What is Venture Capital?
Venture capital is a special type of investment for financing newly established or early-stage startups with significant growth potential. It is often considered riskier than other forms of financing since it involves the funding of these high-risk startups by venture capitalists.
These investments typically provide cash flows for startups over the period required for investors to make a profit. Thus, startups can overcome the financial obstacles in the initial stages and sustain their growth.
Venture capitalists who generally establish venture capital trusts are bound by Communiqué on Principles Regarding Venture Capital Trusts No. III-48.3 (“Communiqué”) in accordance with Capital Markets Law No. 6362 (“Law No. 6362”).
Venture capital investments are governed by the pertinent legislation, especially Law No. 6362 and Turkish Commercial Code No. 6102 (“Code No. 6102”). Code No. 6102 regulates venture capital investments extensively, from incorporation to share transfers.
Law No. 6362 contains detailed provisions on the establishment, management and operation of venture capital investment funds and trusts, including terms of establishment for funds, portfolio management principles, and investment limitations. Finally, the Communiqué on Principles Regarding Venture Capital Funds (III-52.4) sets forth specific requirements and practical details regarding the activities of venture capital funds.
What are the Stages of Venture Capital Financing?
- Pre-Seed Funding
This round of financing refers to the funding of a startup with a business plan in the conceptual stage.
- Seed Funding
In the seed stage, venture capitalists meet the financial needs of a startup while it develops a product or service before selling it on the market.
- Series A, B, C… Funding
Series A, B and C funding rounds aim to provide startups with the capital they need in their growth stages and generally help them access more capital as they grow.
How to Raise Capital?
- First Contact and Communication of a Business Plan
The entrepreneur often presents a business plan consisting of the business idea, goals and financing needs. The venture capitalist reviews and evaluates this business plan comprising important details such as market potential, competitive advantage, and revenue projection. - Due Diligence
The venture capitalist performs a “check-up” to analyze the startup in detail. This process concerns various aspects, including products, customers, suppliers, contracts, commitments, market research, validity of the business model and distribution channels, and presents any relevant risks. - Negotiation and Contracting
The venture capitalist and the entrepreneur negotiate the basic terms of their agreement, such as the investment amount, allocation of shares, management rights, capital increases and exit strategies. In this process, the parties create a “term sheet” specifying the basic terms they agree upon. While not binding, this term sheet provides a basic framework for negotiations. - Venture Capital Exit Strategies
The venture capitalist aims to “exit” the venture by making a profit or reducing risks. There are various exit strategies, including an initial public offering (IPO) and the sale of company shares.
Key Consideration in Investment Processes: ESG
In venture capital financing, ESG (Environmental, Social and Governance) presents an increasingly important set of factors that influence investment decisions and support the growth of startups in line with their long-term sustainability goals. It entails the following aspects:
- Environmental: This aspect concerns a startup’s environmental impact, carbon footprint and stance towards climate issues.
- Social: This aspect concerns a startup’s social impact in terms of human resources and human rights.
- Corporate Governance: This aspect concerns a startup’s approach to management and operations.
Venture capitalists and portfolio companies should incorporate ESG principles into their strategies and operations if they aim at the maximum possible return from their financing, and startups should adapt to ESG criteria to manage their investment processes.
ESG compliance is becoming increasingly important for young companies and startups. The reason is that the European Union has passed several regulations on ESG criteria and requires companies to meet the relevant transparency, reporting and sustainability standards. Examples include the Sustainable Finance Disclosure Regulation (SFDR), which encourages sustainable investments in financial markets, the Corporate Sustainability Reporting Directive (CSRD), which requires companies to report their ESG performance in detail, the Carbon Border Adjustment Mechanism (CBAM), which taxes imports of carbon-intensive products, and the Taxonomy Regulation, which defines sustainable economic activities.
ESG factors support long-term value creation, and ESG due diligence has become a standard part of due diligence for many venture capitalists. ESG due diligence is a comprehensive review process in which venture capitalists evaluate a startup based on environmental, social and governance criteria in addition to financial analyses. ESG focuses on how a startup runs its business. For example, a tech startup may adopt strong cybersecurity measures to protect and secure user data while embracing sustainable production processes to reduce environmental impact.
As investors increasingly recognize the link between financial success and ethical and sustainable business practices, startups that prioritize ESG considerations are more likely to have a competitive edge. In this context, professional ESG advisory not only guarantees regulatory compliance but also increases potential investment opportunities and helps startups achieve their sustainable growth goals.
Mirace Çoban, Legal Intern
