Term Sheet

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by Andrew Dunn Business Builder, Founder at INDMND.com

Table of Contents

What Is a Term Sheet?

A term sheet is a nonbinding agreement that shows an investment’s basic terms and conditions. The term sheet is a basic template and cover sheet for more detailed, legally binding documents. Once the parties involved agree on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is drawn up.

A term sheet is a bullet-point document outlining a potential business agreement’s material terms and conditions, establishing the basis for future negotiations between a seller and buyer. The four key points of a term sheet are 

  • deal economics, 
  • investor rights, 
  • governance and oversight, and 
  • exit terms.

What Does a Term Sheet Include?

When creating a term sheet, you’ll want to ensure you cover all the aspects of the deal without going into the intricacies of it. A term sheet should be the first step in laying the groundwork for the forthcoming business transaction.

In broad terms, a term sheet should include the following information:

  1. The name of the company selling the assets.
  2. The name of the company that is buying the assets.
  3. A description of the assets being sold.
  4. Any warranties or guarantees being offered and any limitations to those warranties or guarantees.
  5. The asset purchase price, including any contingencies that may affect the price.
  6. The timeframe for a response from the buyer.
  7. Any other pertinent information, such as percentages of who will own how much and who has what voting rights.
  8. It should spell out what happens if the parties cannot agree on any of the points covered in the document.

Who Uses Term Sheets?

Business startups often use term sheets. Startups use documents that require term sheets. They are crucial for investors, often venture capitalists (VC), who may offer capital to fund the startup.

A term sheet is often used as part of a merger or attempted acquisition. It would typically contain information regarding the initial purchase price offer, the preferred payment method, and the assets included in the deal.

The term sheet may also contain information regarding what, if anything, is excluded from the agreement or any items that may be considered requirements by one or both parties.

What Are the Common Types of Term Sheets?

The details you include in a term sheet depend on the transaction type and the agreement between the parties. The two most common term sheet agreements are investment and debt agreement term sheets.

Investment Agreement Term Sheets

An investment term sheet lays out the specific terms and conditions of an agreement between a startup and an investor. Without a term sheet, no binding agreement exists, and either party can back out at any time. Here are the details needed for an investment agreement term sheet.

Investment term sheets can be lengthy and detailed, but some of the most critical items to include are

  • Non-binding Terms: Both parties are not legally obligated to follow the terms outlined in the sheet.
  • Valuations: How much the company is worth, the investment amount, and what percentage of the company is being given to the investor (learn more about Pre-Money and Post-Money Valuation)
  • Anti-Dilutive Provisions: Measures to prevent the company from being diluted (given away) too much.
  • Voting Rights: Explains how much say the investor has in company decisions.
  • Liquidation Preference: How sale proceeds will be distributed between the entrepreneur and investor.
  • Investor Commitment: How long the investor must remain vested.

Debt Agreement Term Sheet

For a debt agreement to be drawn up, both the lender and the borrower must agree on certain key points. This is usually outlined in a term sheet, which is a shorter document that lays out the basic terms of the agreement.

Some key details needed for a debt agreement term sheet include the following:

  • Economic Details: These include the term, loan size, interest rate, and other financial matters common to debt.
  • Risk Mitigation Prerogatives: The lender will often require specific conditions be met or specific information be provided in a recurring and timely fashion.
  • Extension Privileges: The borrower is often allowed to extend a loan, but the term sheet identifies the conditions and cost of the extension.
  • Closing Due Diligence: As part of the term sheet, the lender may stipulate what they require when the loan agreement is drafted. This can include a list of requirements the borrower must prepare to be approved for the loan.

What To Watch Out for With Term Sheets

While an investment deal should ideally be as uncomplicated as possible, you, as a business owner, may come across an investor who tries to pull a fast one on you. When drafting a term sheet, it’s important to know what the investor is looking for and what they offer in return. Some key things to look out for include

  • Unfair Financing: If your investor’s money is serving as a loan, ensure that the repayment terms won’t bankrupt your company.
  • Large Controlling Stakes: Investors might try to take a controlling stake in your company (larger than 50% ownership).
  • Limiting Terms: Your investors may want to limit how other outside investments you can acquire besides their initial investment, which may or may not be good for your company.

If you can’t negotiate fair terms that benefit your business, it may be best to walk away from the deal.

Tips For Writing Term Sheets

While term sheets will vary depending on the circumstances, here are some broad tips for creating term sheets.

  • Summarize the Conditions: The purpose of a term sheet is to outline the key terms and conditions of an agreement between two or more legal parties. The conditions of a term sheet will vary depending on the project or transaction being negotiated. Still, they will typically include information on the following:
    • The parties involved in the agreement
    • The project or transaction being negotiated
    • The amount of money being invested, or the value of the property being transferred
    • The terms of repayment or distribution
  • State the Terms: Ensure you state which are binding and which are non-binding terms, then make sure every other term in the agreement is defined properly, so both parties understand them.
  • Lay Out the Timeframes: Ensure all timeframes are stated clearly, including what happens if they are not adhered to.
  • Encourage Further Collaboration: You might consider creating a sharable and editable document (Word or Google doc) where both parties can suggest and keep track of any changes.

Common Terms Associated With Term Sheets

  • Valuation: A valuation is the estimated worth of a company or asset. It is determined by examining factors such as the company’s earnings, its assets, and the industry’s market conditions. The purpose of a valuation is to provide a snapshot of a company’s current financial situation and to help potential investors determine if the company is worth investing in.
  • Loan Amount: A loan amount is the total amount of money that a borrower agrees to pay to a lender to borrow money. This amount can be a fixed dollar amount or based on certain metrics, such as the Loan-to-Value (LTV) ratio or the Debt Service Coverage Ratio (DSCR). The loan amount will also be based on the property’s Net Operating Income (NOI).
  • Dividends: Dividends are a distribution of a company’s profits to its shareholders. They are typically paid out every quarter and can be in the form of cash payments, stock dividends, or property dividends. Dividends provide shareholders with a regular income stream and give them an ownership stake in the company.
  • Term: A term is a specific length of time that is agreed upon by both the borrower and the lender. This is the amount of time that the loan will be outstanding and payments will be made. Borrowers must understand the terms of their loan agreement to know when the loan is due and when interest will be assessed.

Key Takeaways:

  • A term sheet is a nonbinding agreement that shows an investment’s basic terms and conditions.
  • The term sheet is a template and basis for more detailed, legally binding documents.
  • The four key points of a term sheet are the deal economics, the investor rights, the governance and oversight, and the exit terms.
  • Once the parties involved agree on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is drawn up. 
  • Term sheets are most often associated with start-ups. Entrepreneurs find this document crucial to attracting investors, such as venture capitalists (VC) with capital to fund enterprises.

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