Participation Investor" is the equivalent of angel investor12. Regulations within the framework of Regulation on Individual Participation Capital ("Regulation on Individual Participation Capital") aim to support early stage and growth-stage venture capital firms that have difficulty accessing funds due to the high risk involved by enabling individual participation investors to provide cash capital. In return for such cash capital, individual participation investors acquire shares in the venture capital firm.
IV. CROWDFUNDING
The underlying goal of crowdfunding for venture capital firms, is to get the necessary investment by appealing to crowds of individuals with small amounts rather than to groups of accredited investors with large amounts13. In crowdfunding, which is considered a new method14. contrary to traditional financing methods, there are three players: the entrepreneur seeking funds, the investor seeking to invest, and the crowdfunding platform that brings the entrepreneur and investor together15.
The notion of crowdfunding is differentiated as financial and non-financial16; broadly, it is encountered in four ways in practice: (i) donation-based via electronic crowdfunding platforms for a certain project or venture capital firm without the expectation of any return or profit, (ii) rewards-based for moral satisfaction, (iii) debt-based to be returned with or without profit, and (iv) equity-based, where shares in the venture capital firm are obtained.17
With donation-based and rewards-based crowdfunding methods, both of which are deemed as non-financial, supporters do not obtain shares of the venture capital firm they support18. While donation-based crowdfunding provides no return, rewards-based crowdfunding, that is fundamentally donation-based in terms of supporters’ contribution but distinctively there are perks provided to supporters19, offers discounts or early access to the product before its launch. It can be argued that there are ambiguities as to (i) whether the perks are delivered to supporters if the venture capital firm business is successful and (ii) whether the funds raised will be returned in case funding is not successful20. However, these are the most common and least regulated methods in practice since there is fundamentally no promissory transaction21.
The legal basis of the various methods of crowdfunding22 in Turkey was set out in the 2017 amendment in Law as introduced by the Code numbered 706123. Article 35/A as amended defines the crowdfunding platforms and authorises the Board to determine the principles and procedures these platforms carry out for its activities. Based on this framework, Communique on Equity-Based Crowdfunding (III-35/A.1) (“Communique”)24 was published in 2019.
Donation-based and rewards-based crowdfunding, in which no share is obtained, are expressly excluded from the scope of the Communique; and the principles and procedures of equity-based crowdfunding, of listing crowdfunding platforms, of its activities, of fund-raising from the public through equity-based crowdfunding and of control and supervision of whether the funds raised as such are used for the declared purposes of their use or not are set down by the Communique25.
Crowdfunding is defined in the Communique as “fund-raising from the public through crowdfunding platforms under principles set forth by the Board, for the purpose of raising the funds needed by a venture capital firm or a project, without being subject to provisions of the Law pertaining to investor compensation”. In addition, the Communique requires that the scope of the project or entrepreneur’s venture capital firm seeking funds must be a technology activity and/ or production activity26. Thus, it determines the legal framework of the practice of equity-based crowdfunding in Turkey.
Instruments regarding crowdfunding are not defined in capital market legislation as capital market instruments, and are separated from certain provisions within the scope of Law such as (i) fundraisers through crowdfunding platforms are not issuers27, (ii) no requirement of prospectus when fundraising through crowdfunding platforms28, (iii) venture capital firm is not deemed to be offered to the public even though there are more than five hundred shareholders29, (iv) crowdfunding platforms, crowdfunding and related activities are not in the content of Article 37 (investment services and activities) and Article 38 (ancillary services) of Law30. Nonetheless, Article 29 of the Law that regulates the principles regarding general assembly meetings of publicly-held corporations and the second and fifth paragraphs of Article30 of the Law which regulates participation in the general assembly meeting and voting are by analogy applied to general assembly meetings of venture capital firms of which the shares are dematerialised31.
The Communique provides certain principles with regards to crowdfunding platforms. In order for such platforms to carry out activities under the Communique, it is required for them to be listed by application to the Board. Article 5 of the Communique requires crowdfunding platforms to comply with the conditions listed therein: (i) to be a joint stock corporation, (ii) to have a minimum share capital of 1,000,000 TL fully paid in cash, and its paid-in capital and shareholders’ equity must not be less than this threshold, (iii) all of its shares must be registered shares and its commercial title should contain the phrase “Crowdfunding Platform”, (iv) its articles of association must be in compliance with the provisions stipulated in the Communique, and that the platform will exclusively deal with crowdfunding activities is specified, (v) an investment committee is assigned satisfying the qualifications specified in the Communique. Activities of the Crowdfunding platforms which fulfil the conditions specified in the Communique, without limit to the listed conditions above and is entitled to be listed, are narrowed down exclusively to crowdfunding. However, when performing such activities, crowdfunding platforms can advise venture capital firms or entrepreneurs and this will not constitute a breach of the Communique. Moreover, it is forbidden for crowdfunding platforms to provide advice, analyses and opinion to investors; and platforms are only allowed to carry out secondary market transactions between investors in the relevant market within the frame of the procedures and principles prepared by the Exchange32 and deemed fit by the Board33.
The dealings between crowdfunding platforms34 and venture capital firms,35 both of which must be joint stock corporations, and investors who provide funds to these firms through crowdfunding platforms are excluded from the scope of the Law. These dealings are said to be subject to general provisions36. By general provisions, it should be understood that provisions of the Turkish Commercial Code numbered 6102 are to be applied to the dealings of crowdfunding platforms and venture capital firms, both of which must be joint stock companies, and to provisions of the Code on Consumer Protection numbered 6502 regarding the distance sales and consumer protection and the general provisions of the Turkish Obligations Code numbered 6098 to the dealings of investors who provide funds and crowdfunding platforms37.
Crowdfunding platforms are liable for setting up a campaign page for each venture capital firm or entrepreneur raising funds, and to establish the infrastructure needed for the publication of all periodical statements and of the relevant venture capital firm or entrepreneur through this page throughout the campaign period and for five years following the end of calendar year of the campaign. In addition to such liability, crowdfunding platforms are held liable to publish information form approved by the investment committee on the campaign page, and to keep the information form and all kinds of information that may affect the investment decisions of potential investors on the campaign, available for examination by investors in this page throughout the campaign period and for five years following the end of calendar year of the campaign38.
With regards to the funds raised via crowdfunding platforms, these must be kept by a depository with the purpose of returning them to investors where the targeted amount is not reached, and of transferring them to the venture capital firms’ accounts where the targeted amount is reached39.
Investors are required to become a member of the crowdfunding platform via electronic media in order to be eligible for crowdfunding transactions. The Communique requires a membership agreement consisting of minimum requirements to be signed between the platform and the member investor. This agreement needs to be kept in electronic media and a written or electronic statement needs to be collected from members confirming that the “Equity-Based Crowdfunding Activities General Risk Statement Form” has been read and understood in addition to transmitting a copy of it through appropriate means of communication.
The Communique sets investment limits for non-qualified natural persons. Non-qualified natural persons may invest up to 20,000 Turkish Lira through equity-based crowdfunding methods in one calendar year. However, this limit may be extended to no more than 100,000 Turkish Lira if that is 10% of the relevant investor’s annual net income as declared on the platform40. In terms of venture capital firms, there is a qualified investor requirement in demands exceeding 1,000,000 Turkish Liras. In demands exceeding this amount, a minimum of 10% of the targeted funds must to be met by qualified investors. Furthermore, an entrepreneur or a venture capital firm may raise funds through no more than two campaigns on crowdfunding platforms in any period of twelve months. The upper limit of funds collected during that period is the issue limit for which an exemption is granted by the Board from the prospectus requirement and which is announced through the Board Bulletin every year41.
Where the demanded fund is reached within the time determined for the campaign by an entrepreneur who raises the fund or a venture capital firm that raises the fund, the fund frozen in the depository account opened in the name of the platform is transferred to the frozen account of the venture capital firm opened in the depository, and the collected fund must be used for the capital increase of the venture capital firm within 30 business days following the end of campaign, in the case that the fund is demanded by a venture capital firm. If the fund is demanded by an entrepreneur, the amount is transferred from the platform’s frozen account to the entrepreneur’s frozen account in order to be used for capital increase of the venture capital firm to be established within 30 business days following the date of registration of the establishment in the trade registry. Upon completion of the capital increase, the platform reports to the Central Registry Agency (“CRA”) the amount of funds provided by each investor and the total nominal value of shares to be issued in consideration of the amount of funds. The campaign period is complete when the rights of the frozen account of the venture capital firm in the depository are transferred to the venture capital firm upon registration of the shares on a dematerialised basis in the CRA and the transfer of these shares to the right holders.
V. CONCLUSION
One of the crucial requirements of ventures at the ideas stage when they may have limited resources is financing. Following recent technological developments, venture capital firms with a high potential for fast growth, though highrisk, can be seen as fruitful investment opportunities by investors in terms of the potential for a high rate of profit in short term. In the early stages of a venture, entrepreneurs’ finances resources tend to be family and acquaintances and in the later, more established stages, finances may be provided by angel investors or venture capitalists. Angel investors with the required financial power and experience aim to profit from the venture capital firms at the advanced stages in return for investing their finances and experience. Similar to the expectations of angel investors, private equity funding is provided for venture capital firms by corporate funds where they forecast an increase in the value of the firm within the short to medium term. Both methods are covered in Turkish Law: the former is regulated by the Regulation on Individual Participation Capital, and the latter is regulated by the Communique on Venture Capital.
Nowadays, “crowdfunding” where funding is obtained from multiple investors rather than a sole investor through electronic platforms, is frequently used and there are various versions, which are donation-based, reward-based, debt-based and equity-based. Venture capital firms that seek funding via web-sites can use donation-based or reward-based crowdfunding, with no financial return, as well as by “share acquisition”, both of which depend on different legal frameworks.
In addition to the provision of “crowdfunding platform” subsumed in Law, the Communique was prepared by the Board concerning equity-based crowdfunding; and it is required that the project or venture capital firm which can raise fund must engage in a technology activity and/or production activity. The Communique distinguishes crowdfunding activities from Law’s provision on most matters and designates the provisions to be applied to such activities.
Now the legal framework for crowdfunding has been established, venture capital firms have the opportunity to fund their ventures; at the same time, investors can confidently invest in venture capital firms that promise rapid growth and a high profit return, through the opportunity of acquiring shares in these firms.
BIBLIOGRAPHY
ANU ARORA, “Ewan Hutton, The Regulation of Crowdfunding in the UK”, Comp. Law, Vol. 38 (12), 2017.
ASLI KÜÇÜKGÜNGÖR, Sermaye Piyasası Hukukunda Erken Aşama Girişimlerin Paya Dayalı Kitle Fonlaması Yoluyla Finansmanı, Seçkin Yayınevi, Ankara 2020.
PAUL BELLEFLAMME, THOMAS LAMBERT, ARMİN SCHWİENBACHER, “Crowdfunding: Tapping the Right Crowd”, Journal of Business Venturing, 29(5), 2014.
EDAN BURKETT, “A Crowdfunding Exemption - Online Investment Crowdfunding and U.S. Securities Regulation”, 13 Tenn J Bus Law, 2011.
ERKAN POYRAZ, YUSUF TEPELİ, “Girişimciliğin Finansmanında Risk Sermayesi Finansman Sisteminin Önemi: Türkiye Uygulamaları” Dokuz Eylül Üniversitesi İktisadi ve İdari Bilimler Fakültesi Dergisi, 2016, C 31 V 1.
HALİL BEŞKARDEŞLER, “Türkiye ve Dünyada Risk Sermayesi”, Yüksek Lisans Tezi, T.C. Kadir Has Üniversitesi Sosyal Bilimler Enstitüsü Finans Ve Bankacılık Anabilim Dalı, 2010.
DARİAN M. IBRAHİM, “The (Not So) Puzzling Behavior of Angel Investors”, Vanderbilt Law Review, Vol. 61, 2008.
MEHMET BAHTİYAR, Sermaye Piyasası Hukuku’na Giriş, Beta Yayınevi, İstanbul, 2019.
SETH ORANBURG, “Bridgefunding: Crowdfunding and the Market for Entrepreneurial Finance”, Cornell Journal of Law and Public Policy, Vol. 25, 2015.
OYA EKİCİ, İBRAHİM SIRMA, YUSUF AYTÜRK, “Alternatif Finansman Yöntemi Olarak Kitle Fonlaması ve Yenilikçilik İlişkisi”, BDDK Bankacılık ve Finans Dergisi, C 13 V 2, 2019.
VİRGİNİA ROBANO, “Case Study on Crowdfunding”, OECD SME and Entrepreneurship Papers, No. 4, OECD Publishing, Paris, 2018. YAVUZ AKBULAK, “Paya Dayalı Kitle Fonlamasının Temelleri”, Leges Hukuk Dergisi, Y. 10 Special Vol. 126.
FOOTNOTE
1 Aslı Küçükgüngör, Sermaye Piyasası Hukukunda Erken Aşama Girişimlerin Paya Dayalı Kitle Fonlaması Yoluyla Finansmanı (Kitle Fonlaması), Ankara 2020, p. 22.
2 Küçükgüngör, Kitle Fonlaması, p. 117.
3 For broad evaluation on the subject please see: Erkan Poyraz, Yusuf Tepeli, “Girişimciliğin Finansmanında Risk Sermayesi Finansman Sisteminin Önemi: Türkiye Uygulamaları” Dokuz Eylül Üniversitesi İktisadi ve İdari Bilimler Fakültesi Dergisi, 2016, C. 31, V. 1, p. 35-56.
4 Küçükgüngör, Kitle Fonlaması, p. 55.
5 Official Gazette (“OG”) dated 09.10.2013, numbered 28790.
6 Halil Beşkardeşler, “Türkiye ve Dünyada Risk Sermayesi” Kadir Has Üniversitesi Sosyal Bilimler Enstitüsü Finans ve Bankacılık Anabilim Dalı, Unpublished Master Dissertation, 2010, p. 68.
7 Küçükgüngör, Kitle Fonlaması, p. 63.
8 Küçükgüngör, Kitle Fonlaması, p. 60.
9 For broad evaluation on the subject please see: Darian M. Ibrahim, “The (Not So) Puzzling Behavior of Angel Investors” (Angel Investors), Vanderbilt Law Review, 2008, Vol. 61.
10 Ibrahim, Angel Investors, p. 1406.
11 Seth Oranburg, “Bridgefunding: Crowdfunding and the Market for Entrepreneurial Finance”, Cornell Journal of Law and Public Policy, 2015, Volume 25, p. 405.
12 OG dated 15.02.2013, numbered 28560.
13 Paul Belleflamme, Thomas Lambert, Armin Schwienbacher, “Crowdfunding: Tapping the Right Crowd”, Journal of Business Venturing, 2014, 29 (5), p. 4.
14 Anu Arora, Ewan Hutton, “The Regulation of Crowdfunding in the UK” (Crowdfunding in the UK), Comp. Law. 2017, 38 (12), p. 369.
15 Küçükgüngör, Kitle Fonlaması, p. 84.
16 Virginia Robano, “Case Study on Crowdfunding”, OECD SME and Entrepreneurship Papers, No. 4, OECD Publishing, Paris, 2018, p. 11.
17 Mehmet Bahtiyar, Sermaye Piyasası Hukuku’na Giriş, 1. Baskı, İstanbul, 2019, p. 22; Arora, Hutton, Crowdfunding in the UK p. 369.
18 Oya Ekici, İbrahim Sırma, Yusuf Aytürk, “Alternatif Finansman Yöntemi Olarak Kitle Fonlaması ve Yenilikçilik İlişkisi” (Alternatif Finansman Yöntemi), BDDK Bankacılık ve Finans Dergisi, 2019, C 13 V 2, p. 216.
19 Edan Burkett, “A Crowdfunding Exemption - Online Investment Crowdfunding and U.S. Securities Regulation”, 13 Tenn J Bus Law, 2011, p. 64.
20 Yavuz Akbulak, “Paya Dayalı Kitle Fonlamasının Temelleri” (Paya Dayalı Kitle Fonlaması), Leges Hukuk Dergisi, Y 10 Special Volume Sayı:126, p. 58.
21 Ekici, Sırma, Aytürk, Alternatif Finansman Yöntemi, p. 216.
22 Akbulak, Paya Dayalı Kitle Fonlaması, p. 57.
23 Küçükgüngör, Kitle Fonlaması, p. 214.
24 OG dated 03.10.2019, numbered 30907.
25 Communique Article 2.
26 Communique Article 21 (1) (a).
27 Law Article 3 (1) (h).
28 Law Article 4 (1).
29 Law Article 16 (1).
30 Law Article 35/A (4).
31 Law Article 35/A (2).
32 Law Article 3 (1) (ç): “Exchange: Systems and market places authorised in accordance with this Law and established in the form of joint stock corporations that are operated and/or managed by themselves or a market operator to ensure smooth and secure trading of capital market instruments, foreign exchange, precious metals and precious stones and other contracts, documents and assets deemed appropriate by the Board under free competition conditions and to determine and declare the prices formed, which operate on a regular basis to bring together purchase and sale orders so as to execute them or to facilitate bringing together of such orders […]”
33 Communique Article 21 (4).
34 Communique Article 5 (3) (a).
35 Communique Article 4 (1) (e).
36 Law Article 35/A (5).
37 Küçükgüngör, Kitle Fonlaması, p. 276.
38 Communique Article 11 (3).
39 Communique Article 11 (3) (c).
40 Communique Article 15 (1).
41 Communique Article 16 (7), (8).
