This document proposes establishing a public fund of funds in Turkey to foster the development of a venture capital industry. It argues that venture capital is important for innovation but market failures currently hinder its development in Turkey. These include coordination externalities around building necessary VC infrastructure, information asymmetries in startup financing, and spillovers from innovation not being fully captured. While Turkey has potential for more VC deals and legal issues do not seem to bind the industry, past public interventions have been ineffective. The paper proposes a 10-year public fund of funds that would invest in privately-managed VC funds as a limited partner to address market failures and help develop a self-sustainable Turkish VC industry.

1. Harvard Kennedy School
SECOND-YEAR POLICY PAPER
How to foster a venture capital industry in Turkey?
A Design for a Public Fund of Funds
Ussal Sahbaz
Candidate in Master’s in Public Administration and International Development
(MPA/ID)
March 11, 2010
Advisor:
Dani Rodrik
Section Leader:
Lant Pritchett

2. ii
ACKNOWLEDGEMENTS
I would like to thank my advisor Dani Rodrik, Rafiq Hariri Professor of International
Political Economy; and my SYPA section leader Lant Pritchett, Professor of the Practice
of International Development for their valuable advice.
This paper is part of a study about financing of young innovative ventures in Turkey run
by Ant Bozkaya, fellow at MIT Sloan School of Management, in collaboration with Josh
Lerner, professor at Harvard Business School. I thank Ant Bozkaya for his advice and
continuous support to my project. I also acknowledge financial support from Turkcell to
this project.
I would like to thank all of my interviewees for their contributions. For a full list of
interviewees, please see Appendix I.
I appreciate Jose Romano (European Investment Fund), Mete Cakmakci (Turkish
Technology Development Foundation), Ogeday Karahan (Eurasia Capital Partners), Cem
Sertoglu (Golden Horn Ventures), Muge Inal (KOBI A.S.), Yener Yildirim (Turkiye Araci
Kuruluslar Birligi), Murat Karaege (Garanti Securities), and Ozlem Denizmen (Dogus
Group) for providing data and documents.
Alaattin Alpay (Turkcell), Guven Sak (TEPAV), Asli Kurul (Endeavor) and Avi Hasson
(Gemini Ventures) supported my research by connecting me to their contacts. I thank
them all.
I also would like to thank Orna Berry, Yigal Erlich and Gil Avnimelech for sharing their
viewpoints about the Israeli experience. I acknowledge financial support from TEPAV
for parts of my research trip to Israel.
I appreciate help from several colleagues at TEPAV, Sarp Kalkan, Ulkem Basdas, Ekrem
Cunedioglu, Sinem Uluturk, and Mezenef Hatam for their support in data and logistical
issues.
Finally, I thank my classmates at Harvard Kennedy School, in particular Tevfik Kinik,
Dany Bahar, Ozan Acar, Michael Kransdorff, Frederico Meinberg, and Laila Kassis, for
their help and insights.

3. iii
TABLE OF CONTENTS
Executive Summary iii
1. THE NEED FOR GOVERNMENT SUPPORT TOVENTURE CAPITAL 3
1.1. VENTURE AND INNOVATION 3
1.2. MARKET FAILURES THAT HINDER DEVELOPMENT OF VENTURE CAPITAL 4
1.2.1. COORDINATION EXTERNALITIES 4
1.2.2. INFORMATION ASYMMETRIES IN START-UP FINANCE 5
1.2.3. SPILLOVERS FROM INNOVATION 6
2. HISTORYAND CURRENT STATE OFPRIVATE EQUITYAND VENTURECAPITALIN
TURKEY 7
2.1. PRIVATE EQUITY 7
2.2. VENTURE CAPITAL 8
2.3. THE RELATION BETWEEN PRIVATE EQUITY AND VENTURE CAPITAL 10
3. OTHER POSSIBLE CONSTRAINTS OVER DEVELOPMENT OF VENTURE CAPITAL 12
3.1. DEAL-FLOW 12
3.2. LEGAL / REGULATORYISSUES 14
3.1.1. LEGAL STATUS AND TAXATION OF THE VC FUNDS 14
3.1.2. LIMITED EXIT OPPORTUNITIES 16
3.1.3. PROTECTION OF MINORITY SHAREHOLDERS 17
4. INTERVENTIONS TO VENTURE CAPITAL INDUSTRY SO FAR 17
4.1. KOBI A.S. 17
4.2. ISTANBUL VENTURE CAPITAL INITIATIVE (IVCI)18
4.3. TURKISH TECHNOLOGY DEVELOPMENT FOUNDATION (TTGV) 20
5. FUND OF FUNDS 20
5.1. MISSION 24
5.2. UPSIDE INCENTIVE:BUY-OUT OPTION 25
5.3. MANDATES OF THE FUNDS 26
5.4. ADMINISTRATIVE STRUCTURE 29
5.5. SELECTION OF LIMITEDPARTNERS AND GENERAL PARTNERS 30
5.6. MANAGEMENT OF AND RELATIONS WITH FONFON FUNDS 32
5.7. CO-INVESTMENT 33
5.8. OWNERSHIP AND LEGAL STRUCTURE 34
5.9. EVALUATION 36
5.10. EUROPEAN UNION STATE AIDREGIME 38

4. iv
EXECUTIVE SUMMARY
Venture capital (VC) financing, a crucial element of an innovation eco-system is very
limited in Turkey. This paper attempts to discuss the reasons for the lack of VC
significant financing in Turkey and offers a public fund of funds as an industrial policy
intervention to foster the availability of and access to VC funds.
Development of venture capital requires government intervention
The social returns that is generated by the first movers to VC industry is higher than the
private returns they get, as a result of three market failures:
 Coordination externalities. The VC industry requires numerous elements of
infrastructure to operate, such as intermediaries, investors, and entrepreneurs who
know about VC investments, as well as an a network of VC funds for
syndications.
 Information asymmetries. High levels of information asymmetries make it costly
to invest in early-stage firms. VC funds engage in expensive `due-diligence`
processes to assess the potential of future businesses. VC due-diligence brings a
`certification effect` to high-quality entrepreneurs.
 Spill-overs from innovation. Innovative ideas are undersupplied than the socially
desirable level, because they might easily be imitated once demonstrated by the
entrepreneur. VC financing is a tool to increase the supply of innovative ideas.
This set of market failures constitutes binding constraint over development of VC
industry. Cross-country evidence shows that at the level of R&D, Turkey has a
significantly higher deal-flow potential than the current level of VC investment. Legal
and regulatory issues also do not seem to bind, because a private equity (PE) industry has
managed to flourish in the last decade, although these issues are as effective on PE as
much as they are on VC.
A public fund of funds approach to foster venture capital industry
A government intervention to foster VC should provide a subsidy that compensates the
investors of the first VC funds for the differential between the social returns that they
generate and private returns they get.
A ten-year public fund of funds will be established with a clear mission of developing a
self-sustainable Turkish venture capital industry. The fund of funds will invest in VC
funds as a limited partner with a share of 50% or less. The private investors will have an
option buy the public share after five years at a price of capital plus a pre-determined
interest rate.
The program will take a pro-active approach for establishment of 5-10 funds that will
have at least one Turkish and one international institutional investor, and hands-on
management in Turkey. The funds will be privately managed with compensation
structures that conform to international standards.
The investee funds will be directed to early-stage investments by smart incentives. The
earlier-stage the investment is, the higher the rate of matching will be. The limits on the
maximum contribution to a fund will also lower the subsidized amount to be invested.

5. 1
Venture capital (VC) financing is very limited in Turkey. For entrepreneurs, VC
financing is one of major instruments to finance start-up firms. VC funds also provide
entrepreneurs with business networks, mentorship and credibility. Therefore VC
financing is one of the crucial elements of an innovation eco-system. This paper attempts
to discuss the reasons for the lack of VC significant financing in Turkey and outlines an
industrial policy intervention to foster the availability of and access to VC funds.
United States is the cradle of the VC; but the importance of VC also is increasing in
emerging economies. Canada, China, India, Taiwan, Singapore, Nordic countries and
Latin America are also following the U.S. lead. In many of these geographies1, the
development of VC industry is initiated and / or supported by some government
intervention. The YOZMA program in Israel is a good example in this regard. Starting in
1993, YOZMA, a program of the Israeli government triggered emergence of a strong VC
industry, which now attracts the highest per capita VC investment in the world. Same is
true for the U.S: in the 1960s, the guarantees provided through the Small Business
Investment Companies program catalyzed nurturing of the VC activity in the U.S2. This
paper argues that a government intervention to develop VC is necessary and very timely
for Turkey.
For the last 3 years, with the implementation of the 9th Development Plan (2007-2013),
increase in R&D and SME supports has become a priority of the Turkish government.
Government targets increasing R&D spending to 2% of GDP in 2010 from its value of
0.8% in 20053. VC stands at the intersection of R&D and SME support policies. A
support scheme to VC industry is by its nature a different support tool than grant or tax-
break schemes related to SME and R&D supports. Despite the recent increase in both
SME and R&D supports, so far VC has stayed as a missing link between these two areas.
This paper argues that there is a necessity and opportunity to initiate a support program to
foster VC industry.
1 With possible exceptions of eastern Canada, which benefited from its geographic proximity to
Northeastern USA, and to some extent China and India, where VC funds followed presence of Silicon
Valley firms;
2 see Lerner (2009, p. 37-39) for an overview of the Small Business Investment Companies program.
3 OECD (2008)

6. 2
The Turkish government recently named development of VC as a priority in some recent
policy documents. The latest SME Action Plan (2007-2009) of the State Planning
Organization4 acknowledges that “given the number of venture-backed enterprises,
Turkey is still at the earliest stage of development of venture capital” (p. 38), and names
development of VC as a priority (Action Plan 4.7). Expansion of VC industry is also
taken as a priority in he State Planning Organization’s 2010 Annual Development
Program (Measures 26 & 91).
The paper is divided into five sections: In the first section, I explain why VC financing is
important is for innovation, and why market failures hinder its development. In the
second section, I provide a short history and overview of private equity5 (PE) and VC
industries in Turkey. In the third section, I provide some evidence to suggest that there is
4 SPO (2006)
5 For the purposes of this study, `venture capital` refers to equity investments in less mature companies at
the start-up, early development, or early expansion stages (see figure below). This definition excludes seed
financing that precedes proof of concept in development of a business. In literature, the term `private
equity` is used with two meanings. First, it refers to all equity investments in private companies, as opposed
to equity investments in publicly trade companies on a stock exchange. With this definition, private equity
includes different forms of financing, such as leveraged buyouts, venture capital, growth capital, distressed
investments and mezzanine capital. A second definition of private equity refers to private equity
transactions that are in later stages to venture capital. For the purpose of this study, the termprivate equity
refers to its second definition, hence it excludes transactions in seed and VC categories.
Source: adopted from del Valle (2009)

7. 3
a deal-flow potential and legal / regulatory issues are not binding constraints over the
development of VC industry. In the fourth section, I review the public interventions to the
industry so far, and discuss why they have been ineffective in alleviating market failures.
In the fifth section, I propose a public `fund of funds` approach to overcome the market
failures that hinder development of the a VC industry in Turkey.
This paper utilizes information from market actors and publicly available quantitative
information. The constraints over VC industry and idea of a public fund of funds were
discussed with different stakeholders in the Turkish innovation eco-system through
structured interviews. The YOZMA experience was also analyzed in detail with
interviews conducted in Israel. A full list of interviewees, including financiers, policy-
makers, entrepreneurs, business angels, and academicians can be found in Appendix I.
1. The need for government support to venture capital
1.1. Venture and innovation6
VC is believed to be an important tool specialized on the financing of young and small-
sized firms, and therefore crucial for start-ups7. In a typical VC fund, general partners
pool resources from limited partners, who are institutional and individual investors, and
invest in firms of high-growth potential. VC funds are established for a certain period,
generally as a closed-end fund of 10 years. The general partners manage the fund and are
compensated at a structure that aligns the interests of general partners with those of the
limited partners. This compensation structure in most cases entails a management fee
(typically at an annual rate of 2% of the fund size) and a carried interest (typically 20% of
the capital gains after liquidation of the investments). The investments are liquidated
through mergers and acquisitions (M&As) or initial public offerings (IPOs). VC is
regarded as a risky asset class with higher returns generally realized in long-term (5-10
year) horizons.
6 Unless otherwise noted, distilled from Lerner and Shephard (2009) Section 2.5 and 2.6, Da Rin, M. and
Penas, M.F., (2007) and Kortum and Lerner (2000)
7 See Bozkaya (2009) Chapter 1 for a detailed literature review on financing entrepreneurship and the role
of VC.

8. 4
With the limited availability of VC, the innovative activities have to be financed mainly
through bank credits or intra-firm financing. Banks are generally not specialized in and
generally reluctant to provide credit for start-up firms. The screening mechanism that VC
funds pick their investments make it a more efficient tool financing innovative activities
compared to intra-firm financing within conglomerates. Venture capitalists decide to
invest if a particular business proposal has a sustainable competitive advantage, which in
the technology industries normally derived from intellectual property and / or innovative
ability. On the contrast, most mature corporations and their banks evaluate projects with
regards to their existing business lines, therefore not investing in many projects that
might have great potential but not fit into the firms’ core competencies.
For entrepreneurs, VC funds not only provide equity financing, but also networks,
mentorship and credibility. VC funds are likely to spot potential future applications of
technology better than large firms that generally have narrower market focus. In the case
of Turkey, VC funds also have potential to bring an international network, crucial in
connecting firm’s R&D, production and marketing strategies to the global economy. The
well-documented positive relation between VC financing and innovation makes VC is
one of the most important components of an entrepreneurial ecosystem.
1.2. Market failures that hinder development of venture capital8
1.2.1. Coordination externalities
The VC industry requires numerous elements of infrastructure to operate. Among them
are: (1) An institutional infrastructure that comprises of intermediaries such as lawyers,
accountants and business advisers who are aware of VC process, (2) investors who
believe that VC funds are viable and know how to back VC funds, as well as invest in
venture-backed IPOs, (3) entrepreneurs who are familiar with pros and cons of equity
financing.
VC funds also benefit from networks with other VC funds9. Access to other fund’s deal
flows through syndications is an important factor positively associated with the
8 Unless otherwise noted, summarized Lerner and Shephard (2009) Section 3.1 and Maula et al (2007)
Section 2.1
9 Hochberg, Ljungqvist and Lu (2007).

9. 5
performance of the VC funds. Syndication provides the VC firms with both a second
opinion from the industry strengthening the screening, and opportunity to diversify to a
larger number of investments to reduce the firm-specific risk10.
The coordination problem in the infrastructure of the VC industry is one of the reasons
why there is a significant cluster effect in VC industry. Venture capitalists do not want to
invest in firms that are geographically far away from them. The cluster effect makes
development of a local VC industry, with offices and teams operating in Turkey crucial
for entrepreneurial finance, because access to VC funds in other geographies is very
limited.
Provision of international funding to Turkish VC is as crucial as the development of local
industry. Because, up to now, Turkish private institutional investors have not been
exposed to VC investments, whereas major international institutional investors have been
heavily investing in VC for decades. It is the certification effect of these international
investors that will attract Turkish institutional investors to invest in this new asset class.
Yet, institutional investors have a significant home-bias11, i.e., the international investors
would want more returns to invest in Turkish VC funds compared to investing in their
native VC funds, as a result of cross-border transaction costs, as well as additional costs
with different culture and language.
1.2.2. Information asymmetries in start-up finance
Problems of adverse selection and moral hazard limit the access of finance for innovative
start-up companies. Banks generally have limited information about the quality of
enterprises, and in Turkish context have little incentive to invest in obtaining information
if opportunities to grow in more straightforward areas like consumer finance are still
abundant12.
Venture capitalists, as opposed to banks, are specialized on early-stage financing, and
hence have developed strong, yet expensive and time-consuming `due-diligence` methods
10 Lerner (2009, p.53)
11 Hursti and Maula (2006)
12 This has been the the case in Turkey in the recent private credit expansion since 2005, see World Bank
(2008).

10. 6
to assess the potential of future businesses13. As a result of this screening procedures, VC
backing brings a new enterprise not only finance, it also provides a `certification effect`14
about the quality of the enterprise. It provides signals to the banks as well, opening high-
quality entrepreneurs better access to financing channels.
1.2.3. Spillovers from innovation
A large body of literature documents existence of positive knowledge spill-overs from
R&D15. Although some of the innovations are patentable; in practice private returns are
far below social returns even in the patentable cases, because innovators as well as small
business owners fail to file or defend patents in an efficient and timely manner. Indeed,
this is why public supports to R&D are justified. As venture capitalists generally invest in
innovative firms, any support to VC can also be regarded in this line, as a part of a
support a larger innovation system.
Moreover, most of the innovations are simply unpatentable. They are just new ways of
doing things, improved or less costly methods of production, distribution or marketing.
The non-patentable ideas are undersupplied compared to socially desirable level, because
they are easily imitated once demonstrated by the entrepreneur. The profit expectation of
the potential entrepreneur is hence lower than the case he would have with a patentable-
idea, therefore the potential entrepreneur is less likely to innovate. This `self-discovery
externality` makes a public support to innovative activities desirable16.
The latter sort of innovation is more relevant to Turkish context. Innovative efforts in
Turkey take place more in the firms rather than in universities, hence the innovations are
more likely to be unpatentable. They also fail to be in the scope of public R&D supports.
In this case, a support to VC financing emerges as one of the few ways to incentivize
innovative activities.
13 Maula, M. at al (2007)
14 Lerner (1999)
15 Among them, see Griliches (1992).
16 Rodrik (2004). Rodrik explicity acknowdledges improving `developing mechanisms for higher risk
capital` as an industrial policy to fix the self-discovery externality (p. 26).

11. 7
2. History and current state of private equity and venture capital in Turkey
This part summarizes the development of PE and VC markets in Turkey and reviews the
current state of the industry. Figure 1 depicts the number and amount of PE investments
in Turkey in the 1995-2008 period.
2.1. Private equity17
The first PE transactions are recorded in 1990s. Sparx Investment, a company backed by
Nomura Capital Investments introduced PE to Turkey in 1995. In 1996, Vakifbank, a
state-owned Turkish bank, established its own PE fund, Vakif Risk Sermayesi, and
invested in one company. The number of transactions until 1999 was very low.
The Turkish PE industry had its first surge in the years of 1999 and 2000. The IMF-
backed stabilization program combined with the “dot-com boom” in the international
markets paved the way for this surge. A number of foreign funds opened offices in
Istanbul. In 2000, two important Turkish funds were also established: TURKVEN was
started by 3 young Turkish fund managers, with the assistance of Advent, one of the
largest international funds, and managed to raise its first fund of 44 USD million from
five institutional investors, including International Financial Corporation, European
Investment Fund and Turkish Technology Development Foundation (TTGV18). Is
Girisim was started by Isbank, the largest private bank in Turkey, with a commitment of
30 USD million.
This short-lived surge ended in 2001 as a result of the financial crisis in Turkey. Given
the burst of the dot-com boom and uncertainties associated with the region after 9/11,
many foreign funds lost their appetite with the Turkish market. There were almost no
investments until 2003 and very few between 2004 and 2005.
Since 2006, Turkish PE markets witnessed another and a larger surge. With improved
economic outlook for Turkish markets, large international players increased their activity
in Turkey. In 2006, Providence Capital acquired Digiturk, an online digital TV platform,
and Texas Pacific Fund acquired Mey Icki, the spirits conglomerate – the first three digit
17 Unless otherwise noted,this section is based on Deloitte (2007) and interviews.
18 See Section 4.3 for more information about TTGV.

12. 8
PE deals in Turkey. Also in 2006, the two major Turkish funds, TURKVEN and Is
Girisim had their first exits. In 2007, two more Turkish players entered into market –
Antika Partners with a fund of USD 400 million and Dundas Unlu with a fund of USD
150 million. TURKVEN closed its second fund, all with international investors, in
200719. Recently, Turkey became an attractive location for the funds from the Gulf
Region; for instance, Abraaj Capital, the largest fund in the Gulf, committed a USD 500
million fund for Turkey20.
Two major public interventions to this market, KOBI A.S. and Istanbul Venture Capital
Initiative were also established in this last period, in 2006 and 2007 respectively (Section
4.1 and 4.2 provides a detailed discussion of these initiatives).
Figure 1. Combined PE and VC investments in Turkey (# of transactions and amounts,
1985-2008)
Source: TurkVCA, Cem Sertoglu
2.2. Venture capital
VC investments in Turkey have been very limited, both in number of transactions and
amount invested, albeit the surge in PE (Figure 2 & 3).
19 http://www.turkven.com/
20 Bozkaya and Lerner (2009)

13. 9
The first VC investment, by TURKVEN, took place in 2006. Is Girisim had one VC
investment in 2007. Numerous foreign funds also took a limited number of VC positions.
There had been 9 VC deals so far that constitutes only less than 8% of the total
investment in the industry21.
Figure 2. Number of PE and VC transactions in Turkey (1985-2008)
Source: TurkVCA, Cem Sertoglu
Three Turkish funds are focused on VC investments. Teknoloji Yatirim A.S., established
in 2005, is a subsidiary of TTGV. Teknoloji Yatirim A.S. had 2 investments in biotech, 2
in software, and one in entertainment industries22. Two other players, Golden Horn and
iLab are focused on online ventures23. These three funds have invested around USD 20
million in 17 deals so far. Golden Horn is targeting to raise a larger fund in 2010. Yet,
these are very small figures both in the number and size of the deals compared to those of
PE deals.
21 Analysis from TurkVCA data.
22 Interview with Haluk Zontul
23 Interview with Cem Sertoglu

14. 10
Figure 3. Amounts PE and VC investments in Turkey (1985-2008)
Source: TurkVCA, Cem Sertoglu
2.3. The relation between private equity and venture capital
The domination of PE over VC is apparent from the number of funds focused on different
stages depicted in Figure 4. There are 29 funds operating in PE, compared to only 4 with
an explicit focus in VC. The buyout activity is dominated by the opportunistic takeovers
of international players with larger capital pools. On the other hand, the midmarket
(approximately USD 15-50 million) transactions constitute most of the PE deals, is
particularly crowded24. The industry players expect the market to extend to small-cap PE
transactions of around USD 10 million, but not to VC.
The fact that there is an established PE industry may be useful in igniting the
establishment of VC infrastructure, because some of the legal and accounting issues are
common between the two. However, PE and VC are two different in two major respects:
 From the point of view of the fund managers, the skills sets required for PE and
VC are mostly different25. PE is based on evaluation of established companies
with a known history; while VC is based on evaluation of a business plan or a
24 Anecdotal evidence also supports the overwhelming demand for PE transactions. For iVCi, 80% of the
requests it gets fromfunds is in mid-market PE segment (interview with Jose Romano).
25 This point was emphasized by most of the interviewees in the financial sector as a major constraint.

15. 11
company so young that it is not possible base evaluations on history of the
company. Therefore, getting into VC will require costly investment in new skills
by the fund managers.
 When PE and VC are compared, the information asymmetries are much larger in
VC, because the latter deals with business plans or young companies, while the
latter deals with established companies with long histories. This is why major
reason risk-averse institutional investors and fund managers focus on PE, rather
than VC26.
 The cost of the expensive due-diligence process is generally independent of the
size of the transaction, making it relatively more costly for the funds in VC
category27. The early-stage investments require both more time and resources to
manage, and more time to recoup investments. Yet, the management fees in the
industry are generally a percentage of the size of the fund, hence again managing
smaller VC investments is costlier than larger PE funds28.
Figure 4. Number of funds in different categories
Source: author’s analysis form TurkVCA data
26 Dhingra (2007)
27 Maula, M. at al (2007)
28 Dhingra (2007)

16. 12
3. Other possible constraints over development of venture capital
In this section I present two hypothesis for the binding constraints other than the market
failures presented in Section 1.2, and discuss why they are not at the moment binding
over development of a VC industry in Turkey: (1) deal-flow, (2) legal / regulatory issues.
The evidence against these hypotheses suggests that the abovementioned market failures
play an important role in explaining the underdevelopment of VC industry in Turkey.
3.1. Deal-flow
The venture capitalists cannot profitably operate in geographies where they do not have
access to a critical mass of deal-flow, because they would not be able to cover the high
fixed-costs of their operations. Therefore absence of a critical mass of innovative
business ideas / companies would avoid development of VC industry. Is this the case in
Turkey? This section explores the answer to this question with the available data and
concludes that it is unlikely that in Turkey there is a shortage of innovative business
ideas. This conclusion is in line with the overwhelming anecdotal evidence that I have
gathered through most of the interviews.
The evidence presented below should be taken with a grain of salt and should not lead to
a misunderstanding for the policy-makers. First, the data availability problems limit our
ability to distinguish between demand and supply factors of the deal-flow. Second, VC
operates in a very complex innovation eco-system, and after a government intervention
triggers VC industry, one of the other elements in the eco-system may become a binding
constraint; and some of these elements also suffer from specific market failures and
require public intervention. Therefore, while our conclusion leads to an urgent focus on
the market failures on VC, it should not be regarded as an excuse for negligence on the
other innovation policies.
Research and development (R&D) firms and other public and private research institutions
are the major sources of VC deal-flow. In a cross-country sample, given a certain level of
R&D, if the level of VC investment for a country is lower than the cross-country average,
then this might be taken as evidence that deal-flow may not be a binding constraint. One-

17. 13
way to investigate whether deal-flow is a binding constraint is to see if to compare the
level of VC investment with indicators of R&D.
Figure 5. VC investment is lowin Turkey given the level ofgross R&Dexpenditures (2007)
Note: Turkey is represented by dot close southwest corner
Source: EVCA, OECD, national statistics authorities
Figures 5 and 6 compare level of VC investments with gross R&D expenditures (GERD,
both business and government R&D) and number of triadic patents29. All variables are
normalized with GDP. The sample of countries is restricted to OECD countries in
Europe, because these countries share similar levels of development as well as similar
legal / institutional structures with regards to VC (with the possible exception of the UK
that has common law). Turkey’s performance both in the VC investment and R&D are
low. However, given the level of Turkey’s R&D performance, the VC investment is
significantly below the cross-country regression line. To put it into different word, given
its current level of R&D, Turkey has a significantly higher potential of VC deals than the
current level.
29 Triadic patents are a series of corresponding patents filed at the European Patent Office (EPO), the
United States Patent and Trademark Office (USPTO) and the Japan Patent Office (JPO), for the same
invention, by the same applicant or inventor.

18. 14
Figure 6. VC investment is low in Turkey given the level of patents (2007)
Note: Turkey is represented by dot close southwest corner
Source: EVCA, OECD, national statistics authorities
3.2.Legal / regulatory issues
The constraints on VC regarding regulatory / legal issues can be categorized into three
categories: (1) issues regarding legal status and taxation of the VC funds, (2) limited exit
options, (3) problems with protection of minority shareholders. Below we analyze these
issues; and suggest that, while Turkey needs a modernization in the legal and regulatory
infrastructure, the lack thereof is not seem to be a binding constraint over the VC
industry. As such, the reforms in this area are not likely to foster the VC industry unless
they are accompanied by other measures to address the market failures.
3.1.1. Legal status and taxation of the VC funds30
In Turkey, the all PE and VC funds are regulated under Capital Markets Board (CMB)
regulations31. Funds under CMB regulation enjoy large tax advantages. They are exempt
30 The analysis on regulatory constraints is mostly based on information compiled from Capital Markets
Board (2009) and ISE (2008).
31 Communiqué Regarding Principles of Investment Funds, Series: VII No: 10

19. 15
from corporate tax as well as personal income tax for the partners. Under CMB
regulations, all VC funds have to get an operating license from the CMB, have
independent audits every 6 months, and file certain reporting requirements to CMB. Up
until 2009, there was an additional requirement for the funds to be quoted in the Istanbul
Stock Exchange (IMKB). This requirement resulted in not only new reporting burdens,
but also created a distortion in the partnership structure of the VC firms. In 2009, this
requirement was practically waived32. Also, the current regulations only allow for open-
ended funds, but not for fixed duration closed-end funds that is the common practice in
the industry.
In many countries that has a developed VC industry, including the U.S. and Israel, the
key regulatory innovation that has been conducive to VC has been `tax flow-through.` In
these jurisdictions, a VC fund is legally a limited partnership, but for the tax purposes
only, it is transparent; all the tax is accrued directly to the partners in accordance with
their shares. Hence, if the partner is a non-profit tax-exempt entity, it doesn’t pay taxes.
In the absence of transparency for tax purposes, the VC fund would pay tax, but the non-
profit investor wouldn’t pay taxes for his dividend income, yet it would still be taxed.
Tax flow-through for VC funds boosted investment from non-profit funds to the VC
industry in the U.S.
The full exemption in Turkey, as opposed to tax flow-through, brought high regulatory
requirements for the VC/PE funds. The regulation is delegated to the CMB, whose
competence is regulating the capital markets and transactions related to publicly listed
companies. Regulation of PE transactions (in its large definition) is, in fact, merely
related with regulation of transactions related to publicly listed companies. A
modernization in the regulations should introduce tax flow-through and self-regulation to
the industry.
These said, evidence suggests that legal status and taxation issues do not bind
development of VC. These issues have the same effect on PE funds; but these funds
32 The waiver is for the funds whose partners are `qualified investors.` The list of `qualified investors` quite
large and encompasses virtually all sorts of financial institutions, public bodies and high net worth Turkish
or foreign persons.

20. 16
developed rapidly in the last 5 years. All of these funds are established in other
jurisdictions of favorable regulations, but operate in Turkey33. Because the income of the
fund is due to capital gains, not due to the operations of the investee firms; it is taxed in
the jurisdiction where the fund is established. In this way, the PE funds currently operate
in Turkey are able to gain flow-through. If regulation and taxation issues were a binding
constraint they would hinder development of PE as well. The rapid rise in PE shows that,
regulation and taxation issues cannot be binding constraint on the development of VC.
All of our interviewees also agreed that it is possible to overcome current regulatory
restrictions by establishing the funds in foreign jurisdictions. Some even argued, funds
may prefer to stay in other jurisdictions even if the regulatory climate was better in
Turkey, because investors in the funds prefer to operate in jurisdictions that they have
been used to and Turkey is infamous for her regulatory uncertainty.
3.1.2. Limited exit opportunities
Another constraint on attracting investors to VC industry in Turkey is the limited exit
options. There is no secondary dynamic public equity market for young technology
companies with flexible IPO requirements, like NASDAQ. However, it is hard to argue
that non-existence of a secondary market will be a binding constraint over VC. Cross-
country evidence suggests that IPOs do not have significant effect in explaining
variations in VC activity (while has significant negative effects on PE)34.
In fact, rather than dealing with a secondary market with a very low market
capitalization, there might be more efficient exit options: First is the developing PE
industry35. In fact, international practice shows that acquisition by a PE fund or an
existing mature company is a very common exit option for VC funds. Second, although it
has significant transactions costs, there are no legal restrictions on IPOs abroad. Cross-
border public offerings hence constitute another option: Israel, for example, with its
developed VC industry, has the highest number of public offerings in NASDAQ after the
33 Only two funds are established under Turkish laws: KOBI A.S. is a public fund (Section 4.1), Is Girisim
is a subsidiary of Isbank, the premiere private bank in Turkey, which is historically associated with the
Turkish Republic, and has a broad public ownership structure. As confirmed in our interviews,
establishment of these funds under Turkish law is a preference of these conditions, not of a suitable
regulatory framework.
34 Jeng and Wells (2000)
35 Interview with Murat Ozgen

21. 17
U.S. sales to PE firms and cross-border IPOs might constitute better options.
3.1.3. Protection of minority shareholders
Protection of minority shareholder rights is weak in Turkey. In an index to measure
performance of countries in protection of minority shareholder rights in World Bank’s
Doing Business indicators, Turkey currently ranks 60th among 160 countries – below
emerging market countries like Poland, Mexico and India. Turkey requires reform in
transparency of companies to their investors, rights of minority investors on director’s
conduct and enforcement of judicial decisions in this area.
However, while they might have detrimental effects on PE investments, issues with
minority shareholder rights are unlikely to avoid VC investments. The reason is the fact
that VC funds put hands-on management effort into companies and choose their portfolio
companies accordingly. For the investee firm also, the network and expertise of the
venture capitalist is generally as much valuable as the equity investment it gets. Because
of this nature of the deal, it is much more unlikely that minority shareholder issues will
be a problem for a VC fund.
4. Interventions to venture capital industry so far
4.1. KOBI A.S.
KOBI A.S. is established as a (semi) public VC fund to finance young SMEs in 200636.
The shareholders are the Union of Chambers (TOBB), Halkbank (a public bank focused
on SME financing), KOSGEB37, along with a few individual chambers of commerce /
industry. KOBI A.S. is a VC fund operating under Turkish law, hence 49% of its shares
are listed in Istanbul Stock Exchange. The ownership and administration is dominated by
TOBB, a semi-public institution38. The investment committee comprises of 4
representatives of TOBB, 2 representatives of Halkbank and one representative of
KOSGEB. KOBI A.S. started with a fund of a size of 40 million TLs (~25 million USD),
36 KOBI is literally the acronym for small and medium sized enterprise in Turkish.
37 KOSGEB is the government agency for small- and medium-sized firm supports. Its board is comprised
of directors of main economic policy-making agencies and chaired by the minister of industry and
commerce. KOSGEB enjoys a large autonomous budget and relatively flexible administrative procedures.
38 TOBB is established by law and chamber membership is compulsory. TOBB is one of the influential
organizations in Turkey with very strong financial resources.

22. 18
and has spent 28 million TLs in 4 investments so far39.
KOBI A.S. played a great role in introducing VC finance to Turkish entrepreneurs.
Backed by the network of TOBB, it created awareness in emerging entrepreneurial
centers in Anatolia. However, the number of investments has been low for the period of
operation and none of these investments is early-stage. Numerous factors have resulted in
this outcome: First, KOBI A.S. compensation structure for fund managers is not in
accordance with industry practices, limiting prospects for aligning incentives for the best
performance of the fund. Second, although there is a professional VC team; the
investment committee does not include VC professionals, and regarded as conservative in
making investment decisions. Third, small size of the fund limited propensity to take risk,
particularly to invest in early-stage, because options for portfolio diversification stayed
limited. On top these; a (semi) public fund does not serve the purpose of developing a
venture capital industry; because it does not deal with the market failures in the VC
industry, but rather it attempts to provide direct finance to the start-up firms40.
4.2. Istanbul Venture Capital Initiative (iVCi)
Istanbul Venture Capital Initiative (iVCi) was established in 2007 as a fund of funds to
invest in PE and venture capital funds in Turkey. It is an initiative led by the European
Investment Fund (EIF). EIF is the European Union’s specialized financial body for Small
and Medium Enterprises (SMEs), fully owned by European Investment and EU
Commission. EIF has a mandate to support EU policies in entrepreneurship, technology,
innovation and regional development by making equity investment in SMEs; however it
also requires the generation of an appropriate return for our shareholders.
EIF expressed interest in establishing a VC fund of funds in Turkey in 2006, modeled
after her experience with Neotec, which had a considerable impact in developing early
stage financing in Spain. However, given the low level of PE activity in Turkey by then,
EIF set the purpose of the first fund to establish a PE backbone. Along with the 50
million euros it committed, EIF was able to secure 100 million euros commitment from
39 Interview with Suleyman Sahin
40 Gilson (2003) documents and analyzes the failure of the German public VC funds experience of WFG.
Also see OECD (1997).

23. 19
public institutions41. Private financial institutions were not eager to join; the private
participation has been limited to two actors and 10 million euros42.
There had been numerous regulatory difficulties in establishing iVCi under Turkish law.
These difficulties resulted in a delay in starting operations, and the fund of funds was
established in Luxembourg in 2007. iVCi does not have an office in Turkey yet (opening
of one is planned in 2010), and although there is a separate investment committee, the
due diligence process for the investee funds is undertaken by EIF. iVCi has a large
mandate encompassing all stages of firms, and investment in funds as well as direct
investment in firms. However, strategically, it is focused on investing funds of lower
mid-market PE funds (30 million euro average fund size). iVCi closed deals with two
funds in 200943, and more investments are in the pipeline for 2010. iVCi is expecting to
invest in a limited number of early-stage focused funds at the end of the first fund, and
envisioning a second fund of funds later with a more focus on early-stage44. Better
utilization of iVCi has recently been announced as an official priority of the
government45.
iVCi is bringing numerous contributions to the industry. First, iVCi leverages the
expertise and network of EIF, one of the world’s leading players in VC, thanks to the
large budget it got from the EU46. Second, the focus area of lower mid-market PE funds
is still an underdeveloped segment. Third, the public institutions that are involved in
iVCi, particularly KOSGEB, is gaining expertise as an institutional investor.
There are also criticisms: First, some stakeholders think EIF has a very bureaucratic and
conservative due-diligence process, which resulted in a low number of investments so far.
41 KOSGEB (50 million euros), TTGV (40 million euros), the Development Bank of Turkey (10 million
euros)
42 Garanti Bank and National Bank of Greece, each 5 million euros
43 3TS Cisco, an expansion and buy-out fund with a regional focus of Central and Eastern Europe
(www.3tscapital.com); and Eurasia Partners, a small-cap private equity fund focused on Turkey (interview
with Ogeday Karahan).
44 Interview with Jose Romano
45 State Planning Organization’s 2010 Annual Development Program (Measure 26)
46 `…in 2001, the European Commission provided more than two billion euros to the European investment
Fund, making it overnight Europe’s largest venture investor. The amount is very significant relative to the
roughly four billion euros that were invested by European venture funds in that year.` (Lerner, 2009, p.
122)

24. 20
Second, lack of a hands-on office in Turkey is regarded as a short-coming. Third
criticism is the lack of focus on early-stage VC.
iVCi facilitates investments and relaxes the capital constraint of the general partners in
fundraising, however it does not involve a subsidy and hence it might have limited effect
in compensating for the market failures that hinder development of VC. Such an explicit
subsidy might be provided a public fund of funds, and maybe more conducive to the
mission of explicit mission of overcoming the market failures.
4.3. Turkish Technology Development Foundation (TTGV)
TTGV is an independent organization, operated under non-profit organizations law and
funded by initial World Bank grants and numerous government sources. TTGV has
grants in various areas of innovation policy. It also runs its own VC fund, Teknoloji
Yatirim A.S. (Section 2.2), and has invested in two PE funds, Is Girisim and TURKVEN.
It is also a shareholder in iVCi. However, TTGV is not a fund of funds (and does not
claim to be so), and engages in these activities as a part of its larger mission of supporting
innovation47. The efforts of TTGV to support financing of innovative enterprises has
been scattered in different initiatives so far, however this is due to fact that TTGV has a
large mandate and no expertise as a fund of funds. That said, as the leading intermediary
in Turkey in technology development and R&D areas, TTGV is one of the crucial actors
to benefit from in formulating a public intervention in VC industry.
5. Fund of Funds
Industrial policy interventions should target market failures. As such, an industrial policy
intervention to foster VC should focus on the market failures that avoid development of
VC. This section develops a subsidy to the first entrants into the VC industry to
compensate between these differences.
The subsidy will be provided through a 10-year public fund of funds that will invest in
VC funds as a limited partner with a share of 50% or less. A critical element of the
program will be a buy-out option given to the private partners at the investee funds: The
47 interview with Mete Cakmakci and Altan Kucukcinar

25. 21
private investors will have an option buy the public share after five years at a pre-
determined price. This price will be the capital invested plus a pre-determined interest
rate (LIBOR + x). This option will provide a subsidy to the funds that have returns higher
than the pre-determined interest rate.
Figure 7. Fund of Funds
Arrows represent flow of investments
Source: adopted from Lerner (2009, p.134)
I suggest the fund of funds to be named `The National Entrepreneurship Fund of Funds`
with an acronym FONFON48. I henceforth use FONFON instead of `fund of funds`. The
funds that FONFON invests in will be called FONFON funds.
I model this fund of funds idea from the YOZMA experience of Israel49 and New
Zealand50 that is modeled after YOZMA. I also factor in elements of Turkish institutional
48 Ulusal Girisimcilik Fonlarin Fonu
49 The information about YOZMA is collected from Avnimelech (2009), Avnimelech and Teubal (2005).
Senor and Singer (2009), and Lerner (2009); as well as through interviews with Gil Avnimelech, Yigal
Erlich and Orna Berry
50 Lerner and Shepherd (2009), Lerner, Moore and Shepherd (2005)

26. 22
structure, suggestions of stakeholders that I gathered through interviews51, and
experiences of previous interventions. I also utilize the conclusions of literature on public
interventions to foster VC and the general literature on industrial policy. Table 1 shows
how the elements of design fit into the principles that Josh Lerner52 offers for public
interventions to foster VC. Table 2 shows how they fit into the ten principles of industrial
policy interventions of Dani Rodrik53.
Table 1. Josh Lerner’s Rules of Thumb for Development of VC and Elements of
FONFON
Rule of Thumb Element in FONFON
Respect the need for conformity to global standards Fund of funds is a form of intervention that has been
implemented and accepted in international
community.
Funds with compensation structures in international
standards
Let the market provide direction Investing along with private limited partners in VC
funds,rather than direct investments
Direct investments are limited to co-investments
with FONFON funds.
Resist the temptation to over-engineer Independent majority in FONFON investment
committee
Advisory committee holds power to amend
guidelines according to evaluation results
Recognize the long lead times, but also avoid
programs getting too long
A fund lifetime of maximum 10 years. Options at
the 5th year ensure the program will not get longer
than necessary.
Avoid initiative that are too large or too small A USD 100 million size that will invest in 5-10
funds of the size of approximately USD 50 million
Understand the importance of global
interconnections
Requirement of international financial partner in
FONFON funds
Internationally networked leadership for FONFON
Pro-active approach in finding general partners and
limited partners
Institutionalize careful evaluations of initiatives 3-year cycle evaluations to see how FONFON is
contributing to developing a self-sustaining VC
industry, annual action plans.
Advisory committee has power to amend the
guidelines according to evaluation results.
Source: Lerner (2009) and author’s analysis
The design I put forward requires a minimum number of regulatory changes. The
experience shows that the more regulatory change a program requires, it takes more time
51Among many other suggestions, I also utilize some elements of an unpublished memo by Mete Cakmakci
on a fund of funds design.
52 Lerner (2009)
53 Rodrik (2004)

27. 23
to establish and lobbying through the process results in distortions in design. This is
especially true when legislative changes are required. This is why the design below
avoids any legislative change. Therefore, this design should be regarded as an
approximation to optimal given the current regulatory structure.
That said, one of the purposes of the program would be to form and strengthen the
lobbying power of the VC firms. To this end, measures will be taken to make TurkVCA
operational and effective. The program will also be catalytic in lobbying for the measures
for a better functioning VC industry. Once a few funds are triggered through this
program, TurkVCA will become essential in identifying the further constraints, in
particular legal / regulatory obstacles, that may emerge and lobbying to remove them.
Table 2. Dani Rodrik’s Industrial Policy Principles and Elements of FONFON
Principle Element in FONFON
Incentives should be provided only to “new”
activities.
VC is currently nil in Turkey.
There should be clear benchmarks/criteria for
success and failure.
Evaluations in 3-year cycles
Whetherthe buy-out options are exercised
There must be a built-in sunset clause. 5-year buy-out option ensures the program will not
last more than necessary,10-year fund lifetime
ensures sunset.
Public support must target activities, not sectors. VC is a sector independent activity. By its nature,
VC will be focused more on R&D intensive sectors;
however these sectors are ones with most spillovers.
Activities that are subsidized must have the clear
potential of providing spillovers and demonstration
effects.
Spillovers to entrepreneurial activity by creating
new financing opportunities.Spillover to other VC
activities by initiating formation of VC
infrastructure and demonstration effects.
The authority for carrying out industrial policies
must be vested in agencies with demonstrated
competence.
KOSGEB, TUBITAK, TTGV, TOBB
The implementing agencies must be monitored
closely by a principal with a clear stake in the
outcomes and who has political authority at the
highest level.
Advisory committee chaired by State Minister for
Treasury
The agencies carrying out promotion must maintain
channels of communication with the private sector.
Flexibility in rules, quarterly general partner
network meetings, monthly investment committee
representative meetings
Optimally, mistakes that result in “picking the
losers” will occur.
Some funds may have losses, the loss at these funds
will be limited to commitment.
Promotion activities need to have the capacity to
renew themselves, so that the cycle of discovery
becomes an ongoing one.
Possibility of the second fund of funds.
Source: Rodrik (2004) and author’s analysis

28. 24
5.1.Mission
FONFON should have a clear mission: developing a self-sustainable Turkish venture
capital industry in 10 years.
As I have argued in Section 1.1, a self-sustaining VC industry is expected to have
positive effects on innovation. Therefore, FONFON will serve increasing Turkish
innovation, through its accomplishing its mission. It is critical to understand that the
innovation eco-system has many variables, and an innovative economy requires many
other elements of policy interventions, such as R&D grants, angel capital, and training
programs. There already are a number of public support programs targeting different
segments of innovation eco-system (Appendix II) The positive effect of FONFON on
innovation will be dependent on interactions with these programs, hence it is not possible
to evaluate the effect of FONFON on a rather complex target of increasing innovation,
independent of the other variables. This is why I suggest a simple mission that is focused
on VC industry alone.
FONFON should not be used for supporting other development policies either. In many
instances, the policy-making and legislative process is likely to put many targets for a
program, creating a mission creep54. This is a very dangerous inclination for the success
of FONFON, because VC is a very specific tool in financing innovative start-ups.
Inclusion of other targets may significantly distort the incentives for the fund managers,
making the program impossible to serve its major mission. For example, forcing funds a
regional mandate will be a push against the cluster nature of VC funds and innovative
start-ups. Fostering entrepreneurship in poorer regions can be achieved using regional
development policies. In a similar vein, there are different tools for supporting
entrepreneurship in different segments, for which VC is not the best fit. For instance,
separate micro-credit programs can be used for supporting entrepreneurship among poor.
54 See Gompers and Lerner (2001) on how SBIC involved into an inefficient program with the
incorporation of targets other than the original mission, such as regional development targets.

29. 25
5.2.Upside incentive: buy-out option
The critical element in the design of FONFON is a buy-out option given to private
partners. The non-FONFON partners in the FONFON funds will have an option to buy,
partially or fully, the FONFON share at the end of fifth year. The exercise price of the
option will be calculated so as to provide FONFON the return of its capital invested less
any distributions plus a rate of return on that capital that is equal to a pre-determined
interest rate in the form of LIBOR + x. This rate might be determined by taking the rates
of government Eurobonds as a benchmark. The rational private investors will exercise
their buy-out options if, at year five, the underlying value of the investment portfolio (less
distributions made) is at a significant premium to the buy-out price.
In the first stage, the partners will have option to buy the FONFON shares in accordance
with their share among the non-FONFON shareholders. For instance, if an limited partner
has a 50% share in a FONFON fund of a matching rate of 1:2, it will have option to buy
25% more shares from the 33% that FONFON owns. If the options are not exercised in
full by all private partners, the partners who exercise their options will be given another
option to buy the remaining FONFON shares such that each partner will have option to
buy a ratio of the remaining shares equal to its share in the options exercised in the
previous round. This iteration will continue until all private partners declare that they no
longer want to buy FONFON shares. If there remain unexercised options, FONFON will
continue to share the risk and return with private investors. The option is an effective
subsidy to private limited and general partners who invested in high-performance funds,
because their returns will be multiplied.
The critical feature of the buy-out option is that it is a subsidy to the partners of high-
performance funds only. If the return on the investments of the FONFON fund is below
the pre-determined interest rate, then rational private investors will not exercise their
options. Hence, no subsidy will be given to the investors of the bad-performing funds.
Therefore upside incentive is likely to attract better-performing managers compared to
mediocre-performance ones. Also, upside incentive will limit the downside risk that
FONFON takes. Israel, just two years before implementing YOZMA program with an
upside incentive, had an experience with a guarantee program. INBAL program, which

30. 26
provided 70% guarantee to VC investors, is not regarded as a great success – four funds
established merged into larger investment / holding companies. INBAL experience is a
showcase about outcomes of different incentives in a very similar environment55.
The FONFON contribution to the funds is an effective subsidy to the general partners –
time independent of their performance. At a matching rate of 1:1, the general partners
will get twice management fee and carried-interest as they would get without
contribution. The subsidy to general partners is not conditional on high performance
(although the size of the carried interest is proportional to performance), because of two
reasons: First, unconditional subsidy will be more effective in directing fund managers to
early-stage. Second, the structure of the incentive to limited partners will ensure that they
screen the teams they invest in better.
5.3.Mandates of FONFON funds
The purpose of FONFON is to improve early-stage VC financing. Therefore, the
FONFON funds are expected to mostly engage in early-stage investments. Since the
FONFON funds will be learning Turkish market with this program, smart and flexible
incentives might work better than strict criteria. Given the incentives, the funds will still
be able to invest in later stage opportunities, if they see it in their best interest at that
moment. There will be two smart incentives:
Incentive 1: Increasing matching rate for earlier stage
FONFON will match the private investors according to the mandate of the fund in terms
of the stage of the investment. The ratio of public share will decrease, as the investment is
later stage; so that the subsidy will get higher in stages that have been affected by larger
degrees of market failure. This matching structure will ensure that the investors in more
risky early-stage investments will get more upside incentives.
I suggest the following matching ratios: start-up: 1:1, early expansion: 1:2, expansion:
1:4, late expansion: 1:5. The FONFON funds might usually have investments at different
stages. In this case, the matching ratio will be calculated as a weighted average. For a
55 Avnimelech (2009).

31. 27
fund that has 40% start-up, 40% early expansion and 20% expansion mandate, the
matching ratio will be 0.4 x 1 + 0.4 X (1/2) + 0.2 x (1/4) = 0.7, i.e., 65:100. In this
scheme, since the calls to draw up the FONFON commitments will take place when the
investments take place, FONFON’s share in an individual fund will change in time if the
fund has investments in different stages.
Incentive 2: Maximum Investment and Fund Size
There will be two rules that limit the size of investments of FONFON funds. Since later-
stage investments typically require a larger amount of capital, this will also direct the
funds to earlier-stage:
 FONFON will invest a maximum of 20 million USD, and a maximum of 20% of
its funds in an individual fund.
 Each FONFON fund will not be able to allocate more than 10% of its fund to one
investment.
Given these rules, a fund that has half early-stage and half early-expansion mandate will
get 40% matching, and attain a size of 50 million USD (with a maximum rate of upside
incentive). Hence, the maximum size of investment this fund can make is 5 million USD.
This size will be a good check to keep the fund operations in its mandate.
So what is the optimal size for FONFON? The size is critical for the success of the
program -- a too large fund of funds size may crowd out private capital56, while a too
small fund of funds size may result in funds of sizes below a critical threshold to sustain
operations. FONFON should target matching at least 5 funds, and a maximum of 10.
Since the decision to invest in a fund is dependent on numerous factors (Section 5.5), and
matching rates vary; there should not be a strict number of funds to be matched.
However, the size of FONFON will to some extent determine the number of funds
invested. The minimum number of 5 is required to ensure there is a network of VC funds
for syndications, create a certain competition in the industry, and pave the way for
sectoral specialization of the funds. A number larger than 10 does not seem viable within
56 See Cumming and Macintosh (2006) for how large size of a co-investment program in Quebec (Canada)
has led to a crowding out private investors.

32. 28
the scope of the program. If we assume a minimum fund size of 50 million USD is
required to provide enough compensation to attract good quality investors; given 20%
maximum fund allocation rule, FONFON at a size of 100 million USD can invest in 5
funds with early-stage / early-expansion mandate (40% matching). Matching rate in
some funds that include expansion and later-expansion will be lower, so a 100 million
USD size might allow for 7-8 funds to be matched. Hence a fund size around 100 million
USD seems to a good benchmark. If there will be direct co-investment (Section 5.7), this
size should be increased by a margin of 10-20%.
Avoid strict criteria about firms
It is also possible to put some explicit criteria such as age (3 or younger), asset size, or
the number of employees (maximum 50) to ensure that the investee companies are not
later stage. However, this is not preferable, because of two reasons: First, these criteria
are strict and may limit flexibility of fund managers to optimize their portfolios. Second,
it is easy to fool these criteria by splitting companies, establishing new ones, etc.
Should there be an industry or technology criteria? For industries, letting the funds to
evolve into certain focus areas is a better strategy than increasing the risk of that funds
face by dictating them certain funds. A criteria for the firm being innovative is a good
option, because it will ensure avoid leaking of the funds to unrelated industries. However,
such a condition does not seem to be administratively feasible. While it is possible to use
criteria that other public bodies use for their evaluations57 (eg. TUBITAK’s R&D grant
criteria), these conditions are prepared to screen firms for a different set of policy targets.
Setting new conditions, on the other, will require administrative capacity to monitor
them. Since there is no prior application, new conditions will also bring ambiguity, which
is very detrimental for the investment decisions of VC funds. All in all, an assessment for
innovativeness of investee firms does not seem feasible. The monitoring over the
FONFON funds should take place not with explicit conditions, but with smart incentives
and representation in the investment committees.
57 Interview with Gil Avnimelech

33. 29
5.4. Administrative structure
It is of utmost importance that the administration of the FONFON will be professional,
free of bureaucratic burdens and political interference. FONFON is to be a lean
institution with a general manager, a few senior and junior investment professionals, and
enough support staff. FONFON’s management office will be located in Istanbul, where
most of the FONFON funds are expected to be located in, and the easiest city to connect
with international investors. The management office will have the following functions:
1. Doing initial screening to the requests from potential FONFON funds. The due-
diligence of the selected proposals will be outsourced to a professional consultancy
firm. Outside consultants will also be used for specific issues, like certain
technologies, and for evaluation purposes.
2. Sitting in the investment committees of the FONFON funds. By sitting investment
committees of and by getting regular information from FONFON funds, monitoring
how the VC industry is evolving, and formulating new strategies for better evolution.
3. Preparing annual reports. Advising government on VC issues and other concerns
regarding entrepreneurial environment.
If FONFON invests in ten funds, four senior investment officers is likely to be enough to
sit in the boards (2-3 each), and monitor these funds. The workload of screening
investment proposals will be replaced by monitoring as investments take place. One
junior investment professional will work with each senior professional. The general
manager will oversee all the work, and take significant role in communicating with the
government. S/he should be a networked Turkish person with international experience
who has close contacts with international and national financial institutions and venture
capitalists, close knowledge of VC, and exposure to dynamics of Turkish public
administration. The general manager will be appointed by the relevant minister (see
below) and will make the other recruitment decisions. The recruitment of senior officials
is very critical, since they will sit in the investment committees of FONFON funds.
The commitment to the FONFON will be paid in advance, and the 10 year budget will be
financed through interest income accrued before the all the amount are drawn to investee

34. 30
funds58. This is to overcome complexities of public finance rules and assure an
independent operating budget to FONFON. Several rules regarding salaries of public
employees, as well as political considerations, may avoid investment officers to be
remunerated as competitive rates. However, this will at least be partly compensated by
the fees they will get from the investment committees they sit in; as well as their future
income expectations due to the experience and network that they will gain through
FONFON.
There will two decision-making committees:
 Investment committee will make the decisions choose FONFON funds. It will
comprise of the general manager, undersecretary of the relevant minister, and
three independent members that will be appointed by the relevant minister upon
the proposal of the general manager. Each member, except the general manager,
will have a proxy to attend the meetings in order to ensure that the committee can
have meetings on time. The decisions will be taken by the majority vote.
 Advisory committee will supervise the investment committee. It will have power
to change the guidelines and strategic priorities. Depending on the periodic
evaluations, it will approve annual and 3-year action plans. It will comprise of the
representatives of the shareholder institutions. The relevant minister will be the
chair of the advisory committee
The political ownership of the relevant minister is critical for the success of the program.
I suggest the relevant minister to be the Minister of State responsible for Treasury,
because it is a coordinator post that fits better into the crosscutting nature of FONFON,
and it has a higher political visibility. An alternative is the Ministry of Trade and
Industry, which is also relevant, but lacks the two properties above.
5.5.Selection of limited partners and general partners
Within two months of establishment of FONFON, the general manager will prepare
guidelines for the framework for the selection FONFON funds and Advisory Committee
58 Interview with Mete Cakmakci

35. 31
will approve it. The guidelines should be formulated in line with the general principles
below59:
 The general partners should have a clear fundraising strategy based on already
established contacts. The strategy should include names and information about
potential limited partners and documentation of their interests. The general
partners will have 6 months to get commitment for at least 75% of the funds from
private limited partners. After 75% of the funds are committed, FONFON will
commit its funds. If general partners will fail to secure commitment of 75% of the
funds in 6 months, FONFON’s investment decision will be waived. The
investment committee may extend this period for 3 more months.
 In order to ensure local skill building in VC and learning from international
experience, FONFON funds will have an office and hands-on management in
Turkey (the fund might be established in another jurisdiction). They will also
have at least one international financial institution as a limited partner and at least
one Turkish qualified investor60 as an limited partner.
 The guidelines should not involve strict conditions for general partners because
different funds with different investment strategies will require different talents.
However, proven track record demonstrated with successful exits and / or
entrepreneurial experience will be pluses. The management team should be
composed of complementary skills and backgrounds.
 The investment strategy should be clear on the targeting stages and focus markets,
and how these fit into the competitive landscape. The stages and markets should
aligned with the skills and backgrounds of the management team.
 The interest from limited partners should also be regarded as a signal; if general
partners already got commitment from prestigious institutional investors, it is a
positive signal about their quality.
 Other important factors for ensuring political supportability are:
59 Some of these elements are designed in lines of discussions with Ogeday Karahan, Mete Cakmakci, Jose
Romano, Selin Ozkan, Yilmaz Arguden.
60 Same definition with that in CMB Communiqué Regarding Principles of Investment Funds,Series: VII
No: 10

36. 32
o No general partner should dominate the carry or decision-making
structure.
o The should not be a significant non-alignment in the interests of partners
(limited partner and general partner.
o FONFON will partner one limited partner in only one fund.
FONFON will publish a tender in a week after the guidelines are approved. It is expected
to potential general partners to approach FONFON after the tender. However, the
establishment of first fund(s) will most probably not be based solely on the general
partners approached after the tender, but also require networking in international and
Turkish investors. The general manager should not hesitate to work together with
potential general partners to look for high-quality limited partners and / or convince
potential limited partners to invest. Likewise, he should not hesitate to approach potential
general partners in his network before they approach FONFON. The performance, hence
selection of the first is very critical to demonstrate the success of the program. The first
selections is likely to based more on the quality of general partners and fundraising plan,
while the fit of investment strategies into the general strategy of FONFON will have
increasing weight in the later selections.
The proposals will be referred to due-diligence after a first screening by a team of
investment professionals. At this stage, staff will actively work together with general
partners of high potential to make their proposals more attractive. The due diligence
report will be presented to the investment committee. The investment committee may
invite the general partners for an interview with the general manager and investment
officers. The investment committee will vote based on the views of the investment
officers, due-diligence report and the interview. All this process should take no longer
than 3 months.
5.6.Management of and relations with FONFON Funds
The FONFON funds will have management and compensation structures will be framed
with an agreement between general partners and FONFON after selection. The
compensation structure is essential for aligning incentives of limited partners and general

37. 33
partners in a VC funds, hence it should approximate the international standards of 2%
management fee and 20% carried interest.
The FONFON funds will also have investment and advisory committees. The
composition of investment committee will provide collective learning in Turkish VC
industry, while ensuring the general partners will have the power to manage their funds:
It will comprise of general partners, one representative of international limited partner,
one representative of the Turkish limited partner, and one representative of FONFON
(one of senior investment professionals). The general partners will also have right to
appoint independent members. The committee will decide by majority vote.
Generally, institutional investors like EIF and IFC do not sit in investment committees. In
the usual structure the investment committees include general partners and independent
members only. Many of the interviewees also emphasized that public representatives
should be in advisory committees, not in investment committees. Although this is another
alternative, I believe the structure outlined above will be more conducive to collective
learning in the industry. It will also impose government’s observation over the funds
activities, while it will not be possible to motivate the investment committee politically,
because of the majority vote rule. Giving FONFON representative an observatory role is
also an option, however in this case his contribution and learning is likely to stay limited.
There will also be a monitoring and reporting framework that will be a part of the
agreement with FONFON and the fund. FONFON will get economic and financial data in
regular period of 6 months. These reports will be evaluated by FONFON and will provide
basis of its evaluation and strategy formulation.
5.7.Co-investment
FONFON is designed as a fund of funds, but it is also possible to give a limited mandate
for co-investments with the other FONFON funds. These co-investment may stimulate
first investments by the funds, and with this demonstration effect may pave the way for
more funds to come.

38. 34
The part of FONFON that is allocated for co-investments should be limited to 5% of
FONFON and to the first 2 years, so that it will really be for demonstration effects only.
Further, the investments will be possible only to the investee firms of FONFON funds,
not direct investment to other firms. This will keep the market selection procedure that
the fund of funds model brings (as opposed to a public VC fund that engages in direct
investments). It will also avoid conflict of interest between FONFON and FONFON
funds, since they will not be in competition. Third, it will ease the administrative
procedure: Due-diligence will be done by the FONFON fund, and it will be up to the
FONFON investment committee to co-invest or not based on this due-diligence.
FONFON is expected to exit from these investments at the end of 10 years, preferably
together with the exits of the FONFON funds.
5.8. Ownership and Legal Structure
Whatever the legal structure is, it is of critical importance to establish FONFON under
Turkish law, because this will show the importance of this initiative for the Turkish
government. There are two major alternative ownership structures for FONFON, and
variations of legal structures within them: (1) a public – private partnership with a mutual
fund structure, (2) a public fund of funds under limited company or a mutual fund legal
structure. I believe the second alternative is superior to the first one in terms of
overcoming the market failures and administrative feasibility. Table 3 shows how these
two alternatives and a public venture capital fund alternative compare in terms of
technical correctness, administrative feasibility and political supportability.
Alternative 1: Public – Private Partnership
A private-public partnership with Turkish financial institutions and blue-chip companies
as well as international institutional investors (EIF, IFC, etc.) will bring two advantages:
First it will be possible to leverage networks, experiences and credibility of these
institutions. Second, the risk and cost will be shared. Such a closed-end fund can be
established under Turkish law, under the newly added hedge fund61 alternative in the
61 serbest fon

39. 35
mutual funds communiqué of the CMB. Mutual funds are tax-exempt; therefore tax-flow
through will not be an issue for institutional investors.
However getting private partners to FONFON has significant disadvantages that is likely
to limit its role to overcome the market failures in the VC industry: First, given the higher
information asymmetries, private investors may hesitate to involve in a highly early-stage
oriented fund of funds. In this case, government may need to provide certain guarantees
to convince the private partners to join FONFON. If the guarantees are large, the
advantage of sharing cost and risk will mostly disappear. Second, the private incentives
will ask for returns that beat the government bond rate, therefore they are very unlikely to
agree with the buy-back option. Yet, buy-out option is the most critical element in the
design outlined so far. The role of a private-public partnership may stay limited to
facilitation – iVCi is already doing this (Section 4.2) Therefore, the private-public
partnership should take place at the level of FONFON funds, not at the level of fund of
funds.
Table 3. Comparison of FONFON with other alternative interventions
Technically correct Administratively feasible Politically supportable
Public VC fund
(KOBI A.S.)
(-) It does not foster a
VC industry,it just
provides funding
(-) Risks associated with VC
investments are too high to
take for public officials
(-) 2-20 compensation
structure is very hard to
justify
Private-public
Fund of Funds
(iVCi)
(-) Hard to give the
upside incentive with
private money
(-) There are legal
impediments in Turkish law
(+) Risk is shared with
private investors
Public Fund of
Funds
(FONFON)
(+) Correct set of
incentives
(+) No requirement for
change in any law
(-) Selection of VC funds
and risks associated with
them can be a political
problem, but if the due-
diligence is strong this
problem will be minimal.
Source: Author’s analysis
Alternative 2: A public fund of funds
A public fund of funds will have all the advantages that I have elaborated in the earlier
parts of Section 5. The only potential disadvantage will be the fact that risk not be shared
by private agents. However, failures are inherent to the nature of the VC activity, and

40. 36
these risks will be minimized by regular evaluations and adjustments in the FONFON
program.
Should the public fund of funds be established under one public agency or with
participation of a number relevant agencies? Establishing under one agency of a large
budget (eg. KOSGEB) is administratively easier, because there will not a need for inter-
agency protocols, establishment of a company or a mutual fund. However, this alternative
also has disadvantages: First, FONFON will be under control of one agency that reports
to a certain ministry. It will be harder to limit political influence through the checks that a
multi-agency structure brings. Second, it will also not be possible to leverage expertise of
different agencies. Third, the agencies kept out may lobby against the program that may
result in stop, misdirection or slow-down in the program.
A structure that involves a number of public agencies will enjoy the advantage of
bringing different institutional experiences, checks and balances, and will also avoid
negative lobbying of agencies that do not participate. KOSGEB, with its experience in
SME supports and large financial resources with a relatively easy mechanism to spend, is
one of the key stakeholders. TUBITAK, with its experience in R&D supports, is also
very relevant. The shareholders should also include some relevant non-profit
organizations: TTGV has financial resources and has been the primary technology
support and public-private intermediary for years. TOBB also has large financial
resources and enterprise network all over the country.
Under this alternative, FONFON can be established as a joint-stock company (A.S.) or as
a hedge fund (serbest fon) under the mutual funds regulations of the CMB. A mutual fund
structure will enjoy a more flexible tax structure. All of the agencies mentioned below
have a qualified investor status and hence can join mutual funds.
5.9.Evaluation
The regular evaluations of FONFON should assess if FONFON is working well towards
achieving is mission of developing a self-sustainable Turkish venture capital industry in

41. 37
10 years. Given short-termism is prevalent in Turkey62, it is critical to acknowledge and
also create public awareness about the fact that development of VC industry takes time,
so it is crucial to avoid short-termism.
Table 4. Targets of3-year cycles and questions for evaluations
Target VC funds Capital supply Industry
3rd
year Establishment of 5-10
FONFON funds
How many FONFON /
non-FONFON funds are
established? How many
are branches of
international funds?
How many local
institutionalinvestors
invested in VC funds? In
what amounts?
What is the VC
investment / GDP ratio?
Is TurkVCA active?
What is the level of
awareness about VC
among entrepreneurs?
6rd year Exercise of the
options by the
successful funds
How many FONFON /
non-FONFON funds are
established?
How many are branches
of international funds?
To what extent the
FONFON options were
exercised?
Are there second fund-
raising?
How many exits?
How many local
institutionalinvestors
invested in VC funds? In
what amounts?
What is the VC
investment / GDP ratio?
Is TurkVCA a successful
lobbying organization?
What is the level of
awareness about VC
among entrepreneurs?
Is there reliable data on
the performance of
investee firms?
9th
year Administration of the
remaining funds
To what extent the
FONFON options were
exercised?
Is there entry without
FONFON support?
Are there second fund-
raising?
How many exits?
How many local
institutionalinvestors
invested in VC funds? In
what amounts?
What is the VC
investment / GDP ratio?
Is there need for a
second fund of funds?
Are there specific
industries that should be
targeted with FONFON
II?
Source: author’s analysis
Given the long-run nature of the target, evaluations should be done in three-year cycles.
FONFON should formulate 3-year and 1-year action plans along with the results of these
evaluations. The action plans will be approved by the advisory committee. The advisory
committee will also have power to change the regulations that govern FONFON in order
to achieve the targets more efficiently. FONFON administration will present its
performance to the advisory committee and the general public with annual reports. At the
end of the third cycle, the advisory committee will also advise the government about a
62 This point was emphasized by many interviewees, particularly by Jose Romano

42. 38
decision to establish a second fund of funds, FONFON II, and its possible size. This
second fund of funds may particularly target sectors that has potential, but has not
attracted enough VC investment so far. Table 4 provides targets for the consecutive
cycles of reviews together with a set of questions to be investigated concerning different
aspects of the program.
The evaluation should mainly be concerned with the self-sustaining VC industry.
There are difficulties in making this assessment quantitatively because it is hard to find a
benchmark. However, investigating evolution of different stages of VC investment / GDP
can be useful. Quantitative assessment may also involve comparison of the performance
of FONFON funds with non-FONFON funds. The difficulty in this assessment is that
there may not be enough number of non-FONFON funds to make this comparison,
especially in the first 3-year cycle. The non-random selection of FONFON funds may
also complicate the comparison.
Another component of evaluations will involve the performance of the investee firms.
This is not directly related to FONFON’s mission, but the insights might point other
shortcomings in the evolution of the innovation eco-system. FONFON will utilize this
information set to advise for reforms and interventions in other areas. When evaluation
the performance of investee firms, a comparison can be made with the investee firms who
were just above the decision threshold and just below. Another strategy is comparing the
performance of investee firms of FONFON funds with the performance of the investee
firms of the non-FONFON funds. A shortcoming of this approach is the non-random
nature of FONFON fund selection. In addition, both approaches may have problems of
data-gathering from non-investee firms and investee firms of non-FONFON funds63.
5.10. European Union State Aid Regime
FONFON should be in line with the European Union (EU) state aids rules, because
Turkey has committed to these rules with the Customs Union agreement in 1995. No
institutional structure to assure this commitment has been put into place yet, however it is
63 Some of these suggestions about evaluations are based on Lerner (2009, p. 142-152)

43. 39
crucial to take these rules into account, because an institutional convergence to the EU is
likely to take place in the lifetime of FONFON.
The EU Commission has so far had a lenient approach to state aids to foster VC activity.
Community Risk Capital Guidelines provide a framework for the evaluation of these
support programs by the Commission. If the investment decisions are taken under a
commercial logic and equity investments are used to finance areas where market failures
exist, the guidelines provide a safe heaven for public investments below 1.5 million euros
per year, and procedures that are lighter than those of the regular investigations for
investments over this amount64. The Enterprise Investment Scheme of the UK, which has
similar characteristics to FONFON has recently got an exemption from the Commission
under these Guidelines65.
The state support provided to most of the investments by the FONFON funds will be in
the safe harbor. The amount of state support in the largest likely investment presented in
Section 5.3 is 2 million USD (40% of 5 million USD) – an amount slightly above the
threshold in the current exchange rate. The fact that the equity investment is provided for
multiple years makes the annual potion even lower.
64 Guidelines numbered: 2006/C 194/02
65 Commission decisions numbered: NN 42a/2007 and NN42b/2007

44. 40
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46. 42
APPENDIX I
List of Inverviewees
Interviewee Institution Date City
Aksel Sahin TURKVEN January 15, 2010 Istanbul
Asli Kurul Endavour Turkey December 17, 2009 Istanbul
Cem Sertoglu Golden Horn December 30, 2009 Istanbul
Gamze Cizreli CEO, Bigchefs December 24, 2009 Ankara
Gil Avnimelech Faculty member, Ono Academic
College
January 8, 2010 Tel-Aviv
Haluk Zontul CEO, Teknoloji Yatirim A.S. December 29, 2009 Istanbul
Jose Romano EIF, iVCi January 14, 2010 Athens
Mete Cakmakci Secretary-General,TTGV December 22, 2009 Ankara
Altan Kucukcinar TTGV December 22, 2009 Ankara
Murat Ozgen CEO, Is Yatirim December 29, 2009 Istanbul
Ogeday Karahan Partner,Eurasia Partners December 30, 2009 Istanbul
Orna Berry Venture Partner,Gemini Funds,
former chief scientist of Israel
January 4, 2010 Tel-Aviv
Selin Ozkan Garanti Yatirim December 18, 2009 Istanbul
Suleyman Yildiz CEO, KOBI A.S. December 23, 2009 Ankara
Tacettin Ileri Principal, Makimsan (an investee
firm of KOBI A.S.
December 24, 2009 Ankara
Tuna Sahin Vice-chairman, KOSGEB January 21, 2010 Ankara
Yener Yildirim Turkiye AraciKuruluslar Birligi December 30, 2009 Istanbul
Yigal Erlich Founder and CEO of YOZMA January 7, 2010 Tel-Aviv
Yilmaz Arguden Turkey Representative, Rotchild December 18, 2009 Istanbul
Ziya boyacigiller angel investor December 29, 2009 Istanbul
Clemente del Velle head of Securities Markets Unit,
IFC/World Bank
January 24, 2010 Washington D.C.
References to interviews reflect the views of the interviewees and not necessarily the institutions they are
affiliated to.

47. 43
APPENDIX II
The programs for Turkish government targeted in various parts of innovation
ecosystem
Area Name Agency Type
R&D SANTEZ Ministry of Industry
and Trade
Grant
R&D TEKNOGISM, ISBAB TUBITAK Grant
Incubators TEKMER, IGEM KOSGEB Service
Incubators Technology Development
Zones
Ministry of Industry
and Trade
Tax exemption, credit
for construction
Seed capital Incentives for Start-ups KOSGEB Seed capital up to 10k
euros
Investment
support
Investment allowances Treasury Grant up to 40% of
fixed investment value
Credit support Subsidy to interest
payments from public
banks
KOSGEB Grant
Credit support Credit guarantees Credit guarantee Fund
(KGF)
Guarantee
Entrepreneurship
training
KOSGEB Centre for
Entrepreneurship,
university
entrepreneurship center
KOSGEB, universities Service
Networking TOBB entrepreneur
networks, Istanbul Fashion
and Textile Cluster,
KOBINET
TOBB,ITKIB,
KOSGEB, Endavor
Service
Source: Author’s analysis