ABSTRACT
This article provides an explanation of the investment process of venture capital investment funds and discusses the basic issues such as the definition of venture capital investment funds, asset formation, investor agreements, portfolio management and taxation, and the fundamental building blocks of venture capital investment funds.
I. INTRODUCTION
Venture capital investment funds are significant financial instruments that contribute to economic development by providing capital to ventures with innovative and high growth potential. These funds help entrepreneurs overcome the financial obstacles they encounter, while offering investors the potential for high returns. Regulated and supervised by the Capital Markets Board, these funds operate within certain legal frameworks. This article addresses the investment processes of venture capital investment funds by discussing the definition of venture capital investment funds, asset formation, agreements with investors, portfolio management and taxation.
II. VENTURE CAPITAL INVESTMENTFUND
Venture capital funds are private equity funds established to invest in newly incorporated companies with high growth potential. One of the biggest obstacles faced by individuals with entrepreneurial spirit in the process of realizing their innovative ideas is financial problems. Venture capital investment funds, which play an important role in overcoming these problems, offer solutions for entrepreneurs to find the capital they need.
According to the Capital Markets Board1, a Venture Capital Investment Fund is defined as “an unincorporated asset established for a period of time by portfolio management companies and venture capital portfolio management companies for the purpose of operating a portfolio of assets and transactions determined by the Capital Markets Board (Board) in accordance with the principles of fiduciary ownership for the account of shareholders with the money collected from qualified investors in return for participation shares”.
The Communiqué on Principles Regarding Venture Capital Investment Funds No. III52.4, published pursuant to Article 54 of the Capital Markets Law No. 6362, constitutes the legal basis of venture capital investment funds. The Communiqué generally regulates the principles regarding the incorporation of venture capital investment funds, which assets can be held in the portfolios of venture capital investment funds and which limitations the portfolio is subject to, valuation principles, how the fund profits will be determined and how they will be distributed, the activities of venture capital investment funds within the framework of the legislation and which principles the management is subjectto, how venture capital investment funds can merge or transform, in which cases venture capital investment funds will be liquidated and how the liquidation will take place in case of such liquidation.
In light of these descriptions, the general principles of Venture Capital Investment Funds can be considered as follows: 1) Being incorporated for the purpose of investing in venture capital companies, 2) Being incorporated by venture capital portfolio management companies or portfolio management companies, 3) Being incorporated for a limited period of time, and 4) Not having legal personality (legal personality is available only for certain transactions).
III. COMPOSITION OF THE ASSETS OF VENTURE CAPITAL INVESTMENT FUNDS
Venture capital investment funds enable investors to deploy their capital in dynamic and potentially high-growth ventures. These funds are specifically designed to support new business ideas and invest in innovative projects.
It is stipulated in Article 4/1 of the Communiqué that the fund carries out its investments with the money or interest shares collected from qualified investors in return for participation shares. In addition, Article 5/1 of the Communiqué further stipulates that the assets of the fund are separate from the assets of the founder, portfolio depository and portfolio manager.
The assets of the fund are composed of money or interest shares collected in return for participation shares. Furthermore, Article 26/1 of the Communiqué allows funds to utilize loans or interest-free financing, but this possibility is limited to a maximum of 50% of the total value of the fund.
A. The Immunity of Fund Assets
The protection of fund assets is vital to safeguard the interests of investors and to ensure that funds are operated in accordance with their objectives. The assets of funds are considered as a separate asset to ensure investors’ confidence in the funds and to reduce the risk of their investments. In this respect, a number of regulations have been introduced to protect the assets of funds.
In the second paragraph of the fifth article of the Communiqué, it is stated that fund assets belong only to the fund account and cannot be pledged or used as collateral except for obtaining loans and hedging derivative transactions, provided that it is specified in the fund bylaws and export document. Furthermore, even if the management or supervision of the founder or the portfolio depository is transferred to public institutions, the fund assets may not be used for any other purpose; they may not be seized for the collection of public receivables, no precautionary measure may be placed on them and they may not be included in the bankruptcy estate.
In order to protect the assets of the funds from the portfolio manager and the founder, the third paragraph of the same article stipulates that the debts and liabilities of the founder or portfolio manager to third parties cannot be set off against the receivables of the funds from the same third parties.
IV. INVESTOR AGREEMENT AND PARTICIPATION SHARE
Investors put money into funds in order to invest in new ventures and make a profit as a result. In venture capital investment funds, investor agreements and participation shares enable the investor to participate in the fund portfolio. Investors participate in the collective portfolio by purchasing fund participation shares. These participation shares represent a portion of the portfolio owned by the fund.
An investor agreement is an agreement that enables the investor to become a fund participation shareholder. With this contract, the investor joins a structure consisting of the fund founder and the fund management company. The fund founder manages the investor’s investments and transfers the profits back to the investor’s account. Although investors are fund shareholders, they do not have the right to participate in the management of the fund.
Pursuant to Article 3.1.(v) of the Communiqué, Investor Agreements are defined as an individual or collective agreement between the fund and the fund participation shareholders covering the matters not covered in the fund bylaws and the issue document. In terms of regulating the content of the agreement, the parties have freedom of will in accordance with the regulations in the Legislation. Moreover, the fact that investor agreements are not subject to the approval of the Board does not restrict this freedom of will.
Investor agreements generally regulate issues such as the investors’ commitments of resources and sanctions for non-compliance with the commitment, the conditions under which share transfers can be carried out, the methods by which the equalization mechanism can be made, and what kind of privileges will be provided if it is desired to grant privileges to a group of participants.
V. PORTFOLIO OF VENTURE CAPITAL INVESTMENT FUNDS
The primary purpose of Venture Capital Investment Funds is to create and manage a portfolio using the money or interest shares collected in exchange for participation shares. However, the content of the portfolio to be managed is subject to certain limitations imposed by the Legislation and the Board. These limitations apply both (i) in terms of the assets and properties that may be included in the portfolio and (ii) in terms of the management of the assets within the portfolio.
A. Limitation Regarding the Assets, Properties, and Transactions That May Be Included in the Portfolio
In the third paragraph of Article 4 of the Communiqué, it is stipulated which assets and transactions may constitute the fund’s portfolio. According to the article, the fund’s primary activity is managing a portfolio consisting of venture capital investments. Accordingly, various financial instruments such as venture capital investments, shares of joint-stock companies, debt instrument, time deposits, and derivative instrument transactions may be included in the fund’s portfolio. Additionally, gold and other precious metals, lease certificates, participation shares of investment funds, and other investment instruments deemed appropriate by the Board may also be part of the portfolio2.
B. Venture Capital Investments
One of the assets that may be included in the fund’s portfolio is venture capital investments. The provisions regarding venture capital investments are detailed in Article 18 of the Communiqué. Within this scope, the qualifications of venture capital companies are defined; these companies are required to have growth potential, offer the possibility of generating high returns by improving their operational, production, or sales performance, and have the capacity to achieve their objectives with the financial or institutional support provided. Funds can only invest in venture capital companies that have the status of a joint-stock or limited company. Additionally, these companies are expected to aim to create or develop tools, equipment, materials, services, or new products, methods, systems, and production techniques with market potential in the fields of industry, agriculture, and commerce, or to be in a position to achieve these objectives with the support of management, technical, or capital resources.
Additionally, companies operating to implement a project are also classified as venture capital companies. Venture capital companies must be established or to be established in Türkiye, or if established abroad, at least 80% of their assets must consist of subsidiaries or affiliates in Türkiye. The third paragraph of Article 18 of the Communiqué details the investments that may be considered venture capital investments. These investments include direct or indirect capital transfers to venture capital companies, establishing partnerships through share transfers, and investing in the debt instruments or lease certificates of venture capital companies not traded on the stock exchange. Further more, various investment instruments such as acquiring participation shares in venture capital investment funds, partnering with special-purpose joint-stock companies, and option agreements based on venture capital company shares are also included. The objective of these investments is to support the growth potential of venture capital companies and increase the possibility of generating high returns.
C. Limitation Regarding the Management of Assets Included in the Fund’s Portfolio
In addition to the limitations on the assets or transactions that will constitute the fund’s portfolio, the Board has also imposed certain restrictions regarding the management of the portfolio. These restrictions may be divided into two main categories: limitations related to venture capital investments and limitations related to other investments aside from venture capital investments.
1. Limitations Related to Venture Capital Investments
Venture capital investments hold significant importance in the portfolios of funds, and there are various restrictions related to the management of these investments. These restrictions aim to ensure that funds invest in venture capital investments at specific ratios and that these investments are supervised. Among the limitations established regarding venture capital investments is the requirement that at least 80% of the total value of the fund consists of one or more venture capital investments. Additionally, if the fund makes direct investments in venture companies that meet the qualifications specified in the SME Regulation within an accounting period, and if these investments exceed 10% of the total value of the fund, the 80% ratio is adjusted to 51%. Compliance with these investment limits is mandatory based on the total value table of the fund at the end of the accounting period.
2. Limitations Related to Investments Other than Venture Capital Investments
There are certain restrictions applied to investments other than venture capital investments. These limitations aim to ensure that funds act in accordance with specific investment strategies and maintain control over risks. Funds cannot engage in short selling of capital market instruments, conduct securities transactions on credit, or borrow capital market instruments. Additionally, they may only invest in derivative instruments for the purpose of hedging their portfolios against currency, interest, and market risks, provided that there is a provision in their bylaws to that effect. The open position amount arising from derivative instruments must not exceed 20% of the total value of the fund. Investments in companies that are not listed on foreign exchanges and have growth potential may amount to a maximum of 10% of the total value of the fund, in accordance with the methods specified in the Communiqué. Furthermore, in the management of assets in the fund’s portfolio that are not venture capital investments, compliance with the investment strategies and limits outlined in the fund’s information documents is mandatory. These restrictions are outlined in Article 23 of the Communiqué and aim to minimize risks in fund management and ensure compliance with regulations.
VI. MANAGEMENT OF VENTURE CAPITAL INVESTMEN FUNDS’ PORTFOLIOS
The management of venture capital investment funds is primarily entrusted to the founder. According to Article 7 of the Communiqué, the founder is responsible for representing, managing, and supervising the management of the fund in a manner that protects the rights of the fund’s participation shareholders. Additionally, it is the founder’s obligation to ensure that the fund’s activities are conducted in accordance with the provisions of the bylaw and the export document. Regarding management authority, it is stipulated that the founder has the authority to dispose of the assets belonging to the fund in their own name and on behalf of the fund, in compliance with the legislation, bylaw, and export document, and to exercise the rights arising from such disposal.
A. Portfolio Manager
The Communiqué allows the founder to transfer management authority under certain conditions. According to this regulation, the founder’s management authority may be transferred to another portfolio management company, a venture capital portfolio management company, or real estate and venture capital portfolio management companies through an agreement made within the framework of the Principles Regarding Portfolio Management Companies and Their Activities (III-55.1) (Communiqué Article 7/2). The execution of such a transfer must be conducted in accordance with the details of the relevant agreement and the conditions stipulated by the legislation. This regulation offers flexibility to ensure that fund management is carried out by professional and experienced organizations, contributing to the effective maintenance of management processes. Thus, by transferring the founder’s responsibilities in fund management, it becomes possible to benefit from the knowledge and experience of specialized companies in this field.
Within the scope of portfolio management, the agreement to be signed between the founder and the portfolio manager is referred to as the “portfolio management agreement.” This agreement must detail the rights and obligations of the portfolio managers arising from the transfer of portfolio management. In other words, the rights, responsibilities, and other obligations of the portfolio managers concerning the management of the portfolios they have acquired should be clearly defined. This regulation was introduced in order to prevent uncertainties that may arise in the portfolio management process and to clearly define management responsibilities. In this way, the portfolio managers can fulfill their responsibilities completely, thereby enhancing the effectiveness and orderliness of the management process.
VII. TAXATION OF VENTURE CAPITAL INVESTMENT FUNDS
A. Taxation of Venture Capital Investment Fund
1. Tax Liability of Venture Capital Investment Funds
Considering the social returns and significance of venture capital investment funds, tax regulations have been introduced to encourage these funds. According to Article 2/1(c.2) of the Corporate Tax Law3, funds subject to the regulation and supervision of the Board, as well as similar foreign funds, are considered capital companies. Therefore, venture capital investment funds are also regarded as corporate tax subjects. This regulation aims to establish a tax regime that aligns with the social and economic contributions of venture capital investment funds while determining their tax liabilities.
According to subparagraph (d) of the first paragraph of Article 5 of the Corporate Tax Law, the earnings of venture capital investment funds are exempt from corporate tax, provided that these funds are established in Türkiye. This regulation allows for the exemption of all earnings of venture capital investment funds from corporate tax, in contrast to securities investment funds and gold and precious metals-based investment funds, which are only exempt from tax on earnings derived from portfolio management activities. Therefore, venture capital investment funds are exempt from corporate tax not only for their portfolio management activities but also for all other earnings. This practice aims to enable venture capital investment funds to benefit from tax advantages on the earnings they generate under the capital markets legislation.
2. Withholding Tax on Earnings of Venture Capital Investment Funds
In addition to taxation, Article 15 of the Corporate Tax Law establishes provisions for withholding on certain earnings. Venture capital investment funds are included within the scope of this provision, necessitating withholding on their earnings. Under Article 15 of the Corporate Tax Law, withholding is generally applied to corporate earnings based on profit distribution. However, in the case of investment funds, withholding on the earnings of these funds is mandatory regardless of whether profit distribution occurs. This situation indicates that the earnings of investment funds are subject to specific regulations within the tax legislation and that the withholding practice is implemented on an expanded basis.
Although withholding is stipulated under the Corporate Tax Law, the withholding rate to be applied on the earnings of venture capital investment funds has been set at 0% by the Council of Ministers Decision No. 2009/14594. This regulation indicates that venture capital investment funds are completely exempt from the tax payable on the annual tax return under subparagraph (d) of the first paragraph of Article 5 of the Corporate Tax Law, as well as from the withholding required under the third paragraph of Article 15. This situation demonstrates that venture capital investment funds are largely relieved of their tax obligations, thereby allowing these funds to benefit from tax incentives.
3. Withholding on Earnings from Securities and Other Capital Market Instruments of Venture Capital Investment Funds
Tax withholding is anticipated on the earnings that venture capital investment funds derive from securities and other capital market instruments. However, according to the provisional Article 67 of the Income Tax Law4, the withholding rate applicable to these earnings is set at 0% for capital companies and investment funds defined in the first paragraph of Article 2 of the Corporate Tax Law. Therefore, there is no tax burden arising from withholding on the earnings of venture capital investment funds as specified in provisional Article 67/1 of the Income Tax Law. This regulation ensures that the tax liabilities of venture capital investment funds are kept to a minimum, thereby allowing these funds to fully benefit from tax incentives.
B. Taxation of Venture Capital Investment Funds Investors
1. Taxation of Individual Investors
Individual investors who wish to invest in venture capital investment funds can do so by purchasing shares in these funds. The taxation of the income earned by these investors varies based on their tax liability status. This variation depends on whether the taxpayer is an individual or a corporate entity, whether the income is derived from individual investment or within the framework of a commercial enterprise, and whether the taxpayer is a full taxpayer or a limited taxpayer.
One of the main earnings for individual investors from their investments in venture capital investment funds is dividends. According to the first paragraph of Article 75 of the Income Tax Law, these dividends are considered as capital gains and are subject to income tax.
In a ruling issued by the Revenue Administration, it is stipulated that dividends received by investors from holding investment fund participation shares are considered periodic returns. Additionally, it has been indicated that these dividends must be subject to withholding under the first paragraph of provisional Article 67 of the Income Tax Law. Therefore, the dividend income obtained by individuals from investment fund shares, which are recognized as capital market instruments under the legislation, should be taxed through withholding as per this regulation.
On the other hand, the withholding tax rate applied to the income earned from venture capital investment fund participation shares varies depending on whether the taxpayer is a full or limited taxpayer. According to the first paragraph of provisional Article 67 of the Income Tax Law, dividend income earned by both full and limited taxpayers is subject to a 10% withholding tax. If the investment fund participation shares are held for two years or longer, the withholding tax rate applied to the income earned from these shares is zero. This regulation provides a tax advantage for long-term investors.
2. Taxation of Corporations
According to Article 5/1 b-a-3 of the Corporate Tax Law, the dividends obtained by fully taxable corporations from participation shares of venture capital investment funds are exempt from taxation under the participation income exemption. No distinction is made regarding whether the corporation receiving the dividends is fully or limited liable for tax purposes. In addition, in relation to the participation shares of venture capital investment funds acquired after July 15, 2023, the revenues derived from the return of these participation shares to the fund and the value increase gains arising from these participation shares valued in accordance with Article 279 of the Tax Procedure Law are also exempt from corporate tax. This regulation continues to reduce the tax burden on taxpayers by providing relevant tax advantages for venture capital investment funds.
VIII. CONCLUSION
Venture capital investment funds make significant contributions to economic development by providing capital to innovative and high-growth potential enterprises. These funds help entrepreneurs overcome financial barriers while offering investors the potential for high returns. As discussed in the article, venture capital investment funds manage portfolios generated from capital collected from qualified investors, and the content of these portfolios is subject to limitations set by the Capital Markets Board.
The assets of the funds are protected through various regulations to ensure investor confidence, and the funds’ earnings are supported by tax incentives. Additionally, investor agreements and participation shares allow investors to become participation shareholders in the fund portfolio. The management of venture capital investment funds is carried out by the founder and the portfolio manager, ensuring that the funds are operated in accordance with their objectives. In this context, venture capital investment funds serve as an investment vehicle supported by legal regulations, offering significant opportunities for both entrepreneurs and investors.
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FOOTNOTE
1 Capital Market Board, Girişim Sermayesi Yatırım Fonu Tanıtım Rehberi, (Access Date: 12.08.2024), https://spk. gov.tr/kurumlar/fonlar/yatirim-fonlari/ girisim-sermayesi-yatirim-fonlari/tanitim-rehberi.
2 Official Gazette dated 02.01.2014, numbered 28870.
3 Official Gazette dated 21.06.2006 and numbered 26205.
4 Official Gazette dated 06.01.1961 and numbered 10700.
