In most M&A deals, one of the first documents that parties to transaction must negotiate is the Term Sheet or Letter of Intent. This is a non-binding agreement between parties confirming their intention to enter into a transaction and a summary of the material terms of the deal. It also allows the parties to determine very early in the process whether there is a basic agreement on key terms and confirm that there are no “deal-breaker” issues before either party has devoted substantial time and resources. Lastly, it helps to facilitate the preparation and negotiation of the definitive documents for the transaction setting an outline of the key provisions for the M&A agreements.
Is there any difference between Term Sheet and Letter of Intent?
Letters of Intent and Term Sheets are very similar in function. They all aim at providing essentially outlines of the M&A agreements that the parties to transaction expect to make. In essence, the Letter of Intent is in fact a unilateral proposal from one party that expresses intention to carry out the transaction under certain conditions (despite the fact that such conditions may have been discussed by the parties). Generally, the parties to M&A transaction may use either of them for them for the purpose of their transaction.
Generally, letters of intent and term sheets are used for one of a few purposes including:
- To clarify complex terms that will later be included in a contract;
- To provide notice that the parties are officially negotiating with one another; or
- To provide certain safeguards in case the negotiating parties do not end up entering a contract.
Since Term Sheets and Letters of Intent only provide salient terms and conditions that parties provisionally agreed on or hope to achieve, many of the elements included in these documents are non-binding. Nonetheless, terms regulating the process of negotiation are usually binding and one party may sue another and recover damages if those terms are breached. To avoid doubt, parties to transaction may expressly indicate which terms are legally binding to them.
Standard Content of a Term Sheet
At the time of negotiating a term sheet, the parties to the potential transaction often have limited information and typically have not engaged in comprehensive due diligence, and therefore the proposed terms for the transaction that are included in the term sheet are generally not legally binding on the parties. However, as a practical matter, the term sheet sets the expectations of the parties regarding the final terms, and any deviations from such terms after the term sheet is signed will require justification.
A. Non-Binding Terms:
Structure: Since structure of the transaction (i.e. equity sale, merger, asset sale) can have significant implications in respect of purchaser liability, tax treatment, closing mechanics and other things, it is often included as one of the first terms of a Term Sheet. (For more information about transaction structures, see our practice brief on M&A Transaction Structures).
Purchase Price: A Term Sheet shall provide the general purchase price, which parties agree should the negotiation successfully complete. Hence, this provision typically includes not just the amount that the buyer proposes to pay for the target business but also detail about the form and method of payment (i.e. cash, share swap, seller note, a combination of these). In addition, the timing and manner of payment is usually specified to describe how much will be paid at closing versus following the closing and whether any post-closing payments will be contingent upon future events or on the business meeting certain performance targets or other metrics. Sometime the parties would want to have a portion of the purchase price to be placed in escrow bank account to secure any indemnification or other obligations of the seller (e.g. the seller only can get the money upon satisfying the conditions required by the buyer), it is often stated in the Term Sheet as well.
Indemnification Framework: often, a Term Sheet will include a brief summary of the parties’ expectations for the non-financial terms of the definitive purchase agreement, especially regarding the scope of the seller’s indemnification obligations to the buyer. In some cases, the parties will take the time to include specifics such as the length of survival of indemnification and the limitations on indemnification.
Key Closing Conditions: It is quite common to include a list of the expected closing conditions for the transaction, such as any regulatory approvals or third party consents that will be required. If a buyer intends (or does not intend) to include its ability to obtain financing as a condition to closing, that may be included as well.
Due Diligence: A Term Sheet shall define the scope of the proposed due diligence review (both financial and legal due diligence). The seller shall undertake to provide the full access to information of its business under the Term Sheet. Certain Term Sheets also indicate some limits for due diligence.
B. Binding Provisions:
Exclusivity: In an M&A deal involving a private company target, the Term sheet usually contains an exclusivity provision that restricts the seller from negotiating or soliciting offers from other potential buyers. The period of exclusivity is a critical term and frequently will drive the timeline for the subsequent diligence process and negotiation of agreements, although it is not uncommon for the period to be later extended by the parties.
Confidentiality: A Term sheet generally provides that its terms are subject to any confidentiality agreement previously entered into by the parties or, if there is no such agreement, that the terms of the term sheet and the information shared between the parties will be held in confidence and not disclosed.
Expenses: A Term sheet often includes a provision describing how the transaction expenses will be allocated between the parties. Often this section will provide that each party will bear all expenses incurred for its own benefit (e.g. legal and broker fees) and may provide for sharing of other expenses (e.g. regulatory filing fees).
Governing Law: A Term Sheet commonly includes a provision regarding which jurisdiction’s laws will govern any disputes that may arise.
Some considerations for buyers and sellers in negotiating a Term Sheet.
Use of Advisors. Sometimes, parties to a potential transaction will wait until after a Term sheet is signed before contacting legal, tax and accounting advisors to assist with the deal. It is, however, encouraged that advisors get involved before the conclusion of the Term Sheet. Some very critical decisions are made at the time of negotiating an Term Sheet, such as the structure to be used for the transaction, which could have a significant impact on the economics and risk-allocation of the transaction. Even though most of the terms of the Term Sheet are non-binding, it should be noted that this document is intended to serve as the agreed terms for the deal.
Potential Liability. Parties to a Term Sheet should be careful to expressly state that the Term sheet is intended to be generally non-binding, and clearly identify any provisions that are intended to be legally binding. Failure to have clear and unambiguous language in this regard could have the unintended effect of committing the parties to terms before the final documents are agreed and signed.
Process. While it is important to include the key terms proposed for the potential transaction, the details and finer drafting should be deferred until the definitive deal documents are prepared. Including non-material issues at the Term Sheet stage can unnecessarily lengthen the time to complete this first step, potentially causing lost deal momentum, frustration and a longer overall transaction timeline.
What Happens After the Term Sheet Execution?
The Term Sheet is just the base for negotiation of the main M&A contracts. After a Term sheet or term sheet has been signed, the parties still have a lot of work to do. It should be noted that term sheets are not substitutes for contracts, yet they provide clarity to mutual understandings in the often complex world of business negotiations. As a matter of fact, Term Sheets may not always fully reflect final and enforceable agreements between the parties.
Dung Le & Tran Viet Dung