Global private equity (PE) activity appears to have diminished compared to ten or 15 years ago, but several major PE firms from Turkey are seen to be taking the lead in PE.

Besides these groups, there has been rising activity in venture capital funds. This has been thanks to the growth of the start-up ecosystem, with investment companies acting like a PE or venture capital fund established under the sponsorship of leading holdings in Turkey, particularly following the coming into force of legislation on venture capital investment funds. Venture capital and angel investor entities played the biggest role amongst all financial investors in 2022, taking part in 91% of the total number of deals involving financial investors.

2022 was rather a slow year for PE deals, which decreased by 83% compared to the previous year according to independent reports. With the lingering effects of the COVID-19 pandemic, the Russia–Ukraine war, high inflation rates throughout the world, presidential elections and the devaluation of Turkey's currency, the level of PE activity in the country mirrored this environment, and PE entities are adopting a “wait-and-see” approach before making sizeable investments in Turkey. Due to the recent devastating earthquakes, financing difficulties and uncertainties caused by the upcoming local elections, this approach will likely continue in 2023 as well.

On the purchaser side, acquisition finance has been utilised in some transactions, even if financing is not as affordable as before. Indeed, acquisition finance is being used increasingly in transactions in which the co-investor model is adopted.

Starting in the last quarter of 2022, distressed M&A represented a more meaningful percentage of M&A volume. PE funds have had a definite focus on certain sectors due to the impact of the COVID-19 pandemic, technological developments, the Russia–Ukraine war, the depreciation of the Turkish lira and the recent earthquakes. Technology, e-commerce, data-based management systems, financial technology and the gaming sector are also expected to be in high demand.

Conventional production sectors, which constitute the centre of export operations, have retained their appeal, especially after the massive devaluation of Turkey’s currency after the presidential elections in May 2023. Following the effects of the pandemic, the sectors that still attract particular attention in the field of production include packaging, chemicals (production and distribution), automotive supply, fast-moving consumer goods and cosmetics. In 2023, there is a strong likelihood of investor interest in the construction and cement sectors, primarily due to the Turkish government's objective to swiftly reconstruct the 11 cities impacted by earthquakes.

The Russia–Ukraine war has also affected the Turkish M&A market for PE deals, as the subsequent sanctions on Russia immediately red-flagged contemplated M&A deals involving targets that had business in Russia or with Russian entities.

In parallel to the dynamism of investments in Turkey, the venture capital investment trust (girişim sermayesi yatırım ortaklığı or GSYO) system has been developed as a financing company model in compliance with the legislation passed by the Capital Markets Board (CMB), which has been adapted to the global private equity fund company model under local legislation.

GSYO System

The GSYO system has been further enhanced by the CMB in subsequent periods. As such, portfolio management companies and venture capital portfolio management companies are granted the right to establish a venture capital investment fund (girişim sermayesi yatırım fonu or GSYF), which mainly consists of rights based upon venture capital investment and other assets and transactions provided for in the legislation. This is on behalf of the shareholders in accordance with the principles of fiduciary property by using sums collected from qualified investors in return for a participation share.

The CMB defines a GSYF as an asset that is established for a definite period but is not a legal entity. To this extent, the CMB grants permission for the establishment of GSYFs in compliance with Turkish capital markets legislation, provided that the requirements therein are fulfilled. Principles concerning the establishment of those funds, their activities and sales to qualified investors are set forth in detail in the capital markets legislation.

A GSYF can be established by portfolio management companies and venture capital portfolio management companies, and participation shares in GSYFs will be sold to qualified investors. In line with the international “private equity” model, different types of participation shares can be identified for GSYFs. Accordingly, GSYFs may issue qualified participation shares or general partner shares and other types of participation shares – eg, limited partner (LP) shares.

Decree No 32

The prohibition of payment in or indexed to foreign currency for certain types of contracts introduced under Decree No 32 on the Protection of the Value of the Turkish Currency and the communiqué and presidential decree issued thereunder serves as a significant legislative regulation that deeply affects PE portfolio companies, as well as Turkish markets and the investment sector in its entirety. Even though persons based in Turkey are subject to certain restrictions in terms of the contracts listed in the mentioned legislation, several exceptions are provided for in the legislation.

Exceptions

Since Turkish PEs are controlled via LPs based in foreign jurisdictions and investing via special purpose vehicles (SPVs) based mostly in Europe or the UK, PE deals do not generally fall within the scope of Decree No 32, and the “purchase price” in M&A deals involving PEs can be determined and paid in foreign currency.

On the other hand, the regulation in the legislation concerning the prohibition of payment in foreign currency is a significant element for portfolio companies and investors targeting sustainable EBITDA value.

Penalties

In the case of a breach of the prohibition, an administrative fine may be imposed as a sanction on each party to the contract. This is very likely since all transactions conducted through banks in Turkey are notified by the Banking Regulatory and Supervisory Authority (BRSA) to the relevant ministry, even if no complaint has been filed.

Restriction on the Use of Cash Commercial Loans

Another regulation currently affecting the Turkish finance and investment sector is the restriction on the use of cash commercial loans, which has been introduced by the BRSA for companies meeting certain conditions. The BRSA has further provided some flexibility in the relevant restriction, and adopted certain commitment mechanisms.

The E-commerce Regulation

The radical amendment to the Law on the Regulation of Electronic Commerce (the “E-commerce Regulation”) is another regulation introduced in the legislation, which makes an impact on Turkish venture capital investment funds and portfolio companies. Regulations were passed into law as of 1 July 2022 and came into force as of 1 January 2023, aiming to prevent the unfair commercial practices that are assumed to facilitate the imbalance in negotiation power that e-commerce marketplaces such as Amazon, Trendyol, Hepsiburada, N11.com and Çiçeksepeti have on sellers/merchants who sell their products via the platforms of these marketplaces, and which are dependent on such platforms.

Having achieved disproportionate growth and development with the impact of COVID-19, including in Turkey, e-commerce marketplaces and their intermediary platforms have become the focus of domestic and foreign investment and portfolio management companies. Changes introduced by the E-commerce Regulation are likely to have sector-based impacts, either positive or negative, on the e-commerce sector, which is growing fast thanks to investment appetite, as well as on the stakeholders in the sector.

Prohibitions on e-marketplaces

Various prohibitions have been imposed on e-marketplaces (eg, prohibition on using vendors' product data in their own favour, prohibition on restricting vendors' advertising and promotion activities on other platforms, and prohibition on sales and advertising limitations in certain categories), and regulations have been introduced to ensure that discounts and marketing budgets are pro rata to net sales volumes.

On the other hand, challenges in offering payment services and providing e-money, and restrictions in selling own-brand (private label) products and providing logistics and courier services have been introduced for e-marketplaces.

Obligations of e-commerce

The most significant change concerning entry into the e-commerce market in Turkey is the introduction of the obligation for both e-marketplaces and e-commerce websites selling their own brands to obtain an e-commerce licence in proportion to their net sales volumes. The obligations of being subject to the requirement of a licence and paying a licence fee are expected to bring a different dimension to e-commerce websites' plans on their net sales volumes.

Another regulatory obligation brought by the E-commerce Regulation concerns the obligation of intermediary platforms that provide an e-commerce platform (“e-commerce intermediary service providers”) to notify the Ministry of Commerce of any kind of share transfer or acquisition by company shareholders reaching up to 5% and its multiples, and of the establishment of new companies, within one month.

In the M&A regime of Turkish law, there are several independent regulatory authorities with powers specific to different areas of activity. For companies engaged in different areas of activity, compliance processes vary according to the obligations imposed by those authorities.

Antitrust

Within the framework of Turkish legislation, the Turkish Competition Authority is the only independent administrative authority in the M&A regime. As per Communiqué No 2010/4 on Mergers and Acquisitions Requiring the Approval of the Competition Authority, M&A transactions that exceed the determined turnover thresholds are subject to the approval of the Competition Authority.

By a recent amendment, the turnover thresholds have been adapted to the current exchange rate and status due to the economic conjuncture of the country and rapid fluctuations in the exchange rate. Moreover, transactions concerning the acquisition of tech undertakings operating in Turkey, or engaged in R&D activities or offering services to users in Turkey, are subject to the approval of the Competition Authority, regardless of whether or not the transaction parties exceed the turnover thresholds set forth in the legislation, considering the hostile takeover risk in the tech sector – ie, the risk of the acquisition of new start-ups by large-scale companies.

Tax

Another recent development currently holding regulatory significance in M&A transactions is the new tax applied to “premiums on issued shares” concerning the companies that have increased their share capital in 2022 through this way.

On 12 March 2023, the enactment of Law No 7440 introduced this additional tax, commonly referred to as the “earthquake tax”, for corporate taxpayers who have been utilising certain exemptions and deductions when calculating their corporate income tax. The purpose of this one-time additional tax is to generate funds to address the immediate needs of individuals impacted by the earthquake that occurred in Kahramanmaras and Hatay in February 2023.

The introduction of this “earthquake tax” has sparked debates concerning constitutional principles like non-retroactivity of laws, the predictability of taxation and the principle of equitable taxation. As “premiums on issued shares” is one of the main funding methods of financial advisers, it unfortunately had a negative impact on PE and venture capital deals in the Turkish market.

Environmental, Social and Governance (ESG)

Another aspect that is currently of regulatory importance in M&A transactions is ESG practices. Around the world, investment circles have started to attach higher importance to ESG practices and indicators in their investment decisions. In the developing markets, alongside the concept of investors with social awareness and sensitivity to the environment, potential non-financial risks and opportunities are now being analysed as well. Finally, governance practices are applicable within the framework of anti-bribery and anti-corruption, tax integrity, transparency, accountability, business ethics, management diversity, audit committee formation and risk management issues, which shape the management of companies and identify the hierarchical order of an organisation within the framework of corporate governance principles.

In parallel with international developments, Turkey has also introduced fundamental principles that publicly held corporations are expected to follow during their ESG activities, as announced by the CMB on 2 October 2020 in its Sustainability Principles Compliance Framework. This requires the disclosure of information on whether sustainability principles are applied and the effects of non-compliance with the principles of environmental and social risk management. This development in the field of ESG in Turkey reveals that the country's independent regulatory administrative authorities also closely follow worldwide developments and are open to introducing regulations in line with investors' demands in this area.

Environment

In comparison to previous years, compliance with environmental legislation has gained much higher importance, especially when the target company is a production company or an energy company. This is because target companies falling within the scope of environmental legislation need to have many permits under the relevant legislation so that they can smoothly carry on their activities without facing any sanctions (administrative fine and/or suspension or cancellation of their activities by the relevant authority), and so they can go through a legal examination process with minimal effect on the sale of the target company. The permits and licences that need to be obtained under the environmental legislation include:

• a capacity report;
• an environmental permit and licence;
• an environmental impact assessment (EIA) affirmative letter or EIA Not Required letter;
• industrial waste management plan approval; and
• waste water discharge permit.

Those permits and licences vary depending on the target company's area of activity. For this reason, detailed and accurate identification of the target company's area of activity is important in evaluating whether there is any breach of the legislation by the company. The fact that most companies try to adopt ESG practices and be compliant with those principles and more sensitive towards the environment is having a positive effect on the rise and development of environmental legislation.

Compliance

Although this is not directly regulated under Turkish legislation, the direct or indirect impact on a transaction of international sanctions applied by countries that have a significant role in global markets should also be evaluated under the topic of compliance throughout the legal due diligence process in an M&A transaction involving parties engaged in trade on a global scale. Economic and military conflicts currently taking place in Europe and the resulting all-round sanctions have given rise to the necessity for companies engaged in global trade to adopt a more sensitive attitude in all their transactions from a regulatory perspective.

Turkish companies are also indirectly affected by this: even when they acquire the shares of a company incorporated under Turkish legislation, foreign investors (especially foreign publicly held corporations) require research under the topic of compliance on whether such company (its employees, shareholders, managers, suppliers or customers) has previously been under sanction by the OFAC, the EU or the UK, and whether it is included on any sanctions list. Accordingly, in an M&A transaction, if a company is directly regulated under Turkish legislation or not, whether there is any matter affected by or intersecting with the all-round sanction lists of countries such as the USA, the EU and the UK needs to be examined, and a thorough examination should be made in the due diligence stage of the transaction with respect to the target company's customers, suppliers and any other party with which it is in a commercial relationship, on the basis of “know-your-customer” principles.

Globalisation, technology's increasing impact on conventional business processes (with the effect of digital transformation other than from tech companies), the impact of ESG, international sanctions, concepts such as ethics and compliance, and the effects of the COVID-19 pandemic have materially expanded the scope of due diligence examinations. Accordingly, target companies are put through a legal examination in 18–20 different fields. The list of information and documents requested for the due diligence is being extended every day, and now includes new categories such as national and global compliance, environment and ESG, privacy and data protection, cybersecurity, COVID-19 measures, etc.

In transactions where PE investors are the purchasers, only those companies and sellers with a high level of corporate governance and compliance awareness apply vendor due diligence (VDD).

VDD is actually in the form of a self check-up that is not binding upon the counterparty. Thus, the VDD process is not binding on the buyer. The number of PE investors who conduct a VDD process before exit procedures is much higher, since the primary goal in this situation is to ensure a safe exit and prevent any risk of potentially unfavourable circumstances affecting the deal value.

For buy-side counsels, a VDD report (without reliance) is a non-binding instrument providing ease of follow-up and supporting their own legal due diligence processes. The process creates a compelling story line and enables potential buyers to jump-start their own due diligence process. However, in some cases (usually in more sizeable multi-bidder M&A projects) the legal adviser may be asked to issue a “reliance letter”, where the purchaser is conferred a right to rely on the facts presented in such VDD report prepared by the sell-side legal advisers, for the purpose of speeding up the sale process.

In Turkey, a large majority of PE investments are realised through equity/share acquisition by means of share purchase agreements (SPAs) and/or subscription agreements, depending on the structure of the transaction.

An auction sale is also allowed but rarely applied, especially for target companies controlled by the Saving Deposits Insurance Fund or financial institutions.

In the case of a composition with creditors, the assets of a company that has declared composition with creditors are put on sale under a court order (this is not a mechanism like the one in Greece, where companies in economic distress are sold and restructured under a court order).

Finally, in the case of investments in publicly held corporations, a mandatory tender offer may be triggered if PE investors acquire non-public shares.

Almost all PE investors investing in Turkey establish their investment funds through a limited partnership (LP) incorporated abroad. Such LP is managed by a separate general partnership (GP) based abroad. The LP will have branches in Turkey. The PE's directors are also directors of both the GP and the branches in Turkey.

For investment, the PE investor first reaches a preliminary agreement with the shareholders of the target company and then completes the due diligence processes. Once the stage of signing the SPA is reached, it establishes an SPV in one of the European countries that has mutual treaties with Turkey in terms of taxation, and the SPV becomes a party to the SPA in the capacity of buyer. The LP transfers its investment resources to the SPV prior to closing, and the SPA then pays the consideration at closing and acquires the shares.

When the PE investor wishes to exit, the SPV transfers its shares to a third party and, in return, collects the consideration for the share transfer or the public offering income. Thereafter, the LP and the SPV merge or the SPV transfers the income to the LP together with the amount transferred by the LP by means of assignment of receivables, and thus, having achieved its purpose, the SPA is closed and liquidated.

In light of this, the LP, which constitutes the focal point of the PE fund, generally becomes a party to the preliminary contract. It does not become a party to the transaction agreements but manages such process via the SPV.

Before deciding to invest in any target company, PE funds first establish the funds, receive the necessary commitments and get the resources for the investment ready. The LP is the sponsor and guarantor of this investment process. Usually, the LP signs the non-binding agreement, but it also represents and warrants under the transaction agreements that it has sufficient investment resources. Such representations and warranties function as an equity commitment letter, since all leading PE funds investing in Turkey attach great importance to credibility; any drawback in their commitments harms their future investment opportunities in the country. The usage of debt funds to give comfort in respect of the debt-funded portion of the purchase price is not very common in Turkey.

Leveraged buyouts (LBOs) are usually the most common funding source but do not appear as frequently as they did several years ago, due to recent financing difficulties and high costs on both a global and a local scale.

In practice, PE funds may prefer the method of purchase financing through foreign or Turkish banks rather than financing the transactions with their existing resources. In such cases, transactions can be financed by means of the financing made available by the financial institutions in return for guarantees that they find acceptable.

The investment rate is generally affected by factors such as the size of the target company, the place that the relevant transaction will have within the PE fund, the sector, and whether there are multiple investors. Although a majority share is mostly preferred, a strong or qualified minority (40–49%) or – for transactions at the venture capital level – a minority share may be preferred.

The number of investors and their profile will vary depending on the volume and nature of the transaction and the target company; in practice, however, PE investors usually act independently as the sole investor. According to the size of the transaction or the profile of the target company/sector, a co-investment structure may be set up with international financing institutions or different funds or investment companies.

In the case of transactions conducted through co-investment, the PE entity usually becomes the pilot partner and holds the management rights, and the co-investor may get certain veto rights or a more silent position in the target company.

Consortia compromising a private equity fund and a corporate investor are not very common in the Turkish market.

In PE investment, consideration may be structured by dividing it into different portions according to the potential, business plans and projections of the target company and the sellers' performance and contribution to management following the initial closing.

The closing payment (initial consideration) is made by paying the total share purchase price wholly or partially (depending on the nature of the transaction) to the seller(s) at the closing.

Earn-Out Mechanism

According to the course of negotiations, if the value will increase depending on the target company's fulfilment of certain goals, especially in a scenario where the seller(s) will remain in management after the closing, then the earn-out mechanism may be applied. The transaction agreements regulate the earn-out cap, conditions for entitlement to earn-out, the period constituting the basis for the calculation of the earn-out, and all probabilities such as change of or non-entitlement to the earn-out amount in different scenarios. In Turkey, the earn-out model is a commonly used instrument since a win-win balance is created between the PE investor and the sellers if the sellers believe in the medium-term performance of the company following the closing and remain in the management to achieve those goals.

Deferred Payment Mechanism

The deferred payment mechanism is applied as a consideration share to which sellers may become entitled, especially in the occurrence of certain suspensive conditions.

One of the cases where the deferred payment method has been applied most in recent times is if the net internal rate of return (IRR) earned by the PE fund during the period when it is a shareholder of the company reaches a certain level, at which point a payment is made to the seller as an exit payment based on the amount exceeding such level. In this method, if the net IRR to be earned by the PE fund in USD on the basis of the entire investment cost incurred by the PE fund from the date of closing to the date of exit exceeds the mutually agreed ratio, then an amount in a variable rate or a directly fixed rate over the excess is paid to the seller(s) as deferred payment, as a conditional part of the consideration.

Closing Payment

In PE investments in Turkey, in cases where the PE fund is on the buyer side, there are generally three different models adopted in terms of the closing payment part of the consideration:

• the completion-accounts adjustment model;
• the locked-box model; and
• the fixed-price model, on the basis of the agreed fixed value.

Naturally, those models are determined by the investor, depending on the target company's financial structure, accounting records and the approach of the shareholders of the target company.

Completion-accounts model

When the target company has a strong financial structure and a corporate management and transparency infrastructure, the completion-accounts adjustment model is preferred.

Locked-box model

In the presence of a grift structure, where the sellers have an account relationship with the company, the locked-box model is applied. In this model, which is structured based on a predetermined date (ie, the locked-box date), the sellers are prohibited from carrying out certain procedures and transactions with the company and undertake to act in compliance with those prohibitions (ie, the locked-box covenants). Any breach of those covenants is defined as a leakage, in which case the seller bears an indemnification liability.

Fixed-price model

In the fixed-price model, debts, cash assets and stocks of the company are accepted as fixed until a certain date (very close to closing), and only those values are checked following the closing.

PE funds' preference

In transactions where the PE fund is the purchaser and therefore its priority is the specific circumstances of the target company, the fund will prefer the completion-accounts adjustment or locked-box model, provided that the necessary arrangements are made in the transaction agreements and the necessary measures are taken. The fixed-price model is only applied in exceptional circumstances.

In transactions where the PE fund is the seller in the exit process, the completion-accounts adjustment mechanism is usually preferred by the PE, as it handles the financial management of the company throughout the investment period.

In the event of any leakage, it is agreed under the SPA that the sellers will be jointly and severally liable to pay the purchaser or the company in full and in cash an amount equal to the leakage amount within a certain period (ie, ten business days) after the leakage amount is determined.

Since all amounts are to be determined in either US dollars or euros, no interest is usually applied to the leakage amount. However, if the leakage amount is disputed between the parties, then the interest on the settled leakage amount will be paid to either the purchaser or the company, and will be calculated for the time period starting from the date of the leakage until the day of actual payment. The interest on the leakage amount can also be settled during the adjustment phase of the deal.

In order to ensure predictability and mitigation of potential disputes between the parties over the consideration, a dispute resolution structure framework is implemented, regardless of the consideration model.

The dispute resolution model should be clearly set out in the following order.

Amicable Settlement

Transaction agreements may require a reasonable amicable settlement period (eg, ten to 15 business days) for the parties to settle on the disputed consideration-related matter (ie, the adjustment or leakage amount).

Referral to an Expert

Should the parties be unable to agree on the consideration-related matter within ten business days of the matter being notified to the other party’s representative, either of the parties may refer the matter to an expert (eg, a reputable advisory/accounting firm defined under the SPA) within a certain period (eg, five business days). The parties should endeavour to ensure that the expert is given all such assistance and access to documents and other information as it may reasonably require in making its decision.

Dispute Resolution Under the Transaction Agreement

Should the parties be unable to amicably agree on the findings of the expert, this could potentially lead to a serious dispute. In such a case, the parties should refer to the dispute resolution clause of the SPA. However, due to cost concerns and the duration of a dispute, the parties are not likely to opt to use a dispute resolution mechanism for consideration-related matters.

Under Turkish law, save for the approval of the Investment Committee, PE investments are not subject to any special suspensive conditions, apart from contractual and legal suspensive conditions set forth for the completion of M&A transactions.

In general, the conditions laid down for the completion of the transaction can be summarised as follows.

Antitrust Clearance

As explained in 3.1 Primary Regulators and Regulatory Issues, under Turkish law the approval of the Competition Authority is required for the validity of M&A transactions of undertakings that exceed the turnover thresholds stipulated in Communiqué No 2010/4. The turnover thresholds identified for transaction parties and target companies have been increased under the newly introduced regulation, and Competition Authority approval procedures for PE transactions have been rendered more flexible.

Regulatory Authorities' Clearance

In cases where the company operates in a regulated sector (eg, energy, technology, banking and finance), the approval of the regulatory authority that supervises the company's area of activity may be required.

Change of Control Clearance

A mechanism for approval of the change of control of the entity is required for agreements to which the target company is a party and under which the shareholding structure of the target company is subject to the approval of the counterparty to the agreement.

PE Investment Committee’s Approval

The final approval of the PE Investment Committee is required in all transactions as a general suspensive condition on the PE fund's side.

Agreement on Acquisition Finance Conditions

A final agreement between the PE fund and the financial institution through which it will finance the investment, on the purchase conditions, stands as a significant suspensive condition for the PE fund.

Other Conditions Precedent

Under the SPA, the parties agree that the obligation of the PE fund to consummate the closing is subject to the satisfaction or waiver by the purchaser of each of the general conditions, and also special conditions determined in the line of due diligence findings.

Material Adverse Change (MAC) Clauses

MAC clauses constitute one of the topics of negotiation that is highly addressed in SPA negotiations of acquisition transactions. MACs are developments under or beyond the control of the parties that – if they occur – may have a material adverse impact on the investor's investment decision or change the deal value.

Since government authority approvals are described as a specific condition, or non-approval by an authority is described within the scope of a MAC, the PE investor does not have to accept a “hell or high water” undertaking based on government authority approval. Having noted this, PE deals do not usually face problems during merger control and FDI approvals, so these are usually not even negotiated in that sense.

In PE investment processes, a break fee (or walk-away fee) mechanism in the seller's favour is adopted far less often in transactions where the PE investor is the purchaser, compared to transactions with strategic purchasers.

First of all, the risk of the PE investor competing with the target company or causing damage to the target company through the acquisition of know-how is low. In addition, the PE investor approach is shaped according to certain financial business-based projections, so the PE investor reserves the right to back out of the transaction due to the risk of the non-realisation of those projections.

On the other hand, a break fee may be put into practice where the PE investor backs out of the transaction at its commercial or arbitrary discretion, even though the conditions to be fulfilled by the company and the seller between the signing and closing have been completed and there is no MAC event. Even in such a case, it would be advisable to structure the break fee on a reciprocity basis.

Looking at the issue from a reverse perspective, it would appear that a break fee or a similar penalty clause may be applied in the case of a possible breach of exclusivity, and also if the seller backs out of the transaction at its commercial discretion.

A break fee may also be applied if the seller backs out of the transaction at its commercial discretion (eg, due to a material change in the FX rate) despite the signing of the SPA and in the absence of any adverse situation caused by the purchaser during the period between the signing and closing, and if the parties fail to reach an agreement on the continuation of the transaction.

Transaction agreements may be terminated under the following alternative conditions:

• by mutual consent of the parties;
• unilaterally by the PE purchaser by written notice to the seller with immediate effect, if any MAC occurs;
• unilaterally by either party by written notice with immediate effect, upon non-fulfilment of the conditions before the “long-stop date” determined under the transaction agreement (a typical long-stop date is usually determined as a date one to six months after the signing of the transaction agreement, depending on the sector, regulatory approvals and the company’s good standing position); or
• unilaterally by the purchaser by written notice to the seller with immediate effect upon the occurrence of the seller’s breach that is not cured within the stated cure period.

Representations and Warranties

PE on the purchaser's side

In transactions where there is a PE purchaser, the first guarantee of effective risk management is a broad catalogue of representations and warranties that are properly structured. To avoid any misinterpretation, the precise description of these representations and warranties makes a positive contribution to effective risk management.

Furthermore, defining the seller's representations and warranties as an independent guarantee obligation under Turkish law, and separate from the warranty against defects (defect liability) under the Turkish Commercial Code and the Turkish Code of Obligations, would – from the purchaser’s perspective – prevent limitation of the seller's liability in terms of time. Likewise, considering that the seller's representations and warranties play a significant role in the PE purchaser's investment decision, defining such liability of the seller separately from defect will make the purchaser’s risk management more effective.

PE on the seller's side

In transactions where the PE is on the seller side, together with the founding shareholder (the former seller), representations and warranties are divided as:

• fundamental warranties;
• mutual warranties; and
• operational warranties.

The PE seller assumes full liability for fundamental warranties and mutual warranties, but does not bear liability for warranties related to operations, which are assumed by the founding shareholder.

Liability and Indemnification

The seller undertakes to compensate and/or hold the purchaser harmless from and against all direct or indirect losses, claims, demands, actions, proceedings, payments, disbursements, liabilities, damages, expenses, penalties, fines, indemnities and/or any other losses, including but not limited to court and litigation costs and reasonable attorney’s fees, suffered or incurred by the purchaser, arising out of the breach of any of the warranties and/or any of the seller’s obligations, undertakings or covenants under the SPA, and also under any third-party claims.

In order to minimise the risk of the PE purchaser and also any potential disputes between the parties, it would be helpful to establish alternative indemnification methods and compensation sources under the SPA. After any matter turns into a finally settled claim amount, if the seller fails to indemnify the purchaser within the stated period under the claim process, then the purchaser will be entitled to deduct and collect the finally settled claim amount from alternative instruments that fall under the rights of the seller, such as holdback, earn-out or deferred payment.

Limitation of Liability

Regardless of whether the PE is on the purchaser's or the seller's side, liability for the seller's representations and warranties in the acquisition transactions can be subject to certain limitations, such as time limitation, de minimis and basket, disclosure, etc.

Representations and Warranties Management

In cases where the PE investor initiates the exit process with the founding shareholder (in other words, if the PE investor structures its investment in the company with a capital structure other than 100%), it assumes liability towards the potential purchaser with a limited catalogue of representations and warranties.

In such transactions, representations and warranties are usually divided into three categories:

• fundamental warranties;
• mutual warranties; and
• operational warranties.

Fundamental warranties include warranties related to capacity authority, no breach, legal ownership of shares, corporate status, capital and shareholding.

Mutual warranties cover warranties that are related to books and records, related party transactions, financial statements, material contracts, changes in conditions, taxes, solvency, borrowings, securities, no gifts or benefits, insurance, broker’s fees and compliance.

PE investors do not assume liability for operational warranties that are not within the scope of fundamental and mutual warranties (including employees, assets, real property, IP, disputes, environment, licences, product liability and account receivables). In other words, the founding shareholder will be solely liable for those warranties.

Another significant issue under Turkish law in terms of mutual liability (fundamental warranties and mutual warranties) is whether liability towards the purchaser will be pro rata to the share of the PE investor and other shareholders' groups, or of a joint and several nature. In practice, a prospective purchaser naturally expects joint and several liability from all sellers (including the PE fund) in terms of fundamental warranties and mutual warranties. For operational warranties, sellers are jointly and severally liable towards the PE fund and the founding shareholder, and determine the method of sharing liability and cost under a liability sharing and recourse agreement.

In transactions where the PE fund is the purchaser and there is no PE on the sell side, all representations and warranties are assumed jointly and severally by the sellers without any division as stated above.

Limitation of Liability

As explained in 6.8 Allocation of Risk, limitation of liability varies by different criteria. In transactions where the PE fund is the seller, a cap is usually determined according to the transaction volume. In any case, in transactions where the PE fund is the seller and the liability is shared with another shareholder group (if any), it would be worth defining the maximum liability of each shareholder group.

In terms of limitation of liability, the following limitation mechanism is generally adopted in transactions where the PE is on the purchaser side:

• unlimited liability for matters falling within the scope of specific indemnity and fundamental warranties;
• liability throughout the maximum prescription period for matters related to tax, SSI, etc;
• special or unlimited liability in case of any sensitive issues identified in the due diligence process (eg, breach of competition or a special case), depending on the nature of the issue;
• liability for two or three years as of the closing of other covenants;
• liability up to 100% of the deal value for matters other than those falling within the scope of specific indemnity and fundamental warranties; and
• a de minimis and basket mechanism according to mutual negotiations and understanding.

Disclosure

In transactions where there is a PE purchaser, a limited disclosure letter approach is usually followed, taking the transaction volume into account as well. The seller presents the disclosure letter at the signing stage, subject to negotiations with the purchaser, and it is signed together with the SPA. The seller may provide a supplementary disclosure limited to developments that occur in the interim period only. In transactions where there is a PE purchaser, full disclosure is generally not applied in parallel to the content of the data room.

On the other hand, in transactions where there is a PE seller, full disclosure through a data room organised by the PE fund is preferred since a corporate governance and transparency period provided by the PE fund is followed.

Specific Indemnities

Matters that require specific indemnity – beyond any provisions of the SPA and regardless of being disclosed by the sellers – are limited matters that the sellers will, as a separate and independent obligation, jointly and severally undertake to fully indemnify (and hold harmless) the purchaser or the company or any of the subsidiaries against, without being subject to any limitation under any name whatsoever, for all sums suffered or incurred by the purchaser or the company or any of the subsidiaries arising out of or in connection with that matter. For example, material claims to be defined under the SPA, information not shared during the due diligence, specific due diligence findings such as a pending lawsuit or arbitration, an employment matter, ongoing investigations, etc.

Guarantee and Collateral Mechanisms

In transactions where the PE is on the buy side, the PE entity usually requires certain guarantees and collateral mechanisms in order to avoid any compensation risk from the sellers and to keep the company free of any post-closing disputes. These guarantees and collateral mechanisms are:

• holdback (plus escrow mechanism unless the PE buyer is to retain the holdback);
• a share pledge over the seller’s shares (plus escrow mechanism);
• a letter of guarantee from the seller or the holding of the seller;
• the purchaser’s right of deduction from the seller’s future receivables; and
• a personal guarantee.

In cases where the PE is on the sell side, PE funds do not usually supply collaterals. However, either a letter of guarantee or a sponsor guarantee letter from the LP or a holdback with an escrow mechanism may be considered as a last resort by the sell side, depending on the risk hanging over the company.

Warranty and Indemnity Insurance

It is only more recently that W&I insurance has started to be used as a “deal tool” in the Turkish market, giving the parties an alternative approach. However, due to the detailed due diligence of the authorities in parallel with the purchaser and also high premium costs, sellers – especially founders – do not appear keen to use such insurance mechanisms.

Sellers cap their warranties and purchasers have them backed by a certain amount of holdback, along with an escrow. However, for PEs on the sell side, this approach is likely to raise execution risks and suppress value. Also, as PEs wish to cap their liabilities at a very low level during an exit, this can also limit the pool of buyers.

Therefore, PE sellers are much more likely to adopt this approach as W&I insurance allows them to avoid lengthy disagreements over the caps and survival periods. This way, the PE seller’s warranty caps can be set to a very low level compared to the deal value, providing an easy exit for PE and at the same time keeping the buyer pool wide as the exceeding part is backed by insurance, and there is no need for further escrow. On a global scale, PE funds are using W&I insurance to boost their IRR this way.

Although it varies in terms of the sector and the good standing position of the target, W&I insurance is generally used for business warranties rather than fundamental warranties. For tax-related warranties, parties usually resolve the matter within the SPA by determining the procedures to apply to tax amnesty during post-closing, because tax amnesty programmes are frequently launched in Turkey.

In Turkey’s legal practice, arbitration is the most common and preferred dispute resolution mechanism in all PE or non-PE-related M&A transactions. ICC Arbitration is the preferred arbitration institution, while ISTAC (Istanbul Arbitration Centre) has been widely chosen recently in light of its cost-effectiveness and the reputation of said institution and its arbitrators.

The most disputed matters are as follows:

• consideration adjustments;
• leakage matters;
• third-party claims and management;
• breach of warranties and liability;
• earn-outs and claw-backs; and
• non-compete matters.

In line with the recent investment climate and lack of foreign PE fund activity after the early 2000s, public-to-private PE transactions are not seen in Turkey. In an IPO, the unit share value of the target reaches a certain valuation so public-to-private deals not very attractive to PE if the target is not exceptionally critical for the PE entity's portfolio.

Subject to the limitations of the CMB, special “relationship agreements” can be made with the target and its management, but these are mostly resolved within the SPA.

The following share structure changes of Turkish companies are subject to disclosure to the trade registry under the Turkish Commercial Code: 5%, 10%, 20%, 25%, 33%, 50%, 67% and 100%.

A change of control of the company may also be subject to antitrust clearance, depending on the size of the parties and the yearly revenue of the target company.

Other regulatory approvals may be considered, depending on the company’s sector or subject to the CMB’s approval, depending on the target company’s public position.

According to Turkish capital markets legislation, one of the independent conditions precedent provided for under the relevant communiqué in terms of mandatory offers is that the shareholders should – alone or together with those they act with – directly or indirectly have more than 50% of the voting rights of the publicly held corporation.

Another independent condition precedent is that, notwithstanding the 50% share mentioned above, shareholders should have privileged shares granting the right to select the absolute majority of the board members or nominate their candidates for such number of members. For instance, shareholders who acquire privileged shares granting the right to elect two members of the three-member board of directors of a publicly held corporation under Article 360 of the Turkish Commercial Code will have acquired control of the management, even if their share in the capital and the voting rights is below 50%.

For the above-mentioned change of control events to occur, the acquisition of shares through transfer is not necessarily required. Mandatory offers may also arise if a change of control occurs due to an acquisition of shares through capital increase.

Besides share acquisition, as per Article 26/3 of the Capital Markets Law, the mandatory offer requirement may also be in place if shareholders take over the control of the management under special shareholders' agreements that they enter into among themselves.

However, as stipulated in Article 12/2 of the relevant communiqué, apart from the above-mentioned events, the fact that the absolute majority of the board members can be elected due to the capital structure of the partnership or any de facto event that occurs in the general assembly meeting does not mean that the control of the management is taken over and does not give rise to the mandatory offer requirement.

Cash consideration is commonly used in the Turkish market, while in some deals there will be a partial share swap in global holding companies in the case of global structuring.

In a mandatory tender offer for listed companies in the case of a direct acquisition of control, the mandatory tender offer price shall not be less than:

• the arithmetical average of daily adjusted averaged market price within the six months preceding the disclosure of the acquisition of management control; and
• the highest price paid by the person(s) acquiring management control within the six months preceding the acquisition of management control.

Except for the regulations on public companies and capital markets, under the Turkish legal system no specific offer condition restriction is brought by the regulatory authority over private acquisitions.

A PE or any strategic purchaser may require acquisition finance as a purchaser’s condition precedent under the SPA.

The purchaser may require certain security measures in order to secure the deal during SPA negotiations or during the interim period, including:

• exclusivity and a fair penalty in case of a breach;
• pricing match right, right of first offer or right of first refusal, in addition to exclusivity on multi-bidder transactions;
• non-solicitation; and
• non-compete.

Governance

If the shares are to be purchased from the non-public part of the target and the controlling shareholder, it is possible to establish certain management and veto rights through the negotiation of the shareholders' agreement. If the purchaser prefers to proceed by collecting from the publicly traded part of the target and is planning to come after the controlling shareholder when it reaches a certain shareholding ratio in the target, governance rights are not demanded until that moment. However, of course, minority rights are reserved in line with the CMB and Turkish Commercial Code, although they are subject to certain thresholds.

Depending on the shareholding structure, a PE investor usually requires certain governance provisions under the following topics (naturally, structures vary depending on the shareholding structure between the parties):

• share transfer restrictions;
• board of directors' configuration;
• board-reserved matters;
• general assembly-reserved matters;
• decision priority over funding of the company;
• appointment of independent auditor;
• appointment of certain c-level executives; and
• KPIs under the employment agreements of founder executives.

Debt Push-Down

For a PE to achieve debt push-down into the target after the transaction, a merger process can be followed post-closing. To decide on an upstream or downstream merger, the PE entity usually consults with financers to meet their demands, while considering the licence amendments, operational burden and tax matters of the target.

In practice, a “downstream merger” is preferred by the banks for a debt push-down, rather than an upstream merger, but in a downstream merger it is not possible to implement the facilitated (fast-track) merger set forth under Turkish laws.

Squeeze-Out Rights

Squeeze-out mechanisms may be required on both amicable occasions and/or hostile or conflicted occasions.

Amicable call options may be agreed under a shareholders' agreement where the PE purchaser is entitled to exercise a call option and acquire certain or the remaining equity of the seller on the basis of a certain valuation, to be defined at certain dates following a predetermined anniversary of the closing as defined under the SHA. In return for such call option, the seller may also require an amicable put option to be implemented at certain dates that do not overlap with the call option, following a predetermined anniversary of the closing as defined under the shareholders' agreement.

Call or put options may be required by the PE fund on potentially conflicted occasions in order to avoid shareholding disputes – eg, in the event of a deadlock that is not solved within a certain period defined under the shareholders' agreement, either party may exercise call or put options.

Under the shareholders' agreement, it is common to grant the right of first offer or refusal to any shareholders; the exercise of such right would be irrevocable, especially in order to ensure the PE entity’s exit from the company where the principal shareholder may be subject to a penalty if the shareholder withdraws from the commitment.

The shareholder's agreement may govern matching clauses in favour of any of the parties if a better offer is made. However, if there is no better offer, the principal shareholder would be bound by the original offer.

Parties agree to vote on certain matters in compliance with the shareholders' agreement, as per the voting agreement, in order to sustain governance of the company.

Equity incentivisation of the management team is a common feature of PE transactions in Turkey. Alignment of the management team’s interests with those of investors has been perceived as key to the success of the investment and preparation for the exit. In the case of investment in family-owned businesses, the earn-out mechanism is a common tool for incentivisation of the management team. Recently, stock options or restricted stock units (RSUs) have also been commonly used, especially in the technology and gaming industries.

Stock options or RSUs are the most common form of sweet equity in the Turkish market. In the case of investment in family businesses, as family owners are familiar with the business and the running of the business following the investment, they tend to acquire preferred equity to protect certain shareholders' rights and enjoy veto rights. In the Turkish market, shareholder managers in private equity transactions often favour earn-out mechanisms. Holdback and escrow mechanisms are utilised to secure manager performance.

The most typical leaver provision is related to the performance of the management shareholders following the investment, although under-performance is a peculiar concept in PE transactions. The shareholder management characteristically has two nexuses with the company (ie, shareholder and employee), which are subject to different legal concepts.

The same goes with vesting options. Management equity in Turkey does not usually include standard vesting provisions, as these rights are not explicitly governed by the current legislation. As a result, vesting structures are often adapted from foreign jurisdictions and modified to align with Turkish law, in a process that may encounter procedural and executive challenges later on.

The most common restrictive covenants are non-compete and non-solicitation. Whereas non-compete rules are set out under the law, there is no clear provision regarding non-solicitation, which is applicable to the management shareholders by analogy. Geographic restrictions and time limitations are the main limits of enforceability.

In the Turkish market, the connection between the company and its directors is often described as a “proxy” relationship. Consequently, employment agreements are frequently not concluded with managers who are also shareholders. The forementioned restrictions are typically addressed in the transactional documents. If an employment agreement is executed, these same restrictions are usually included within the employment contract as well.

Minority rights are protected under the Turkish Commercial Code, according to which, in non-public joint-stock companies, some additional rights are granted to shareholders who have shares representing at least 10% of the capital. These rights include the right to:

• be represented on the board of directors of the company;
• dismiss and appoint a new auditor to the company;
• invite the general assembly to an extraordinary meeting and/or the add an item to the agenda of the general assembly;
• request postponement of the discussion of financial statements for one month, without indicating any reason;
• appoint a special auditor to the company;
• request the issuance of registered share certificates;
• request the discharge (liquidation) of the company with just cause; and
• reject the release of the board of directors from liability (arising from the establishment of the company and/or capital increase).

Non-dilution is achieved through the pre-emptive right granted to the shareholders under the code, and can only be restricted under certain conditions.

Veto rights are provided under the articles of association of the company and also the shareholders' agreement. The code also sets out qualified quorums for certain key matters, which may require the affirmative votes of the minority. In cases where the manager is also the minority shareholder, the allocated shares may also be structured as non-dilutable shares in PE deals, where the main contribution is their time and skills.

Management is not necessarily entitled to control the exit, but tag-along rights may be granted.

Depending on the shareholding structure, a PE investor usually requires certain governance rights, as stated below. Naturally, the structures vary depending on the shareholding structure between the parties. Here are some practical provisions on certain typical governance mechanisms.

Share Transfer Restrictions

The principal (founding) shareholders are restricted from transferring all or any portion of their shares to a person without the prior written consent of the PE investor.

Board of Directors' Configuration

The board of directors is the management and representation organ of the company, and consists of three members elected by the general assembly. Two members are elected from among the candidates nominated by the PE shareholder, while one member is elected from among the candidates nominated by the founding shareholder.

Board-Reserved Matters

Unless otherwise determined under the applicable law or a relevant agreement, it can be decided that the matters listed below (examples only) require the presence and affirmative vote of minority/principal shareholder board members:

• any proposal to the general assembly to change the trade name of the company;
• the entry into any new area of business, or a change of the company’s area of activity;
• any change to the accounting reference date or accounting policies, bases or methods of the company;
• the cessation or any material change to the nature or geographical area of any business operation;
• the adoption of and any amendment to the business plan; and
• the adoption of and any amendment to the annual budget.

General Assembly-Reserved Matters

Unless otherwise determined under the applicable law or the relevant agreement, it can be decided that the decision quorum for the following matters (examples only) requires the attendance and affirmative votes of minority/principal shareholders:

• any resolution to change the scope of business or any investment outside the scope of the business;
• any resolution to decrease the share capital or any resolution to increase the share capital, save for capital increases due to legal and financial requirements or capital increases to be made from internal resources;
• any resolution to change the type, rights or form or any class of shares or create a new class, privilege or type of shares of the company;
• any amendment to the company’s articles of association that restricts or limits a certain shareholder group’s privileges;
• any resolution regarding the dissolution or liquidation of the company; and
• any cancellation or limitation on shareholders’ pre-emptive rights of subscription.

As long as shareholders complete their capital contribution undertaking under the articles of association of the company and the Turkish Commercial Code, they cannot be held liable on civil matters, subject to criminal actions or to board members’ responsibilities under Turkish law, for the actions of a portfolio company under Turkish Law, including the corporate veil.

PE investors generally hold a portfolio company for five to seven years. However, niche sectors and targets such as technology or export-oriented manufacturing entities that are already tracked by strategic sharks, even during the PE’s investment, may go within two to three years with a multiple IRR.

The most common methods of exit for PE investors are either sale to a strategic purchaser that is closely tracking the target, or through an IPO, as the case may be.

On some occasions, around 40–50% of PE exit deals are taken “dual track”, at least up to some point. “Triple track” exit processes where a recapitalisation is prepared in parallel and addition to the above are not commonly used.

PE investors enjoy investing after a successful exit in order to achieve a sustainable success story.

Drag-along rights are always required by PE investors in acquisitions in order to ensure ease of exit, and they always utilise the drag mechanisms under the shareholders' agreement. Subject to the shareholding structure, the typical drag threshold is a greater ratio than the current shareholding of the PE investor. The drag mechanism is usually applied to institutional co-investors as well, since they act in concert with PE investors.

Naturally, management shareholders like tag rights to be triggered at least at a certain threshold with a valuation no less favourable than the PE investor’s share valuation. Subject to the shareholding structure, the typical tag threshold is 50% or a range near to 50% in cases where the PE investor owns the majority. The tag mechanism is usually applied to institutional co-investors as well, since they act in concert with PE investors.

At any time, a PE shareholder has the right to perform a local or global listing of the company’s shares in a reputable local and/or international stock exchange in single or multiple offerings, including public offering, private placement and sale to qualified investors at the PE shareholder’s sole discretion.

In accordance with the distribution of IPO rights under the shareholders' agreement, for ease of the PE shareholder’s exit, the PE shareholder exclusively participates in the first IPO transaction to sell its shares and the shares offered in any listing. The cost of an IPO is usually borne by the target. It should be further noted that the PE shareholder also holds the right to unilaterally select an investment banker for the IPO procedures, in practice.