What is a Term Sheet, and can it be considered as an offer?

A Term Sheet is a document that arises from negotiations between the investor and the startup’s founder. This document sets out the key elements of the main investment agreement. It includes the amount of financial resources, the stake that the investor will receive, the method of investment, and other terms, rights, and obligations.

According to Article 24, paragraph 1 of the Law on Obligations, it states: “An offer is a proposal to conclude a contract made to a specific person which contains all the essential components of the contract.”

Additionally, according to Article 28, paragraph 1 of the same law: “The offeror is bound by the offer unless he has excluded his obligation to maintain the offer, or if such exclusion arises from the circumstances of the work.”

Therefore, if we identify this document in our legislation, it would represent an “Investment Offer.” The offer is subject to the exclusion of the obligation to maintain that offer, meaning even if the exclusion arises from the circumstances of the work (for example, if the necessary funds are not raised in the projected investment round).

For example:

The startup company X aims to raise €50,000 for 10% of its company in the initial phase. The funds are being gathered from multiple private investors. During several months of negotiations with different private investors, the startup company receives several Term Sheets (non-binding offers) from different investors who want to invest a total of €36,000. If the startup company fails to find an additional €14,000, it means that the conditions for the investment are not met, and the funding round fails.

Is a Term Sheet a mandatory document for every investment?

Usually, when a startup company receives funding from one or several investors acting together, such a document is not necessary. The reason is that if the parties agree on the essential elements, they proceed directly to the signing of the main Investment Agreement.

This document is not mandatory but is used and recommended when dealing with multiple different and independent investors.

AI pic. generated with open art

What is an Investment Agreement?

An Investment Agreement is a fundamental and key document that governs the legal relationship between the investor and the startup company. This agreement defines all the important elements and conditions under which the investment will take place. It contains the agreed-upon obligations and rights of both parties, the method of investment of the funds, and the management of the acquired stake in the company.

Key elements of the Investment Agreement:

Investment amount: The precise amount that the investor will invest in the startup and the conditions under which that investment will be made are established.

Method of acquiring equity: The investor receives a stake in the company, which is determined based on the estimated value of the startup (pre-money/post-money valuation). The equity can be acquired immediately by making a new contribution and increasing the share capital or as a loan that under certain conditions is converted into equity.

Rights and obligations: The rights of the investor and the founders are established, including voting rights, participation in management, and restrictions on the transfer of equity (tag along/drag along, pre-emptive rights). For more details on these rights, refer to the brochure “My First Investor.”

Shares vesting for founders: This mechanism determines how long the founders must stay with the company to fully acquire their equity. It ensures that the founders remain committed to the company’s development. However, in our case, this mechanism is not possible because the shares are fully acquired at the time of making the contribution, upon the company’s establishment. Instead, a contractual clause—reverse vesting—can be used. This clause obliges the founders to remain with the company for a certain period, and if they fail to meet this obligation, they agree to transfer their equity or a portion of it back to the company, without compensation.

Participation in future funding rounds: These provisions determine the same or more favorable conditions for initial investors who would invest in subsequent stages.

Meaning of the Investment Agreement and whether it is registered in the Central Registry?

The Investment Agreement not only regulates the relationship between the startup and the investor but also plays an important role in the long-term management of the company. It serves as a foundation for future development phases, new investments, and potential exits from the company.

In the Law on Trade Companies or the Law on the One-Stop Shop System and the Management of the Commercial Registry and Registry of Other Legal Entities, there is no provision for the registration of this Agreement in the Central Registry. This means that the Investment Agreement is kept in the company’s archive.

img by mindandi on freepik

Pre-money / post-money valuation (company valuation before and after investment)

The valuation of a company is one of the most important aspects when determining the conditions for investment in a startup. Pre-money and post-money valuation are two key terms that denote this value before and after the investment.

Pre-money valuation (Value before investment)

Pre-money valuation represents the estimated value of the startup company before the new investment is made. It is important to note that there are various methodologies for determining a company’s value. However, in the early stages of development and during the first investments, this value is often determined “arbitrarily” by the founders themselves. For example, if the founders arbitrarily set the company’s value as a pre-money valuation of €500,000 and the investor invests €100,000, then the estimated value of the startup before the investment is €500,000.

Post-money valuation (Value after investment)

Post-money valuation, on the other hand, represents the value of the company once the new investment is taken into account. It is the total value of the company after the investment, including both the pre-money value and the new funds invested. In the same example, if the startup has a pre-money valuation of €500,000 and the investor invests €100,000, then the post-money valuation will be €600,000.

Example of share calculation:

Pre-money valuation: €500,000
Investment amount: €100,000
Post-money valuation: €600,000

In this case, the investor will receive a stake in the company calculated as part of the post-money valuation:

Percentage of stake = (Investment amount / Post-money valuation) × 100
Percentage of stake = (€100,000 / €600,000) × 100 = 16.67%

Thus, the investor will receive 16.67% of the company, while the remaining 83.33% stays with the existing founders of the startup.

Meaning of Pre-money and Post-money Valuation

These values are crucial in negotiations between investors and startup companies. The pre-money valuation determines the initial position of the startup, while the post-money valuation determines the final ownership structure after the investment. Founders typically strive for a higher pre-money valuation to retain a larger share of ownership, while investors seek a fair value that will provide them with an appropriate stake for their investment.

Value in relation to contributions?

According to Article 193, paragraph 1 of the Law on Trade Companies: “The share of the partner is determined according to the size of the contribution made by the partner, unless otherwise stipulated by the partnership agreement.”

This article allows founders and investors to contractually determine their shares. This means that even though the investor’s contribution is €100,000 and the founders’ contribution is €5,000, with a total capital of €105,000, the investor can contractually receive a 16.67% stake while the founders receive 83.33%. Since the company’s value is different from the contributions and that same value is not subject to registration in the Central Registry, but rather arbitrarily determined by the founders, the negotiation process is very important. By securing such an investment, the arbitrary value gains a sort of “confirmation” from the investor as a real value.

Cap Table (capitalization table), known locally as the book of shares

The Cap Table is an important document that outlines the ownership structure of a startup company. This document provides a detailed overview of all partners in the company, their stakes, and how capital is distributed among them. The Cap Table is particularly significant for startups as it offers a clear view of who has control within the company and the value of each partner’s shares at different stages of funding.

Locally, according to the Law on Trade Companies (ЗТД), this document is defined as a book of shares.

In Article 195, paragraph 1 of the ZTD, it is specified that: “The manager of the company is responsible for maintaining the book of shares in which, after the registration of the establishment of the company in the commercial register, data for each partner is entered, including:

• Name and surname,
• Unique identification number (ЕМБГ),
• Passport number or identity card number if the partner is a foreign individual, or another valid identification document in their country, and their nationality, as well as their place of residence, or
• The name, registered office, and unique business identification number (ЕМБС) if the partner is a legal entity,
• The date on which they became a partner,
• The amount of the contribution made by the partner and what has been paid or committed to be paid based on that,
• The method and timing of payments, additional contributions made,
• A description and declaration of the agreed value of the non-cash contribution that has been made or is committed to be made in the future,
• All obligations that burden the share,
• The number of votes they have when making decisions as partners,
• As well as any special rights and obligations arising from the share.

Need for Legal Reform

The Macedonian startup ecosystem is significantly developing, with increasing access to financing and early-stage investments. However, this progress is accompanied by numerous legal and regulatory challenges.

The Law on Trade Companies was enacted over two decades ago and does not address the specifics of today’s startups and their financing needs. This situation necessitates a careful and innovative approach when drafting contracts, as well as excellent communication and understanding between founders and investors. Founders often need to be prepared to negotiate the terms of investment, especially concerning the company’s valuation and the distribution of shares. The negotiation process not only defines the rights and obligations of both parties but also impacts the long-term success of the company.

The absence of judicial practice in this area further complicates the situation, making it essential for investors and founders to carefully formulate their legal agreements. It is crucial to ensure that written contracts are clear and precise to avoid potential disputes in the future.

Therefore, initiatives for legal changes are of great importance, such as the initiative to introduce a new type of commercial entity—a variable capital company.

The future development of the startup ecosystem will greatly depend on the legal regulation’s ability to adapt to new challenges and the adoption of best international practices to create legal certainty and trust between investors and startups.

Note: This text represents informative content, derived from the applicable laws in Macedonia, along with the author’s personal opinion. The content should not be considered professional advice in any way or in any part.

SCHEDULE A MEETING WITH SOMEONE FROM OUR TEAM