Term Sheet: Everything You Need To Know

What is A Term Sheet?

A term sheet is a formal agreement signed during a pitch meeting or an initial commercial agreement regarding the proposed transaction. The term sheet, memorandum of understanding, or letter of intent all serve the same purpose by allowing the parties to a transaction to communicate their intentions through a written document that includes all of the key terms and conditions of the deal.

The terms of the term sheet, however, change depending on the transaction. Term sheets typically serve as a template for the execution of definitive agreements between the parties, making them non-binding agreements. However, one must consider the facts and circumstances of the situation in order to evaluate the nature of the term sheet, “whether binding or not binding.”

A term sheet is a document that outlines the key financial and other significant terms of a proposed transaction. These terms are subject to negotiation and certain preconditions, and they form the basis for the creation of final legal documents like a business transfer agreement, joint venture agreement, subscription agreement, etc.

The Objective of The Term Sheet

The term sheet’s goals are to detect potential problems with the proposed deal before spending time and money on due diligence and to determine rights and obligations with regard to the transaction before signing final contracts. A well-negotiated term sheet also tends to identify “deal-breakers” and reduce future disagreements.

The term sheet also establishes a deal’s expected growth, valuation, and risk mitigation measures. The term sheet acts as a blueprint for the paperwork that must be created when:

• Buying or selling a company.
• Buying or selling stock.
• Capital-raising rounds.

Who Publishes Term Sheets

• The terms and conditions of an investment, as well as the investor’s justification for participating in your business, are outlined in a term sheet.
• Term sheets can be issued by angel investors or private equity companies, but venture capital firms are more likely to issue them.
• Term sheets are more formal and extensive than other agreements like a legal agreement or a straightforward letter of intent.
• They include details on the amount you expect to raise, the conditions that must be met before the investment closes, and the number of shares that will be distributed to investors.
• They also provide details on the deadline for closing the investment as well as the rights of each party once it has been completed.

Term Sheets For Various Transactions

• Term sheet – PE/VC transactions

The purpose of PE and VC deals is to generate financial gains. PE Transactions are entered at a later stage in the company’s business cycle than VC Transactions, which are entered at the start up or early stages of the company. Both, however, demanded that the term sheet contain the same phrases. Terms like valuation, investment amount, anti-dilutive clauses, affirmative rights, liquidation, conversion rights, etc. are typically included in a PE/VC term sheet.

• Term sheet – M&A transaction

The goal of an M&A transaction is to benefit the company strategically and restructure. The information on the offered price, the method of payment, the assets and liabilities, the company specifics, and other standard terms will be included in the term sheet utilised in an M&A transaction.

Things to take into account when drafting a term sheet.

Here are a few things to think about when creating your term sheet:

• Consider the investor’s investment requirements
• What kinds of businesses do they usually finance?
• What kinds of investors is your business looking to partner with?
• Do you want a venture capital business that is in its very early stages or one that is more established.
• Does your business seek Series A or Series B financing?
• If yes, when should your term sheet be provided and what details should it contain?

What Should Be In The Term Sheet?

The term sheet has to include the following key phrases:

1. Security Offering Type
2. Valuation and Capitalization
3. Committee of Directors
4. Consent to Conversion
5. Anti-Dilution Measures
6. Exit/Liquidation Preference
7. Purchase Cost
8. Finance Amount
9. Electoral rights
10. Confidentiality

Conclusion

The target and the potential buyer sign a term sheet, which is a pre-contractual document that outlines the key terms of the proposed transaction but is largely non-binding in nature. In contrast, term sheets frequently include legally binding clauses relating to non-solicitation, exclusivity, confidentiality, etc.

A term sheet, which is created before signing final agreements, may also be referred to as a head of agreement or memorandum of understanding. As was already said, the parties to a transaction vigorously negotiate the terms of a term sheet. The format of a term sheet is typically in the form of a table or dot-point list for clarity.

It covers the crucial components of the transaction. In comparison to M&A term sheets, PE/VC term sheets are often smaller. When an investor decides to enter into a contract with a target company, the term sheet becomes relevant. The transaction’s first crucial stage is the creation of a term sheet. It contains every crucial and necessary element of the final agreement.

References

1. https://en.wikipedia.org/wiki/Term_sheet
2. https://www.forbes.com/sites/alejandrocremades/2018/07/07/term-sheet-here-is-everything-entrepreneurs-must-know-when-fundraising/?sh=32395c7943ef
3. https://blog.salesflare.com/term-sheet-guide
4. https://corporatefinanceinstitute.com/resources/templates/word-templates-transactions/term-sheet-guide/
5. https://www.toptal.com/finance/fundraising/common-term-sheet-mistakes-founders-make

The article has been contributed by Shivanshu Jha, a student at Fairfield Institute of Management and Technology.