In Turkey, investors generally perceive venture capital as a financing method that supports technological innovations and projects with high growth potential. The key issues negotiated by the parties involved in the structure are the Founder Leaver Provisions, which are also derived from the principle of freedom of contract recognised in Turkish law.
It should initially be noted that in Turkey, there is no specific regulation governing the exit situations in agreements related to venture capital. Similar to the UK and the US, the framework of exit and leaver provisions is determined through negotiation in the pre-participation process of the venture capital, considering specific circumstances. These provisions are determined within the framework of agreements privately negotiated by the parties and become effective mostly within the scope of Capital Market regulations, Turkish Tax Law, Turkish Commercial Law, Turkish Code of Obligations, and Turkish Labor Law.
In Turkish legislation, as in other jurisdictions, the negotiation of the exit / leaver and remuneration provisions may vary depending on whether the departing party is a founder, shareholder, or key employee (sometimes including different contracts with senior executives). These provisions are generally included in shareholders’ agreements for founders and shareholders, and in employment contracts and/or separate stock option agreements (or phantom stock option agreements) signed for key employees and/or senior executives.
Like performance-based bonuses, phantom option agreements provide benefits to employees if their work reaches certain performance levels. However, this benefit does not grant the right to acquire shares in the company or its affiliates, but financial rights such as dividends related to these shares. Although there are different forms of phantom option agreements, the most preferred one in Turkey is an agreement concluded between the founding shareholder and the employee, promising the employee the payment of a portion of the profit by reference to the value of the relevant shares at the time when the right conferred by the phantom option agreement crystallises.
At this point, it is also important to briefly mention the role of the articles of association of the company. It will be important to amend the articles of association as necessary, in accordance with the parties’ agreement regarding the approval mechanisms for share transfers.
The main objective in negotiating the exit / leaver provisions is to make prior arrangements to avoid any disruption in the venture’s activities at the time of separation. In terms of remuneration provisions, the aim is generally to build stock option plans or other options (such as profit sharing or performance rewards) into the remuneration structure. In particular, these practices have become popular in Turkey in order to motivate and retain key employees of ventures that have the potential for rapid growth but have not yet achieved that momentum. The venture’s current journey, stage, growth potential, market conditions, and bargaining power of the relevant parties are important factors in negotiating these provisions.
The remuneration provisions in shareholders’ agreements and stock option agreements are not necessarily limited to venture shares, but may also apply to the venture’s and/or investor’s affiliates or subsidiaries. It is important to thoroughly analyse the venture, the investor, and the affiliates and subsidiaries in terms of whether they are incorporated as Turkish or foreign companies and to establish them in the most advantageous manner for taxation.
In Turkey, there is generally a reverse vesting arrangement ranging from three to five years for founders and shareholders, while there is a linear (forward-looking) vesting arrangement for employees and senior executives who are engaged either as employees or pursuant to other contractual arrangements. Initially, venture founders and shareholders are provided with a certain percentage of venture shares, and based on predetermined criteria (such as contribution to the venture, achievement of specified key performance indicators, etc.) outlined in the shareholders’ agreement, the founders’ venture shares are either protected or reduced.
As in other jurisdictions, ‘bad leaver’ provisions are included in the shareholders’ agreement. Cases other than those falling under bad leaver provisions, such as departure due to health reasons or voluntary departure after a certain period, are considered as ‘good leaver’ situations. Although the good and bad leaver arrangements can be flexibly regulated under the scope of “contractual freedom”, in practice, the basis of bad leaver situations primarily consists of circumstances that give rise to justifiable termination of the contract by the employer due to “breach of morality and good faith.”
Where a founder or shareholder is classified as a bad leaver, their venture shares are usually repurchased at a discounted price by those who have the right of first refusal for purchasing these shares as provided by legislation and tax regulations, as long as circumstances allow. There are also cases where the repurchase price can decrease to the nominal value in situations permitted by legislation.
For key employees and senior executives engaged under other types of contracts, vesting provisions may be solely based on the achievement of key performance indicators (“KPI”), or solely time-based (“Cliff”), or versions that incorporate both conditions. The provision of KPI and time-based arrangements should be carefully specified in the option agreements. In option agreements that are structured with solely time-based or solely KPI-based arrangements for key employees and other senior executives, an entitlement can be granted before the expiration of the time period or before the fulfillment of the KPI. However, this is not a commonly preferred method for the growth of the venture.
Furthermore, although stock option agreements are regulated separately from employment agreements, they may be subject to the mandatory provisions of Turkish Labor Law as they ultimately constitute contracts signed between key employees and the employer. All provisions under Turkish Labor Law are either relatively mandatory or absolutely mandatory as long as they are in favor of the employee. Courts tend to interpret provisions that are considered relatively mandatory, have loopholes, or are open to interpretation in favour of the employee.
It is also important to mention the tax advantage for employees and other senior executives who acquire shares in a Joint Stock Company with linear (forward-looking) vesting provisions. According to the law, “shares held” for more than two years are exempt from income tax, regardless of the amount of profit arising from their disposal. From a tax law perspective, a Limited Liability Company (“LLC“) and a Joint Stock Company (“JSC”) have similarities, but in Turkey, an LLC is generally preferred as the required founding capital is smaller than JSC.