Term sheets are documents (often) drafted by attorneys, which contain the key provisions that startups and investors agree to when striking a deal. Fundamentally, term sheets stipulate the financial obligations of each party and outline the conditions of the sale of stock to investors or the sale and purchase of a company. Critically, term sheets allow the parties to identify or predict any issues that may arise before the (potentially) wasteful commitment of time, money, and resources into a deal.
Core Provisions of Term Sheets
Common provisions in term sheets include the scope of the transaction, retainer agreements concerning key employees, payment terms, and the non-compete restrictions. The scope of the transaction must be clear; for instance, if a company’s assets are being sold, the term sheet will specify which assets are to be included or excluded in the sale. “Key employees” refer to important directors and officers whom a company relies on to operate the company. Indeed, it is often the case that when one company is purchasing another, the buyer will condition the purchase of the business on the retainer of the original company’s employees.
Although sales prices are typically negotiated between the parties before attorneys become involved, the payment terms are often discussed later and articulated within the term sheet. This may include agreements on partial payments, consequences of outstanding payments, etc. Lastly, it is common for a buyer to include a provision restricting the seller from competing with the buyer after the deal is closed. While this may be a more challenging provision to negotiate if the seller intends to start a similar new business, the terms of noncompetition can be narrowly defined to satisfy both parties.
Binding or Non-Binding Provisions
Depending on the term sheet, provisions may be binding or non-binding. Typical binding provisions include an exclusivity period, terms of fees and expenses, and confidentiality arrangements. An exclusivity period is a range of time during which one party cannot ask for or obtain any other offers for its business. This ensures that other parties cannot get involved and offer better deals. Additionally, term sheets may contain binding provisions stating conditions, which trigger require payment of particular fees and expenses from each party. These fees are commonly paid before closing the deal. Lastly, confidentiality provisions are quite typical of term sheets. Confidentially agreements, as a contractual requirement, are important in that they maintain the secrecy of the deal and protect the discretionary interests of each party.
Words Matter – Choose Them Carefully
Ultimately, term sheets are tricky because many of the words and terms contained within them are terms of art. That is to say, the terms have a legal, rather than mere, ordinary meaning. Indeed, a word used during the course of an everyday conversation may have a vastly different meaning if and when provided in a term sheet. Ultimately, term sheets are drafted in such a way as to balance the interests of the contracting parties – each party must do as much as it can to advance its own interests without excessively alienating and distressing the other party.