Introduction

A vital preliminary step in a typical business merger or acquisition (M&A) transaction is for the buyer and seller of a business to sign a term sheet. Although generally non-binding, term sheets are a critical transaction feature and can influence the entire progress of the deal, lock-in value, and are often difficult to row back on.

This article provides an overview of the fundamentals of a term sheet in an M&A transaction and why obtaining specialist legal and financial advice ahead of the term sheet stage is money well spent.

What is a Term Sheet?

A term sheet is a largely non-binding and short-form document that outlines the key terms and conditions of a potential agreement between a prospective buyer and seller of a business. It is typically used in M&A transactions in the early stages of a deal and serves as a roadmap for drafting the final, legally binding documents.  A term sheet is an indication of the parties commitment to pursuing the deal on mutually acceptable terms, subject to detailed due diligence investigations and documentation.

You may also come across terminology such as letters of intent, non-binding indicative offers, heads of agreement, and memorandums of understanding – don’t be bamboozled, these are all essentially the same as term sheets. 

Why are Term Sheets Important?

The content of term sheets can dictate the future course of the transaction and serve as a blueprint for the deal. They provide a framework that summarises the key deal points, focuses the next steps, and guides further detailed negotiations, ensuring a more efficient, transparent, and structured deal process.

Once committed to writing, and despite the agreed commercial terms not creating binding legal obligations, a term sheet can be somewhat difficult to renege on without risking the deal and goodwill between the parties. That is, rashly entering into a term sheet may lead to the need for subsequent renegotiations which could kill the opportunity and potentially result in reputational risk. For this reason, specialist legal and financial advice at the term sheet stage is crucial to a successful outcome. 

Another critical function of a term sheet is a meeting of minds in terms of price and locking in the value of the transaction to validate the plausibility of a deal. By specifying the purchase price or valuation method upfront, the term sheet reduces uncertainty and sets clear expectations, thereby minimising the risk of last-minute renegotiations and derailment.  

The dark side to this, is that, without specialist advice, tax, structuring, or de-risking, advantages and/or protections may not be known or implemented, and can present significant downside. You don’t know what you don’t know. It is therefore critical to ensure that the provisions of a term sheet are appropriate, that adequate protections are in place, and that value isn’t inadvertently lost through a disparity of advice or transaction experience between the buyer and seller.

This all usually translates to meaningful reductions in time and professional fees as the deal proceeds more constructively and smoothly.  

Non-binding (mostly)

Term sheets are mostly non-binding except in relation to confidentiality and exclusivity. By granting the buyer a binding period of exclusivity in relation to the deal, a term sheet gives the buyer comfort and confidence to commit often significant internal and external time and resource to progressing the transaction to more intensive due diligence and definitive legal documents. 

Concepts such as non-refundable deposits or break fees can also be included as binding aspects of a term sheet to add some rigour and focus to proceedings, and as a reimbursement mechanism if a party elects to ‘back out’ down the track. 

Key Elements

A term sheet typically includes:

• Purchase price or valuation methodology;
• Structure of the transaction (e.g., asset purchase vs. share purchase);
• Payment terms (e.g., cash, stock, earnouts, vendor finance);
• Security for payment (e.g. guarantor, stock, warranty and indemnity insurance);
• Completion mechanism (completion accounts or locked box – see here);
• Key conditions for closing;
• Timelines;
• Expectations around representations and warranties; and
• Confidentiality, exclusivity, and due diligence terms.

As above, while a term sheet is usually and predominantly non-binding, it helps to ensure both sides are aligned on the deal's fundamental aspects before committing significant time, resource, and legal and financial horsepower (and fees) to its progression. Term sheets reduce the scope for misunderstandings and provide a clear foundation for moving forward and ultimately, closing the deal.

Summary

Finally, a well-crafted term sheet with specialist legal and financial input, can result in a far superior and more valuable deal for buyer or seller. It can prevent misunderstandings, reduce negotiation time, provide a clear indication of the transaction’s feasibility early on, and reduce professional fees accordingly. By establishing key deal points and managing expectations, term sheets facilitate smoother negotiations and contribute to a more efficient and successful M&A process.

Our Dentons New Zealand Corporate and Commercial Team regularly advises clients on M&A transactions from both buy and sell side. For further information on or assistance with an M&A transaction or any other Corporate and Commercial advice, please get in touch with the Dentons contacts listed here or your usual contact at Dentons.