Whether you’re an entrepreneur looking to sell your company or an investor aiming to acquire a business, understanding term sheets is essential. A term sheet is a non-binding document that outlines the key terms and conditions of a proposed business deal. It serves as a blueprint for the more detailed, legally binding agreements that will follow.
Note: Although term sheets are typically referred to as non-binding (I even did so in the paragraph above), some clauses in the term sheet may create legal obligations, so be sure you understand where those obligations may arise. This is often where transaction-based law comes in.
Term sheets are crucial in setting expectations and aligning both parties on the fundamental aspects of the transaction before investing significant time and resources into due diligence and negotiations. They help identify potential deal-breakers early on and provide a framework for further discussions.
Key elements typically found in a term sheet include:
- Valuation and Purchase Price: This section outlines the agreed-upon value of the business and how the purchase price will be determined. It may include details on whether the price is fixed or subject to adjustments based on financial performance or due diligence findings.
- Deal Structure: Will it be an asset sale (where specific assets of the business are transferred) or a stock sale (where ownership of the entire company changes hands)? Each structure has different implications and levels of complexity. This also may affect whether the buyer is assuming the company’s liabilities, or if they are remaining with the seller.
- Payment Terms: This details how and when the purchase price will be paid. It could involve upfront cash, deferred payments, earn-outs (additional future payments based on the business’s performance), or a combination of these.
- Financing: If the buyer is seeking financing, the term sheet may outline the expected sources of funds and any contingencies related to securing that financing.
- Due Diligence: This section typically specifies the scope and duration of the due diligence process, during which the buyer will investigate various aspects of the business.
- Exclusivity: Often, buyers will request an exclusivity period (also known as a “no-shop” clause) during which the seller agrees not to entertain other offers. The duration of this period should be carefully considered by both parties.
- Conditions to Closing: These are the requirements that must be met before the deal can be finalized. They might include obtaining necessary approvals, key employee retention, or reaching certain financial targets.
- Representations and Warranties: While the specifics are usually left for the final agreement, the term sheet may outline key representations and warranties expected from each party.
- Indemnification: This section provides a high-level overview of how potential future claims or liabilities will be handled post-transaction.
- Confidentiality: Terms regarding the non-disclosure of sensitive information exchanged during the process are typically included.
- Employee Matters: This might cover retention of key employees, treatment of stock options, or any planned changes to the organizational structure.
- Governing Law: Specifies which state’s laws will govern the interpretation of the agreement.
For sellers, it’s crucial to strike a balance between providing enough detail to move the process forward and maintaining flexibility for negotiations. Be cautious about granting long exclusivity periods or agreeing to onerous terms that might hinder your ability to explore other options.
For buyers, the term sheet is an opportunity to clearly articulate your vision for the deal and set the stage for a smooth transaction. However, be prepared for pushback on terms that might be perceived as too buyer-friendly.
Remember, while a term sheet is mostly non-binding (except for certain clauses like confidentiality and exclusivity), it sets the tone for the entire transaction. Approach it with care and consider seeking transaction-based legal advice to ensure your interests are protected.
Whether you’re buying or selling, a well-crafted term sheet can save time, reduce misunderstandings, and pave the way for a successful transaction. If you have questions about term sheets or need assistance in negotiating one, don’t hesitate to reach out for guidance.
