You just received an offer. Maybe you are looking to sell your business, buy a business, or bring an investor into your business. Exciting, right? Before you pop the champagne or prosecco, there is an important document that could shape the deal: the term sheet.
The term sheet plays a pivotal role in modern business transactions. It is often the first formal document exchanged between parties, setting the stage for negotiations and shaping the final agreement. While typically non-binding, a well-crafted term sheet can streamline deal-making, clarify expectations, and mitigate future disputes.
A term sheet is a short, structured document that outlines the key terms and conditions of a proposed business transaction. It is typically the first formal step in deal-making and is used to negotiate and establish the principal terms of the transaction.
The primary purpose of a term sheet is to guide negotiations (one party can present a term sheet to start the negotiation process) and, once an agreement is made on the principal terms, it documents the understanding and agreement of the parties on the principal terms. This helps parties identify areas of agreement and potential friction early in the process and avoid spending months of time and resources on a transaction that will not close.
In addition to facilitating negotiation, term sheets can signal serious intent to proceed with a transaction already underway, provide a basis for due diligence, help secure internal approvals or financing, and serve as a reference point for future amendments or disputes.
While the specific contents of a term sheet vary depending on the nature of the transaction, most include the following core elements:
Transaction Structure. This outlines the type of deal being proposed—whether it is an equity investment, loan, asset purchase, share purchase, merger, partnership, or joint venture. For example, in a startup financing round, the structure might be a convertible note or a SAFE (Simple Agreement for Future Equity). In an acquisition, it could be a share purchase versus an asset purchase, each with different tax and legal implications.
Valuation and Pricing. This section specifies how the business is valued and what the buyer or investor is paying. In venture capital, this might include pre-money and post-money valuation. In acquisitions, it could detail the purchase price and any earn-out provisions. For example, a startup might be valued at $10 million pre-money, with a $2 million investment resulting in a 20% ownership stake.
Capitalization and Ownership. This includes the current and projected ownership structure, share classes, and dilution effects. It helps investors understand their stake and voting power. For instance, a term sheet might show that after the investment, the founder retains 60% ownership, while investors hold 40%, with specific rights attached to preferred shares.
Governance and Control Rights. This defines how decisions are made and who has control. It may include board composition, voting thresholds, veto rights, and information rights. For example, an investor may require a board seat and veto power over major decisions like issuing new shares or selling the company.
Liquidation Preferences. This determines who gets paid first and how much in the event of a sale or liquidation. A common clause might state that preferred shareholders receive their investment back before common shareholders receive anything. For example, a 1x non-participating liquidation preference means the investor gets their money back, but no more.
Anti-Dilution Protections. These clauses protect investors from dilution if the company raises money at a lower valuation in the future. A typical example is weighted average anti-dilution, which adjusts the conversion price of preferred shares to mitigate the impact of a down round.
Exclusivity and Confidentiality. These are binding clauses that prevent the parties from negotiating with others or disclosing deal terms. Exclusivity might last 30 to 60 days, giving the investor time to conduct due diligence. Confidentiality ensures sensitive information is not shared publicly or with competitors.
Conditions to Closing. These are the requirements that must be met before the deal is finalized. They may include regulatory approvals, satisfactory due diligence, third-party consents, or financing conditions. For example, a deal might be contingent on approval from the Competition Bureau or securing bank financing.
Timelines and Milestones. This sets expectations for when key steps will occur, such as signing the definitive agreement, closing the transaction, or hitting performance targets. For instance, the term sheet might specify that closing will occur within 60 days of signing, with milestones for revenue growth or product launch.
Legal Disclaimers. This clarifies which parts of the term sheet are binding and which are not. Typically, business terms like valuation are non-binding, while clauses on confidentiality and exclusivity are binding. This helps avoid misunderstandings and potential legal disputes.
Term sheets are used in a wide range of business contexts, including:
Venture Capital and Private Equity. Investors use term sheets to outline the terms of their investment in startups or growth-stage companies. For example, a VC firm may issue a term sheet offering $5 million for a 20% equity stake, subject to board representation and liquidation preferences.
Mergers and Acquisitions. Buyers and sellers use term sheets (or letters of intent) to agree on deal structure, price, and closing conditions before conducting due diligence. For instance, a strategic acquirer may propose a term sheet to purchase a competitor’s assets for $50 million, contingent on regulatory approval.
Partnerships, Joint Ventures, and Strategic Alliances. Companies entering into collaborative arrangements often use term sheets to define roles, contributions, and profit-sharing mechanisms.
Real Estate and Commercial Transactions. Term sheets are common in lease negotiations, property acquisitions, and financing arrangements.
From a legal perspective, term sheets must strike a balance between clarity and flexibility. Key considerations include:
Binding vs. Non-Binding Language. Clearly delineate which provisions are intended to be binding. Confidentiality is typically binding, as may be exclusivity (requiring the parties to only negotiate with one another for a set period of time). Valuation and most other terms typically are not binding. Ambiguity in a commercial transaction can end up risking delays, increased costs, and even litigation.
Good Faith Negotiations. Courts may impose a duty to negotiate in good faith once a term sheet is signed, especially if it reflects substantial agreement on material terms.
Regulatory and Third-Party Issues. In M&A transactions, term sheets should anticipate regulatory approvals and other potential issues, including consents from third parties to the transaction.
Timing is critical. Entrepreneurs should consider negotiating a term sheet:
Once Serious Interest Is Expressed. Once an investor, acquirer, or strategic partner has shown genuine interest—through meetings, preliminary discussions, or informal offers—it is time to formalize the conversation. A term sheet helps move from exploratory talks to structured negotiation.
Example: A venture capital firm has reviewed your pitch deck and requested financials. This is a good moment to propose a term sheet to define investment terms before deeper engagement.
Before Due Diligence Begins. Due diligence can be time-consuming and invasive. A term sheet sets expectations and protects sensitive information before you open your books. It also helps ensure that both parties are aligned on key deal terms before investing resources.
Tip to consider: Include confidentiality provisions in the term sheet to safeguard proprietary data during due diligence.
When Multiple Offers Are on the Table. If you are fortunate enough to have competing offers, term sheets allow you to compare them side-by-side. This can help you negotiate better terms and create leverage.
Example: Two investors offer similar valuations, but one provides more favorable governance rights. A term sheet helps you evaluate and negotiate strategically.
Before Committing to Any Binding Terms. Some provisions, such as exclusivity or no-shop clauses, can restrict your ability to negotiate with others. These are often binding even in a non-binding term sheet. Never agree to such terms without legal review and carefully considering your options.
Tip to consider: Signing an exclusivity clause too early can limit your options and reduce negotiating power.
When You Need Internal or External Approvals. A term sheet can help secure board approval, attract co-investors, or satisfy lender requirements. It shows that the deal is progressing and provides a framework for decision-making.
Example: Your board may require a signed term sheet before approving a financing round or acquisition.
To Align Expectations Early. Even if the deal does not close, a term sheet helps uncover misalignments early—on valuation, control, or exit strategy. This can save time, money, and frustration.
Tip to consider: Use the term sheet to surface deal-breakers before drafting definitive agreements.
Negotiating a term sheet is both an art and a strategic exercise. While it may seem like a preliminary step, the terms you agree to here can shape the entire trajectory of your deal and your business.
When approaching term sheets, here are some tips to consider:
Know What Matters Most. Before entering into negotiations, identify your non-negotiables. Is it valuation? Board control? Liquidation preferences? Understanding your priorities helps you focus on what truly matters and avoid getting sidetracked by less critical terms. It is helpful if you create a ranked list of deal terms based on impact to your business and long-term goals in advance.
Identify What Leverage You Hold. Your ability to negotiate depends on your leverage, which may come from having multiple offers, strong growth metrics, or a unique product. Use this leverage to push for better terms but do so respectfully and strategically.
Do Not Fixate on Valuation Alone. Valuation is important, but control provisions (like board composition and voting rights) can be just as impactful. A high valuation with restrictive control terms may limit your ability to lead your company effectively.
Ask for Clarification and Context. If a term is unfamiliar or vague, ask for clarification. If the other party cannot explain why a term is needed or what it is designed to accomplish, remove that term.
Negotiate Binding Provisions Carefully. Even in a non-binding term sheet, certain clauses (like exclusivity or confidentiality) are typically binding terms in term sheets. Do not agree to binding terms without legal advice, especially if you are still exploring other offers or opportunities.
Keep the Tone Collaborative. Negotiation is not a battle. Ideally, it should be a conversation that leads to all sides winning, in one form or another. Aim to build trust and alignment with the other party. A collaborative tone can lead to better outcomes and smoother deal execution.
Note the Behaviour of the Other Party. Is the other party pushing you hard to accept their terms? Why are they asking for a certain term or specific wording? What are their interests and pain points in the transaction? Do they get angry if you ask for changes or when you raise an issue or concern? The term sheet is typically less complex than the final, definitive agreements in a business transaction, so if it is difficult to work with the other party now, it will be worse when the deal is closer to closing.
Do Not Be Afraid to Walk Away. You should be prepared to walk away until you finalize all of the terms and conditions that you need. If you are too eager to close, you may accept terms you should not. You should never count your money while you are negotiating your term sheet. If you convince yourself that the deal has to get done with the persons you are negotiating with, you are setting yourself up to accept terms that perhaps you should not. Do not be afraid to pause the negotiations or walk away.
Work with a Lawyer. It is difficult to renegotiate terms once they are agreed and documented in a term sheet. Rather than involving a lawyer after terms are finalized, engage a lawyer and work with your lawyer to identify risks and opportunities, and negotiate a term sheet that helps you reach your goals and minimize your risks.
Term sheets are more than preliminary documents. They are strategic tools that shape the trajectory of business transactions. For clients, understanding their legal and economic implications is essential. For lawyers, drafting term sheets with precision and foresight is a critical service that can protect client interests and facilitate successful deals.
Disclaimer. This information is general and may not apply to your specific situation. Always consult a qualified corporate/tax advisor before making business decisions.
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