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If you are looking to buy a new business or looking for potential investors, it can be useful to outline the key terms of an agreement in a term sheet. This is a brief document you draw up before you sign a binding legal contract. It can be useful for navigating any business transaction, because it sets out the essential terms and conditions of your deal. This type of agreement can also provide a starting point for any negotiations, based on what you and the other party can agree to. It boils down to a few essential terms that you can expand on later. This article will explain:

  • the benefits of a term sheet;
  • if it is binding; and
  • what it may contain depending on what kind of transaction you are using it for.

Why Use a Term Sheet?

A term sheet can be useful when you are making a complex transaction, as it provides an opportunity for both parties to set out their intentions and decide on the essential terms of the agreement. It is also less intensive than other documents you create before the final contract, such as a Head of Agreement. This is because its structure is less formal and you set out the basic terms in bullet points or as a schedule. This means that there is more clarity for you and the other party.

By having a term sheet, this reduces the time spent in the formal contract drafting process. The less time you have to spend with legal counsel sorting and organising documents for a final contract, the less money you may have to spend on the whole process.

Is a Term Sheet Binding?

A term sheet is generally a non-binding agreement. This means that you are not legally required to fulfil the agreed terms. It serves as a preliminary document to clarify the basic terms between you and the other party. 

But, there are some situations where certain parts of the agreement may be binding. For example, confidentiality clauses will be binding if they apply in your transaction.

What Is in a Term Sheet?

The contents of a term sheet can vary, but generally would include: 

  • what you are offering;
  • what you expect from the other party;
  • which assets are you are exchanging; and
  • the purchase price, and what may affect it.

Your agreement should cover what is needed to spearhead any future negotiations, and lay down the groundwork for the final contract.

When Should I Use a Term Sheet?

Here are two possible scenarios where you may use one.

Venture Capital for your Startup

If you are a small startup wanting to gain investors for your company, a term sheet is a vital part of that investment process, because: 

  • it shows investors the exact details of your company; 
  • how you intend to grow in the future; and 
  • how you operate as a business.

Usually, you would negotiate a term sheet with your lead investor, and if they agree, you would also use it after pitching to any other investors as well. This document will show them what you offer as a startup and how they will benefit as a potential investor. This is a good in-between point before signing a binding contract and allows parties to negotiate and agree on what they think are essential terms to their commercial relationship. This may include:

  • your company’s valuation;
  • the type of shares you are offering; 
  • the voting rights attached to those shares;
  • liquidation preferences; and
  • financial milestones to be met by your company.

Sale of a Business

The sale or purchase of a business is another complex transaction where you may find a term sheet beneficial. There can be a lot of moving parts to the sale, and having a written agreement that outlines these parts can make the process less intensive and more clear. It also shows what decisions you need to make before you reach a final agreement and sign the purchase agreement.

If you are aiming to buy a business, you can use a term sheet as an offer of interest before you complete the due diligence period. This means that you have expressed interest in the business, but it gives you a chance to do your research and investigate before you make any final decisions. After the due diligence period has passed, you can walk away from the transaction or negotiate the terms of the agreement as you see fit.

Key Takeaways

A term sheet is a document you create before you draw up a legal contract with whoever you want to sell to or buy from, that lays out the essential terms of what both parties agree on. It can be useful for clarifying both of your intentions and lay down the groundwork for future contracts. If you would like any more information or need help with drafting a term sheet, contact LegalVision’s contract lawyers on 0800 005 570, or fill out the form on this page.

FAQs

What is a Term Sheet?

A term sheet is a document you draw up that lays out the essential terms of your transaction. You use it before you sign a legally binding contract.

Why do I need a Term Sheet?

It can be useful to have a written form of what you and the other party have agreed on, as this can speed up the negotiation process. It also clearly sets out what both parties expect from the transaction and that can make the whole process much easier.

What is in a Term Sheet?

In a term sheet, you should outline what each party is offering, and what you expect to get out of this deal. This means what you are exchanging, whether that be assets or capital, and what you are paying for those assets.

Is a Term Sheet binding?

Not necessarily, but in some situations, it can. Namely, if there are clauses about confidentiality and you agree to abide by them. That means you are bound to keep your business dealings in this transaction confidential.

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