Introduction

The video games industry is gaining traction from entrepreneurs and investors both globally and locally over the past few years due to increasing deployment of software, advanced technology and cloud technology, and high revenue generated by video game companies.

According to Startups Watch’s Year in Review 2021 report,¹ the video games sector became the center of attraction with 52 deals for a total of US$265 million raised and valuations increased by 80 percent in Turkey. Among ten startups raising the most capital at seed stage in Turkey, in 2021, four of them were startups (Hadi, Ace Games, Brew Games and Fomo Games).

Moreover, according to Startups Watch’s 2022-H1 report,²  in the first half of 2022, Turkey not only broke its own record in gaming deals, but also became the country with the highest amount of video game deals in Europe. In the first half of 2022, US$333 million were invested in video game companies across 13 deals.

Foreign investors participated in 1 out of every 4 deals made in Turkey, including foreign investors such as Sequoia Capital, Alpha Wave Global, Qatar Investment Authority, BlackRock Private Equity Partners, Kora, Institutional Venture Partners, Griffin Gaming Partners, Index Ventures, Makers Fund, Balderton Capital and IVP. Note that, legally, foreign investors are generally treated the same as Turkish investors.

Investment vehicles

Video game companies are usually funded either through equity financing or convertible instruments. Equity financing is carried out through capital increase and the subscription price exceeding the nominal subscription value of company shares can be treated as share premium. On the other hand, while convertible instruments are preferred by most investors, they are subject to some restrictions under Turkish Law.

What are the transaction documents?

Term Sheet: The term sheet includes the main subjects of a transaction, such as the type of security, subscription price, the amount of subscription shares, liquidation preference, pro-rata rights, protective provisions, share transfer restrictions and deal structure in general. Term sheets are developed and signed by parties prior to drafting the subscription agreement.

Subscription Agreement: A subscription agreement is signed by the parties to agree on terms and conditions in relation to the subscription and closing provisions such as conditions precedents, closing actions and post-closing actions. Representations and warranties (“R&W”) of the parties and indemnification provisions in case of a breach of these R&Ws are also regulated under the subscription agreement.

Before or during the drafting of the R&Ws, legal, tax, financial and technical due diligence processes may be conducted, and disclosures (if any) may be made in a separate disclosure letter.

Within the scope of legal due diligence, mainly, the company’s corporate status, financial agreements, assets, intellectual and industrial properties, business model, employment matters, disputes and litigation matters, and agreements which the company is a party to, are reviewed in detail.

Shareholders’ Agreement: A shareholders’ agreement (“SHA”) is signed by founders and investors to govern the relationship between the shareholders, as a closing action. Under these SHAs, shareholders may agree on the matters listed below:

1. Governance and management of the company: Parties may agree on terms such as the formation of the board of directors, whether the investor obtains (i) the right to appoint a member or an observer to the board of directors and/or (ii) veto rights (protective provisions) in relation to the board of directors’ and general assembly’s resolutions.
2. Information, inspection and audit rights: Information rights regulate the types of infor-mation investors have access to and the content of the periodic or on-demand reporting by the company. On the other hand, the investor may have the right to audit the company’s fi-nancials by bearing the audit expenses. These rights are usually granted to the investors holding a certain percentage of the company shares. It should be noted that regardless of the rights granted in the SHA; all shareholders have limited information rights under the Turkish Commercial Code numbered 6102 (“TCC”).
3. Provisions regarding share transfers: In Turkish deals, provisions such as a lock-up peri-od, right of first refusal, the right of co-sale, a drag-along right, tag-along right, put option and call option, are all in line with the provisions set forth under the National Venture Capital As-sociation and the British Private Equity & Venture Capital Association. Please note that, if a shareholder breaches an obligation regarding share transfer, Turkish courts cannot enforce that shareholder to act in accordance with its obligation. Turkish courts can only determine a compensation amount regarding the breach of that obligation.
4. Anti-dilution protection: When the number of the company’s outstanding shares increases, each existing shareholder holds a diluted percentage of the company shares. Anti-dilution provisions are regulated to protect the investors’ shareholder percentage and the value of their shares. In Turkey, weighted average anti-dilution provisions are more common to pro-tect the investors’ shares in case of a down round.
5. Employee stock options: The parties agree on the terms of employee stock options such as (i) an option pool which is the amount of the shares reserved for future issuance to em-ployees, and (ii) shareholders who will be subject to the dilutive effect of the option pool. Par-ties may agree on granting, vesting and exercising terms of the stock option as well. Please note that non-voting shares are not regulated under the TCC. Therefore, when an employee holds a share, she/he holds equal shareholding rights with other shareholders. This may cause (i) very crowded and complicated cap tables and (ii) problems in the following invest-ment rounds of the company since every shareholder should sign the SHA in relation to the company. Hence, granting virtual (phantom) stock options to employees is more common in Turkey.
6. Pre-emptive rights (Pro-rata Rights): Pre-emptive rights regulate the rights and obligations of the parties in case of a future share issuance. It should be noted that the TCC grants pre-emptive rights to all shareholders. The parties may agree on the terms such as on which conditions (i) they are going to waive their pre-emptive rights or (ii) their pre-emptive rights may be limited. Moreover, super pro-rata rights, which are granting the right to purchase shares in addition to shareholders’ pro-rata ownership in the company, are rarely granted to venture capital which contributes to the company’s business in various ways. These contribu-tions may be fulfilled in accordance with a cooperation agreement in which the corporate ven-ture capital may undertake to contribute on matters such as customer acquisition and reve-nue increase of the company.
7. Liquidation preference: Liquidation preference regulates the order of the payout in case of a liquidation event. In the SHA, the liquidation event is usually defined not only as the bank-ruptcy or winding down of a company, but also, events such as (major) asset sales, majority share sales, mergers, acquisitions, or change of control of the company. In Turkey, 1x non-participating liquidation preference is more preferred, rather than the full participating or capped participating types. Customarily, the last in first out principle is usually applied in Turk-ish deals.
8. Non-compete and non-solicitation: Non-compete and non-solicitation provisions are usually regulated for the founders (i) while they are shareholders in the company and (ii) after a while following the termination date of their employment or end of their shareholder status. In Tur-key, non-compete and non-solicitation obligation term is usually determined as two years or three years following the termination date of their employment or the end of their shareholder status. In exceptional cases, this term may be extended up to 5 (five) years subject to provi-sions of the Turkish competition law. Although in case of a breach of these obligations the breaching founder is obliged to compensate the loss of the company, it is difficult to deter-mine the actual amount of loss. Therefore, parties usually agree upon a (recurring) penalty clause.
9. Vesting / leaver provisions for the founders: Investors want founders’ involvement in a video game company since founders are the most important asset for the business. In this context, parties may agree on provisions in which founders’ shares are vested over years in accordance with an agreed vesting mechanism and vesting schedule. The vesting schedule may include a vesting cliff and the vesting may be monthly, quarterly or annually. In Turkey, there are certain restrictions regarding companies holding their own shares. Therefore, the vesting mechanism is regulated as reverse vesting in Turkey. If a founder leaves the compa-ny before the end of the vesting schedule, she/he will be transferring her/his unvested shares (or vested and unvested shares) to other shareholders, founders or, subject to certain legal restrictions, to the company. In this regard, the leaving founder may be defined as a bad leaver or a good leaver which affects the amount and the price of the vested/unvested shares to be transferred.

Even though the parties usually agree that the SHA prevails the articles of association of the company (“AoA”), the agreed terms are also reflected in the AoA. However, all agreed terms cannot be reflected in the AoA as per some restrictions regulated under the TCC. On the other hand, since the AoA can be reviewed by third parties through publicly available online trade registry records, the parties may prefer to keep some information, such as the valuation or price per share determined under the share transfer restrictions, confidential. In Turkey, the formation of the board of directors, veto rights of the investors (protective provisions) and liquidation preference terms are generally reflected in the AoA.

What to consider?

Please find below the main subjects to pay attention to:

1. Liability of the shareholders: Under Turkish law, if the video game company is formed as a joint-stock company (“JSC”), the liability of shareholders for obligations is limited to their capi-tal commitment and the shareholders are not liable for the debts of the company including public debts. On the other hand, if a video game company is formed as a limited liability com-pany (“LLC”), shareholders may be liable for amounts owed by LLC to government authori-ties for taxes, duties and charges pro-rata to their shareholding percentage in the company, if the company cannot make the required payments. Please note that the shareholders’ liability is not limited to their capital contribution in this respect.
2. Under the current legislation in Turkey, capital gains derived by individuals (e.g., natural per-son founders) on the sale of shares of a JSC are exempt from any personal income tax if the share certificates of these shares are issued and held for more than two years. Therefore, founders usually prefer forming their companies as JSCs.
3. Liability of the members of the board of directors: In principle, members of the board of directors (“Directors”) are not personally liable for transactions and agreements executed on behalf of the company, under Turkish law. However, the Directors, and to the extent of their delegated authority officers, are liable towards the company, its shareholders and the com-pany's creditors where they negligently fail to perform their duties as determined by law or the AoA. If the management function is delegated, partially or completely, the Directors are re-leased from the liability to the extent of the delegated function. However, the Directors will be held liable if they have not selected the relevant person as an assignee with due care. If the investor wishes to appoint a board member, legal opinion of a local counsel should be ob-tained.
4. Due diligence: 28 successful video game studios are formed by ex-Peak Games (Turkey’s first unicorn) employees. In this context, we would like to point out two important issues to be reviewed in detail during the due diligence process of a video game company.

   Firstly, since the ownership of the intellectual property (“IP”) rights of a video game company are one of the most important issues since investors are in fact, investing in the IP; it is crucial that the company duly owns the IP rights in relation to its games/products. If the founders of a video game company have created their games/products while they were working for another company, then the IP rights of their games/products may belong to their former employer.

   Secondly, founders may have signed a non-competition agreement with their former employers. In the event of a breach of these non-competition obligations, the founders may be liable to indemnify the former employer or to pay a penalty amount. This might have a direct effect on the founders and an indirect effect on the company and the business.



5. Approval of the Turkish competition authority: The parties should also consider whether the transaction is subject to prior approval of the Turkish Competition Authority (“TCA”) for the transaction to become legally valid. A transaction is subject to prior approval of the TCA if (i) there is a permanent change of control in the company, and (ii) the parties exceed the turnover thresholds stated below. Note that the TCA should conclude its preliminary examination regarding the transaction within 15 (fifteen) days. However, this period may be extended subject to the TCA’s additional information and/or document requests.

Firstly, it should be considered whether the transaction leads to a permanent change of control. As per the current legislation, a shareholder having strategic veto rights such as approval of the company’s annual budget, business plan, appointment of the Directors or the c-suites or decisions regarding the major investments might be considered as a change of control of the company.

Secondly, if the transaction is accepted as it is causing a permanent change of control in the company, the transaction must be notified to the Turkish Competition Authority if:

• the aggregate Turkish turnover of transaction parties exceeds TRY 750 million (approx. US$42.2 million/ €41.3 million) and the Turkish turnovers of at least two of the transaction parties each exceed TRY 250 million (approx. US$14.1 million/ €13.8 million), or
• (i) in acquisitions, the Turkish turnover of transferred assets or businesses exceeds TRY 250 million and the global turnover of at least one of the other parties to the transaction exceed TRY 3 billion (approx. US$169.1 million/ €165.5 million); or (ii) in mergers, the Turkish turno-ver of any party exceeds TRY 250 million and the worldwide turnover of at least one of the other parties exceeds TRY 3 billion.

However, the TRY 250 million threshold mentioned under letters (a) and (b) above does not apply to transactions concerning the acquisition of technology undertakings which includes video game companies. The main reason for this exception is to eliminate the risks arising from the acquisition of newly established and developing companies (i.e. killer acquisitions).

In seed stage investments, since the approval process takes a long time, the investors may give up their strategic rights to increase time efficiency. In this context, we recommend each transaction to be reviewed by a local competition counsel.

Authors of the article:

Okan Arican, Partner, Istanbul, Turkey
Dilruba Güldoğan, Associate, Istanbul, Turkey

More insights together with some numbers and statistics in our Video games industry report.

1. Startups.watch, Year in Review 2021 Report, January 2022, V1.01 (https://startups.watch/reports) (last accessed on July 27, 2022).
2. Startups.watch, Turkish Startup Ecosystem 2022 H1 Report, July 2022, V1.1 (https://startups.watch/reports) (last accessed on July 27, 2022).