Term Sheets

Term sheets are a vital part of many business negotiations. This is especially true when selling or buying a company, whether the transaction is for assets or stock, or any kind of equity funding (angel finance, venture capital, strategic partners, etc.). However, I see many situations where term sheets are badly done, or skipped over entirely, and with unhappy results, so I thought I would describe a few basic guidelines and principals of term sheets:

1. Document Basic Terms. Probably the most frequent mistake I see is businesses that skip ahead to drafting lengthy definitive documents such as an asset purchase agreement or stock purchase agreement and not “bother” with a term sheet. They may do this in an effort to be efficient, but it inevitably causes problems at a later stage. Parties on opposite sides of the table often walk away from a negotiating session with different impressions regarding what (if anything!) was agreed to. A term sheet is a vital way to ensure that the parties in fact have a meeting of the minds. When the parties jump into the drafting of complex legal documents without carefully agreeing in moderate detail on key aspects of the deal, there may be angry accusations or worse when someone discovers details in the documents that are contrary to what he or she thought had been agreed upon. Even where there is no such breakdown, the term sheet is invaluable in expediting the drafting of final
2. Understand and State What Is Binding. Most aspects of a term sheet such as the amount of investment or the purchase price are typically non-binding. However, a term sheet usually also includes binding provisions; examples include confidentiality, no-shop restrictions, jurisdiction, and governing law. Term sheets that are drafted without the assistance of outside professionals often do not clearly differentiate between what is binding and what is not. This failure can have disastrous consequences. As one example, potential buyers of a company that walk away from a transaction are often later sued – sometimes successfully! – by the selling company, which claims that the term sheet was a binding
3. Involve Outside Experts. The failure to distinguish between binding and nonbinding provisions is one of the many drawbacks of not involving outside professionals in the term sheet process. A good business attorney will draw clear distinctions between what is and what is not binding and include “magic language” to reinforce the non-binding nature of the majority of the terms. Equally importantly, an attorney will be instrumental in identifying all of the key terms that need to be in the term sheet. For example, we have seen M&A transactions fall apart at the last minute because the parties did not agree at an early stage regarding the duration of the non-compete that the buyers required from the selling shareholders. There are numerous other situations where transactions are cancelled or significantly delayed because of disagreement over items that should have been included in the term

There are many other nuances to term sheets beyond what is discussed here, and each term sheet has its own unique considerations. But as a final comment and key take-away, I will just say that term sheets are not an area where you want to “wing it” – it’s important to get help and to do them correctly.