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Convertible Note Agreements In Turkish Law – Shareholders


A. INTRODUCTION – What is Convertible Note

Table of Contents

A. INTRODUCTION – What is Convertible Note



Convertible note agreements, which were mainly developed in
American Law, are applied as “Loans Convertible to
in Turkish Law. In order to provide
financing; in the convertible note investment type, investors lend
to a start-up, which is in the seed investment stage. In this
system, the loan given by the investor turns into company shares in
the next or future rounds when the specified conditions are

The convertible note is a system in which the investor tries to
ensure that the company reaches the previously agreed value by
giving a loan that can be converted into stock based on the value
that the investor assigns to the start-up, unlike the conventional
method of independent valuation-based investments.


Due to the prohibition of companies to acquire their own shares
in Turkish Law, a convertible note agreement cannot be drafted as a
standard contract in the conventional method. For this reason, the
validity and execution of the relevant contract type in the Turkish
legal system is based on the principle of freedom of contract in
the Law of Obligations and reflects the will of the parties.

In this context, specific to Convertible Note Agreements, in the
American Legal system, in a convertible note agreement made with
the company, the company will keep investor’s shares within the
company in return for the loan given and a structure is set up to
deliver the promised shares to the investor in case of the
realization of the “trigger” and/or triggering
transaction event regulated in the agreement. The relevant
trigger” event can be considered as any
transaction that can be decided by the parties, such as the company
entering a new investment round, the end of a certain period, or
the company reaching a sufficient capital or valuation rate for a
predetermined criterion. In this type of agreements, it is also
advised to regulate, the way in which the loan will be paid back to
the investor in cases where the “trigger” event
does not occur.

Therefore, in the current local practice, the condition of being
a shareholder of the investor is required for registration,
therefore 1 (one) share is given to the investor symbolically just
before the capital increase, so the investor becomes a shareholder
in the company. Afterwards, a general assembly is held with a
capital increase agenda, in which the shareholders of the company,
who have given loans convertible to shares, can
participate in exchange for their receivables from the company for
the newly issued shares.

Although it is not a well-established concept in Turkish law,
with the amendment made on May 11, 2020 in the Capital Movements
Circular (“Governmental Circular“), the
first steps have been taken to put the concept of loans convertible
to shares (convertible loan) on a legal basis. Pursuant to
paragraph 12 of Article 6 of the Governmental Circular, titled
“Payment of share prices in capital
; Regarding the foreign currency
transferred to the account of the person residing in Turkey, the
party to the agreement, provided that the following conditions are
met, there will be no obligation to meet the conditions set forth
in Article 14 of the Governmental Circular on the general rules of
using foreign currency loans:

  1. There is a clear provision stating that the loan will be added
    to the capital within a maximum of 12 months from
    the date of transfer,

  2. Except for the dissolution or liquidation of the company, there
    is a provision stating that the said amounts will be added to the
    capital (not included as a loan), and

  3. There is a provision stating that the entire transferred amount
    will be added to the capital.

However, in this type of transaction, the matter allowed by
Turkish law and allowed to be deposited into the Company account
without being considered as a foreign currency loan within the
framework of the Governmental Circular is the investment of a
foreign investment fund with a convertible note
system in a company that continues to exist in Turkey. Hence,
Governmental Circular does not cover investment transactions made
by Turkish companies.

In this context, it will be possible to establish an appropriate
structure within the framework of the principle of freedom of
contract within the scope of investments and share transfers. In
practice, investors lend to start-ups through convertible note
agreements, in accordance with their own valuation and predicted
success, with a maturity of 12-24 months (sometimes this period may
be shorter). Hereby, cash flow and financing are provided to the
newly established company, and an agreement is established in
favour of the company and the investor at an early stage.

Besides, in practice, a commitment to participate in the
shareholders’ agreement (“SHA”) to
be signed with the investors in the trigger investment round is
usually added to convertible note agreements. As a result of this
provision, there is no negotiation for the shareholders’
agreement with the investors investing in convertible note hence
investors investing with convertible note agree in advance that
they will have equal rights with investors investing in the
relevant investment round.


The main purpose of the Convertible Note mechanism is to provide
the cash flow of the company without being subjected to an explicit
valuation at the first stage, and while this happens, the investor
has the opportunity to get investment back as a shareholder in a
company with a potential to increase in value. Thus, a discount is
applied to the share acquisition of the investor who invests in the
company at an early stage.

In the agreement, the parties make their own valuations of the
company’s value, and this gives the company and the investor
more flexibility to set their own terms for repayment and
converting the investment into shares. In this context, it is aimed
to eliminate the negotiation arising from the valuation process and
share ratio, the rights of the investor in the company and the
shareholder agreement in general, and to bring the investment to
the company as soon as possible. Convertible Note holders are
obliged to wait for the investment made in the start-ups to be
converted into shares until the maturity of the convertible note,
and in cases where the investment is not converted into shares even
though the maturity period is over, investors have the right to
demand the investment back with the determined interest.

Although the applicability of the Convertible Note within the
scope of Turkish Law is controversial and limited, it is seen in
practice that this mechanism is executed from time to time within
the scope of “freedom of contract” originating from the
law of obligations, and it is observed that the frequency of
applying to related investment instruments is increasing day by
day, especially considering the development of the entrepreneurial
ecosystem in our country. However, it should be noted that the
resolution of disputes that may arise in the Convertible Note,
which is not typically regulated under the law, can be complex for
the parties. Consequently, it is highly recommended to draft the
Convertible Note and the accompanying SHA clauses in detail, and to
seek support from a specialist legal consultant during the drafting
and negotiation processes of these contracts.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.


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