1. Introduction

The Turkish e-commerce market has been expanding rapidly over the past few years. In 2018, the size of the e-commerce sector in Turkey reached an estimated 50 billion Turkish liras (approximately USD 10 billion) with an estimated 54 million internet users of which 6 million were retail purchasers in 2018. There is a very active venture capital investment eco-system in Turkey which invests in early stage or start-up businesses to provide growth capital. Approximately 400 new technology start-ups have been founded in Turkey—mainly in technoparks and business incubators—annually since 2011.

2. Investment in Turkish Tech

The size of the available pool of capital available for investment in Turkish technology companies has been estimated at USD 500 million in 2019.

Venture capital is typically invested in the form of equity capital with preferential rights or convertible loans at the early seed or series A funding stages of technology start-ups. Convertible loans have been a popular form of bridge financing for start-ups prior to an upcoming series B round. Convertible loans provide a quick way for a tech company with a high burn rate to raise finance for its business when its valuation at an early stage in its growth is difficult to determine prior to a larger funding round. It protects the founders from early dilution of their equity and enables them to retain control of their business. Venture capital investors on the other hand have the downside protection of a loan and debt ranks higher to equity in case of a liquidation. As the risk of failure is greater at the early stage, investors are compensated on the upside with a discount to the equity price at which future investors invest in or at a pre-determined valuation cap for the company. These are typical structures that have been adopted in the Turkish market.

3. Impact of foreign exchange regulations

Whilst convertible loans have proved a popular financing tool in Turkey, it has recently become more problematic for foreign investors due to the recent amendments made to the Turkish exchange control regulations (mainly introduced by amendments to Decree No. 32 on the Protection of the Value of Turkish Currency (the "Decree No. 32") made from January 2018 and the entry into force of the new Capital Movements Circular of the Central Bank of Turkey on 2 May 2018).

Under these amendments to Decree No. 32, companies resident in Turkey with a credit balance of less than USD 15 million can not utilize foreign exchange loans unless they generate a sufficient amount of foreign exchange income to cover the credit balance. Credit balance means the total amount of foreign currency loans that are outstanding on a company's balance sheet. As a convertible loan is basically a debt recorded on the balance sheet of the borrower until repayment and is not converted into equity until later after a triggering event defined under the loan agreement, it is included in the credit balance of the borrower and so is subject to the restrictions under Decree No.32. This would mean most early stage technology businesses would be subject to this limitation and therefore would not be able to raise a non-Turkish Lira denominated convertible loan. There are various specific exceptions to the general rule under the recent changes but these are targeted at specific sectors and specific issues and would require analysis on a case-by-case basis as to whether they apply.

Another important aspect of Decree No. 32 is that a Turkish company is prohibited from raising foreign exchange credit from a non-financial institution outside of Turkey, therefore the lending entity needs to be an authorised financial institution or a back to back arrangement should be entered into with a lending bank.

In light of the above restrictions, the obvious solution would be to structure the convertible loan on a TL basis but foreign investors would then be exposed to any currency depreciation risk which is not likely to be acceptable. An alternative result of the recent changes may be to force companies to move offshore in order to raise debt in foreign currency and pass down the debt from the parent holding company to the Turkish subsidiary. This is an expressly permitted exception under Decree 32. If neither of these routes are palatable, pure equity financing may be the only realistic means of financing by foreign venture capital investors.

4. Consequences of non-compliance

Failure to comply with the new Decree 32 restrictions can be onerous. Turkish entities violating the regulations may be sanctioned with an administrative fine up to TRY 25,000 and the outstanding portion of the utilized loan may be accelerated or converted into Turkish currency by order of the Turkish Treasury.

5. Conclusion

The bottom line is the recent exchange control Turkish restrictions will make (bridge) financing in terms of convertible loans more difficult to raise for tech start-ups in Turkey. Despite the difficulty of valuing the business at an early stage and risk of dilution for founders, the new restrictions may end up encouraging more straight equity investments offering liquidation preferences and other equity protections for venture capital investors. However this may entail more conservative valuations and lower investments than may otherwise have been the case.

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