Legal Aspects of Venture Capital Investment Funds

What is Venture Capital?

Venture capital is financing that is usually provided for the growth and development of start-up or small-scale businesses. This type of financing usually involves high-risk investments and aims to generate long-term returns. Venture capital not only provides entrepreneurs with financial resources, but also business knowledge, know-how, networks and experience. Venture capital funds are unincorporated entities that operate in accordance with these capital market principles. This financing usually involves risky investments and is used to generate long-term returns. The shares of these funds, which can be established by portfolio management companies or venture capital portfolio management companies, are sold to qualified investors and money is accumulated in the fund through payments such as participation fees. GCIF investors are expected to declare that they are qualified investors. Moreover, as venture capital investment funds generally have long investment periods, investors should take this period into consideration. Legislation on venture capital investment funds may vary across countries. In general, however, private equity funds are regulated and managed in accordance with capital markets legislation.

What is a Venture Capital Investment Fund (VCIF)?

A venture capital investment fund is an asset that can be established by portfolio management companies or venture capital portfolio management companies, operates in accordance with capital market principles and does not have a legal personality. These funds provide fund accumulation thanks to the participation shares collected through sales to qualified investors. Entrepreneurs can obtain capital by utilizing this fund during the production and marketing stages in order to realize their ideas. Although these investments usually carry high risk, they can potentially yield high returns. Venture capital investment funds are regulated by the Communiqué on Principles Regarding Venture Capital Investment Funds (Communiqué) numbered III-52.4 within the scope of Article 54 of the Capital Markets Law No. 6362.

How Do Venture Capital Investment Funds Work?

The operation of venture capital investment funds generally consists of several stages:

  1. Investment Phase: Venture capital funds usually invest in a predetermined sector or area. Fund managers research and evaluate high-potential ventures. At this stage, the financial soundness, operating and management competencies, innovative ideas, growth potential, competitive advantages, marketing strategies and risks are analyzed.
  2. Investment Decision: After selecting the ventures to invest in, fund managers make the investment decision. This decision is determined by a detailed investment agreement that includes the amount of investment, the investment period, and the rights and responsibilities of the investee company.
  3. Support Phase: Venture capital funds provide support to the companies they invest in, such as business consultancy, marketing and sales support, business network and experience. This support contributes to the growth and success of the companies.
  4. Exit Phase: As the companies in which they have invested grow and gain value, venture capital funds develop exit strategies in order to recover their investment and make a profit. These strategies may include options such as public offering, sale or merger of the company.
  5. End of Investment Period: Venture capital funds invest for a certain period of time. At the end of the investment period, they provide return on investment by repaying investors.
  6. Social Benefit: Venture capital funds usually invest in companies that have innovative ideas and provide social benefits. In this way, investors earn financial returns while contributing to social good.

Legislation on Venture Capital Investment Funds in Turkey

In Turkey, the legislation on venture capital investment funds is determined by the Capital Markets Board (CMB). The CMB’s “Communiqué on Venture Capital Investment Funds” sets out the principles and procedures regarding the establishment, management and supervision of these funds. Venture capital investment funds are established to operate a portfolio of assets and transactions determined by the Capital Markets Board in accordance with the principles of fiduciary ownership on behalf of shareholders with the money collected from qualified investors in return for participation shares.

The main activity of the fund is to operate a portfolio of venture capital investments. In this context, the field of activity of the fund is defined in a limited manner in the legislation. Venture capital mutual funds are investment instruments that aim to contribute to the growth and success of companies by investing in high potential new ventures.

Formation of the Venture Capital Investment Fund Portfolio

The assets and transactions that may be included in the portfolio of the funds are as follows:

  • Venture capital investments,
  • Shares of joint stock companies established in Turkey, including those included in the scope of privatization, private and public sector debt instruments,
  • Foreign private and public sector debt instruments and joint stock company shares,
  • Time deposits and participation accounts,
  • Investment fund units,
  • Repo and reverse repo transactions,
  • Warrants and certificates,
  • Lease certificates and real estate certificates,
  • Takasbank money market transactions,
  • Cash collateral and premiums for derivative transactions,
  • Specially designed foreign investment instruments and loan participation securities deemed appropriate by the Board,
  • Other investment instruments deemed appropriate by the Board.

Principles Regarding Venture Companies and Venture Capital Investments

The following investments of funds are considered as venture capital investments:

  • They may become shareholders or founders of venture companies directly or indirectly through capital transfer or share transfer through special purpose companies established in Turkey and collective investment institutions established abroad.
  • They may invest in debt instruments issued by venture capital companies.
  • Provided that the risk arising from the investments is limited to the amount of principal invested, they may directly invest in institutions established abroad for collective investment purposes only to make capital investments in venture capital companies defined in this Communiqué.
  • They may invest in capital market instruments issued by venture capital investment trusts and participation shares of other venture capital investment funds.
  • They may invest in the shares of companies traded on the BİAŞ Emerging Companies Market.
  • They may invest in the unlisted shares of publicly traded companies that are venture capital companies.
  • They may provide structured financing to venture companies as a mix of debt and equity financing.
  • They may invest in debt instruments issued by collective investment schemes whose fields of activity are determined in their articles of association exclusively for the purpose of investing in venture capital companies as defined in the Communiqué. These investments allow venture capital investment funds to diversify their portfolios and distribute their risks.

Required Conditions

Legislation regarding venture capital investment funds may vary across countries. In general, however, private equity funds are regulated and managed within the framework of capital markets legislation. It makes sense to make use of GCIFs for projects that you want to realize and move forward on. Venture capital companies step in to provide funding. These companies can invest in joint stock or limited liability companies. The project that will benefit from this capital is expected to have growth potential.

Initiatives that can benefit from this fund:

  • Established/to be established in Turkey
  • If the subsidiary is established abroad as of the date the financial support is provided, at least 80% of the assets are formed with the subsidiary established in our country based on the financial statements of the last year
  • Limited liability companies must complete the transformation into joint stock companies within 1 year after the financial support is provided.

NOTE: The companies in the fund portfolio do not have to stay in our country, entrepreneurs are free to move their current project abroad for the development of the project.

Investment Limitations

  • At least 80% of the total value of the fund must consist of one or more venture capital investments.
  • In the event that the fund’s direct investments in venture capital companies that meet the qualifications specified in the SME Regulation exceed 10% of the total value of the fund within an accounting period, the above investment limit is applied as 51%.
  • Compliance with the investment limits must be ensured as of the total value table at the end of the fund’s accounting period.
  • Funds may not invest in gold, other precious metals and other commodities and futures contracts based on them.
  • They may not short sell capital market instruments, conduct securities transactions on credit, or borrow capital market instruments.

Nature of the Fund

  • Fund assets may not be pledged as collateral or pledged except for the purpose of obtaining loans and making derivative transactions for protection purposes, provided that it is in the fund account and that there is a provision in the fund rules and issue document.
  • It cannot be seized, including for the purpose of collection of public receivables.
  • No precautionary measure may be placed on it.
  • It cannot be included in the bankruptcy estate.
  • The debts and liabilities of the founder and/or portfolio manager to third parties and the receivables of the funds from the same third parties cannot be set off against each other.

Participation Shares

  • It has no nominal value.
  • The fund unit share value is calculated by dividing the total fund value by the number of fund units.
  • It is essential that the fund unit share value is calculated at least once a year and notified to qualified investors.

Fund Representation

The Fund is represented by the founder’s board of directors in the execution of all its activities, including all contracts to which it will be a party and participation in the management of venture companies and voting in the general assemblies of these companies. The board of directors may delegate this authority to one or more executive directors.

Establishment and Application Process

The process of setting up a venture capital investment fund (VCIF) is quite detailed and involves specific stages. Here is a general outline of the VCIF establishment process and the places to apply:

1. Decision to Establish a VCIF and Planning

  • First Step Once the decision to establish a venture capital investment fund has been taken, a detailed business plan and investment strategy should be developed.
  • Setting Objectives: Strategic objectives such as the sector in which the fund will operate and the characteristics of the companies in which it will invest should be determined.

2. Application to the Capital Markets Board (CMB)

  • Preparation of the Application File: Individuals or organizations wishing to establish a GCIF must apply to the Capital Markets Board. Documents and information required for the application are prepared.
    • Draft articles of association
    • Documents of the founder and management company
    • Fund bylaws and prospectus
    • Information and documents on management staff and consultants
  • Application to CMB: The prepared file is submitted to the CMB. The CMB evaluates the application and may request additional information and documents if deemed necessary.

3. Establishment and Registration of the Fund

  • CMB Approval: After obtaining the necessary approvals from the CMB, the fund can be established.
  • Registration Procedures: An application is made to the Trade Registry Office for the registration of the fund. The fund becomes a legal entity after it is registered in the trade registry.
  • Registration with CRA: The fund must be registered with the Central Registry Agency (CRA).

4. Operating License and Operational Processes

  • Obtaining Operating License: Necessary applications are made for the Fund’s operating license.
  • Operational Processes: Operational processes are completed, bank accounts are opened and accounting systems are established in order for the fund to start its operations.

5. Investment Process

  • Investment Strategy: Investments are made in ventures in accordance with the investment strategy determined by the Fund.
  • Fund Management: The performance of the Fund is regularly monitored and reported. Valuation of investments is performed.

Application and Consultancy

  • CMB The CMB, the main regulatory and supervisory authority, should be consulted in the process of establishing and managing a GIF.
  • Consulting Companies: Due to the complexity of the process, it is recommended to seek the services of consulting companies specialized in this field.

Tax Advantages

Tax Advantages for Venture Capital Funds

The tax advantages provided to venture capital funds and venture capital investment trusts include important regulations to support the entrepreneurship ecosystem in Turkey and encourage investors. These advantages are determined by special provisions in both the Corporate Tax Law and the Income Tax Law.

Allocation and Utilization of Funds: Venture capital funds are regulated under Repeated Article 325 of the Tax Procedure Law. Businesses keep these funds in a temporary fund account, which are set aside as liabilities in their balance sheets. Funds may be invested as capital in venture capital investment trusts established or to be established in Turkey in accordance with the regulations of the Capital Markets Board or venture capital investment fund shares may be purchased.

The fund is allocated over the earnings or declared income of the year in which it is allocated, and its maximum amount cannot exceed 10% of the corporate earnings or declared income and 20% of the shareholders’ equity. If the fund is not invested in venture capital investment trusts or funds in a timely manner, the tax accrual is realized with interest for delay.

Corporate Tax Advantages: Paragraph 1/a-3 of Article 5 of the Corporate Tax Law exempts dividends derived from venture capital investment fund participation shares and shares of venture capital investment trusts from tax. Paragraph d/3 of the same law exempts the earnings of venture capital investment funds and partnerships from corporate tax.

According to paragraph 1/g of Article 10 of the Corporate Tax Law, the amounts allocated as venture capital funds, not exceeding 10% of the declared income, are accepted as a deduction from corporate income.

Income Tax Advantage: Pursuant to subparagraph 12 of Article 89 of the Income Tax Law, amounts set aside as venture capital funds may be deducted from income up to 10% of the declared income.

Thanks to these regulations, investments in venture capital funds are both exempt from corporate tax and deductible from income tax base. These advantages encourage taxpayers to invest in venture capital, while encouraging the transfer of resources to innovative ideas for the national economy.

With these regulations, venture capital funds and investment trusts provide strong support to the entrepreneurship ecosystem and offer significant tax advantages.

The details of the tax advantages and the benefits they provide can be listed as follows:

  1. Tax Exemption and Exemptions:
    • Capital Gains Tax Exemption: In many countries, capital gains realized by venture capital investment funds may be exempt from tax under certain conditions. This allows investors to retain a higher amount of the gains as net income.
    • Corporate Tax Exemption: Corporations that invest in venture capital investment funds may receive corporate tax exemption at certain rates on their earnings. This encourages companies to invest in venture capital funds.
  2. Income Tax Advantages:
    • Income Tax Deduction for Individual Investors: Individual investors who invest in venture capital funds can deduct their investment amounts from their income tax base at certain rates. This reduces their annual tax liabilities.
    • Dividend Tax Deduction: Dividends from venture capital funds may be subject to income tax deduction at certain rates. This ensures that investors’ income from the funds is taxed at lower tax rates.
  3. Special Incentives for Corporations:
    • Investment Deduction: Companies investing in venture capital investment funds can deduct the investment amounts from their corporate tax base at certain rates. This incentive allows companies to allocate more capital and invest in venture capital funds.
    • R&D and Innovation Incentives: Investments made through venture capital funds can benefit from R&D and innovation incentives in many countries. This encourages funds to invest in technology and innovation-oriented companies.
  4. Double Taxation Avoidance Agreements:
    • Venture capital funds can benefit from double taxation avoidance agreements when they make international investments. This ensures that investors’ earnings in different countries are taxed in only one country and reduces their tax burden.
  5. Tax Planning and Strategies:
    • Venture capital funds develop specific tax planning and strategies to maximize tax benefits. These strategies aim to minimize the tax liabilities of funds and investors.

As a result, the tax advantages offered by private equity funds are important incentives for investors. These advantages enable investors to realize higher net gains by reducing their tax burden. Moreover, tax advantages allow VC funds to attract more capital and invest in innovative companies. This contributes to strengthening the entrepreneurship ecosystem and economic growth.