INTRODUCTION
Investment funds are collective investment instruments where the assets acquired through participation units from investors are managed by a portfolio management company.
In Türkiye, investment funds operate under the supervision and oversight of the Capital Markets Board of Türkiye (“CMB”), either through portfolio-based distinctions such as equities, precious metals, or money markets, or as special-purpose investment funds such as venture capital, real estate, or exchange traded funds.
In recent years, with the rise of venture capital and real estate investment funds due to their tax advantages, such funds have been serving not only profitability but also asset management purposes. Accordingly, the demand for fund structures in which investors hold control over management has been increasing steadily.
In this article, fund structures established particularly through venture capital investment funds (“VCIFs”), which grant participation unit holders control rights over the fund’s operation -primarily in portfolio management- will be explained.
A. FUNDS ALLOCATED TO DESIGNATED INVESTORS
In Türkiye, investment funds are established and managed by portfolio management companies (“PMCs”) licensed by the CMB.
It is possible that participation units to be issued on behalf of funds established by PMCs are not offered to the market but instead allocated to designated investors. These fund structures, referred to as “private funds”, are commonly established by PMCs under umbrella funds and hedge funds.
In a private fund model which is structured as a financial service, investors do not play an active role in management; on the contrary, the professional competence of the PMC is brought to the forefront. Within the framework of the proxy relationship forming the legal basis of funds, matters such as the assets to be included in the portfolio, exit strategies, and portfolio distribution are determined and implemented by the PMC in line with the investor’s financial preferences and risk appetite.
On the other hand, while there are similar structures observed in VCIFs where participation units are allocated to designated investors; there are cases in which the main objective pursued is the establishment of fund structures, in which the investor undertakes the entire management of the fund, starting from the determination of the assets to be included in the portfolio.
The need for establishing such a complex structure among the PMC, the fund, and the investor essentially arises from the restriction in CMB legislation regarding the founder of the fund. Since Turkish capital markets legislation stipulates that funds may only be established by PMCs that are obliged to meet strict financial requirements as well as technical and personnel qualifications, investors who wish to pool their assets under a fund and have them managed are compelled to do so through PMCs.
B. MANAGEMENT OF VCIFs AND GRANTING CONTROL TO THE INVESTOR
VCIFs are managed by an investment committee within the framework of the principles of collective portfolio management determined by the CMB for PMCs, and in accordance with the internal regulations set forth in their bylaws.
Pursuant to article 10/(1) of the Communiqué on Venture Capital Investment Funds No. III-52.4 dated 02.01.2014 (“VCIF Communiqué”), it is possible to delegate the powers regarding the representation of the portfolio to the investment committee, by a resolution of the board of directors of the PMC.
The investment committee is established by fulfilling the requirements stipulated under article 9/(4) of the Communiqué on Portfolio Management Companies and the Principles Regarding Their Activities No. III-55.1 dated 02.07.2013 (“PMC Communiqué”). According to this provision, the investment committee shall consist of at least three persons determined by the PMC, who must meet the required experience and competency criteria.
However, as is frequently the case with the shares of joint stock companies as well, it is also possible to provide for different share groups for VCIF participation units and to grant such groups privileges in management participation or profit distribution. Within this scope, in VCIF structures where participation units are allocated to designated persons and where the investor prefers to have a say in the fund management, the number of members of the investment committee may be increased, and it may be stipulated that, apart from the mandatory members mentioned above, other members shall be selected from among the candidates nominated by the privileged participation unit holder. By this, it is ensured that the investor holds the majority in the investment committee and therefore, has control over the representation of the portfolio.
Such arrangements introduced in the information documents of the VCIF ensure that the rights held by the investor in fund management are granted and protected within the framework of capital markets legislation. On the other hand, pursuant to the final sentence of article 10/(1) of the VCIF Communiqué mentioned above, even if authority is delegated to the investment committee, “transactions relating to foundation, issue of fund units, liquidation, or increase of portfolio management fee of the fund, and other transactions which may affect the investment decisions of fund unit holders are required to be relied upon a decision of the [PMC’s] Board of Directors”.
Although absolute control of the investor over the fund cannot be arranged in the information documents due to this restriction, in practice it is possible to provide the investor with rights beyond those set forth under capital markets legislation through additional protocols commonly referred to as side letters. In such structures, the contractual liability of the PMC is established by a side letter, and the PMC’s obligation to comply with the mutually agreed management principles is secured by a compensation liability in the event of a breach, under the law of obligations. While the PMC continues to be responsible for portfolio management under capital markets legislation, it undertakes further liability under the law of obligations to implement its fund-related decisions in line with the investor’s requests and instructions.
Conclusion
Under Turkish capital markets legislation, funds can only be established by investment companies; which means that investors are obliged to make their fund investments through PMCs that have obtained permission from the CMB.
It is possible to personalise investors’ financial preferences and needs by allocating investment fund participation units to specific individuals. These umbrella and hedge fund structures, which allow investors to participate directly in the management of the fund, including the determination of assets to be included in the portfolio, are referred to as “private funds”.
In addition to these funds, similar structures can also be found in special-purpose funds such as VCIFs. In particular, fund structures where VCIF participation units, are allocated to specific investors are increasingly common in practice, due to their advantage in the taxation of profits earned from the equity in the portfolio.
In addition to the privileges arranged in the fund’s disclosure documents as permitted by capital market legislation, it is possible to establish broader management rights through additional protocols signed between the PMC and the investor in accordance with the principles of law of obligations.
These funds, whose participation units are allocated to specific individuals, must be structured in light of concrete conditions, taking into account the investor’s desired assets and investment strategies, as well as the service policies of each PMC.
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Kılınç Law & Consulting
