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December 21, 2023

An Overview of Crowdfunding

IN GENERAL

Crowdfunding is an alternative method of financing that facilitates the access to funding, in particular for small and medium-sized businesses and venture capital firms with external financing needs, by collecting funds from a large number of individuals, investors or groups via the internet as an option to traditional banking systems and capital markets for obtaining funds to realize a project. Crowdfunding, which is also an investment system, has been created for the purpose of collecting the financial resources needed by business ideas and venture capital firms that plan to produce high-value-added and competitive technological products and services.

Crowdfunding activities have been regulated primarily under equity-based crowdfunding (“EBCF”) in the capital markets legislation, followed by regulations for debt-based crowdfunding (“DBCF”). EBCF and DBCF are mainly regulated under the Capital Markets Law No. 6362 (“CML”) and the Communiqué on Crowdfunding No. III- 35/A.2 (“Communiqué”). Crowdfunding activities based on rewards, donations, and aid can be carried out without being subject to the CML and related legislation and therefore outside the supervision of the Capital Markets Board (“Board”).

Within the scope of the Communiqué, EBCF is defined as “fund-raising from the public through crowdfunding platforms in return of shares”, while DBCF, which is a riskier instrument compared to EBCF, is defined as “fund-raising from the public through platforms in return of crowdfunding debt securities”. Although there is no restriction in capital markets legislation regarding the debt securities that can be issued under DBCF, there are views that only bond issuance and sales can be carried out by those requesting funds through DBCF. There are differences between EBCF and DBCF in terms of authorized fundraisers, campaign processes, monitoring of use of funds and investment limits.

ELEMENTS OF CROWDFUNDING

The elements of crowdfunding include (i) the “entrepreneur” or “venture capital firm” who requests funding for their project, (ii) the “public”, which refers to a large and indefinite number of investors who provide funding, and (iii) the “crowdfunding platforms” that mediate crowdfunding by bringing together the fund suppliers and demanders through an online electronic platform.

In the final analysis of the regulations made within the Communiqué, it is concluded that the user of the funds obtained through crowdfunding must be a legal entity authorized to issue shares or debt securities. Although it is possible for a non-legal entity to initiate the fund-raising and collect funds through EBCF, in order to be able to use of and transact on this fund, the fund demander must qualify as a legal entity, the issuance of shares must be completed and these shares must have been delivered to the fund providers, i.e., investors. In other words, persons outside the definition of venture capital firm in the Communiqué (early-stage project, entrepreneur) are not allowed to access the collected funds. Indeed, in campaigns conducted by entrepreneurs pursuant to the provisions of the Communiqué, it is mandatory for the entrepreneur to establish a joint stock corporation within 90 days following the end of the campaign period. With the establishment of the joint stock corporation, the funds blocked in the account opened on behalf of the platform by the depository will be transferred to the blocked account opened at the depository of the joint stock corporation to be established, and if funds are raised through EBCF, a capital increase will be made by the funded company up to the amount of the funds collected no later than 30 business days following the registration of the establishment process to the trade registry.

In addition, publicly-held corporations, and companies where publicly-held corporations and capital market institutions are in the position of a partner having significant influence, cannot raise funds through EBCF and DBCF, and issuers with unredeemed debt securities as of the date of application to the platform and companies where the issuers with unredeemed debt securities as of the date of application to the platform are in the position of a partner having significant influence, cannot raise funds through DBCF.

Crowdfunding platforms, on the other hand, are platforms that provide intermediary services in terms of their characteristics. These platforms must be joint stock corporations established exclusively to deal with EBCF and/or DBCF activities and their commercial titles must include the phrase “Crowdfunding Platform”. The Communiqué also regulates the minimum share capital requirement of the platforms, qualifications of the shares and conditions regarding the founders and managers. In addition to the establishment conditions, additional conditions are stipulated for the platforms to be listed, and within this scope, the necessary to establish mandatory units, technical infrastructure, and policies and to enter into contracts with Central Registry Agency and the depository. Indeed, it is mandatory for the platforms to be listed by the Board in order to engage in crowdfunding activities within the framework of the Communiqué. The platforms have an obligation to periodically report to the Board and publish their financial statements and activity reports.

ADVANTAGES, DISADVANTAGES AND RISKS OF CROWDFUNDING

Fund demanders are excluded from the definition of publicly-held corporations and issuers in articles 3/(e) and 3/(h) of the CML. Therefore, these persons have an easier and more cost-effective opportunity compared to corporate finance methods, as they are not subject to the obligations such as preparing and obtaining approval from the Board for  prospectuses and issue documents, independent auditing, listing, and similar obligations stipulated in the Capital Markets Legislation for publicly-held corporations, corporations the shares of which are deemed to have been offered to public and/or issuers, except for explicitly stated or regulated matters.

However, shares and debt securities issued through crowdfunding do not have an objective market value since they are not traded in organized markets, and therefore, they can be valued higher than their actual values in some cases. The secondary market for securities issued through crowdfunding is also narrower due to the lower number of securities issued and higher transaction costs. In addition, those who request funds through crowdfunding may not be as professional as capital markets institutions such as publicly-held corporations and portfolio management companies, which could lead to inefficiencies in the management and use of the funds, and these individuals may be more susceptible to the risk of obtaining illegal benefits due to more flexible supervision. On the other hand, the obligation to electronically record all of the company’s shares, including those to be issued in exchange for funds collected through equity-based crowdfunding, and debt securities issued through debt-based crowdfunding, and to monitor the rights related to them on a rightsholder basis at the CSD, ensure the safekeeping of investments.

Although the amount of funds raised through crowdfunding may be low, a wider range of investors can be reached. Unlike bank financing, fund providers and demanders know each other and can communicate directly. However, due to limited public disclosure in crowdfunding, investors may not be aware of the extent of the financial risks associated with the transaction due to unverified or misleading information.

In terms of platforms, the minimum share capital requirement and capital limitations are considered less restrictive than those in the traditional banking system, which is perceived to result in a lower market entry barrier.

IN CONCLUSION

Crowdfunding is an alternative financing method that aims to provide external financing from a wide range of investors through the internet. Crowdfunding activity appears in two different forms in the capital markets legislation: based on equity or debt securities. This method brings some advantages and risks with it, as those who request funding are not considered as issuers or publicly-held corporations in terms of capital markets legislation. Therefore, crowdfunding opens the way for small and medium-sized businesses to obtain external financing, but investors may be at risk due to the lack of institutionalization and experience. The qualifications and conditions required for the establishment and listing of crowdfunding platforms and those who request funding are regulated by the Communiqué.

Authors

Gülenay Kavcar

Gülenay Kavcar

Gökçe Ergün

Gökçe Ergün

Senior Lawyer

Elif Kalebek

Elif Kalebek

Lawyer