When buying or selling a business, the parties often use a term sheet to memorialize the basic terms of the planned transaction. Term sheets are also called “letters of intent” or “memorandum of understanding”, sometimes they use abbreviations, like LOI or MOU. Term sheets are good to get clarity on certain terms and knowing early on if it is likely to be a deal or not. For example, if the buyer wants his financing to come through as a condition of closing the deal, this would be in the term sheet and you would know right away if that is a deal breaker. There are certain things to look out for when negotiating or executing a term sheet:
Most terms should remain “Non-Binding”
The main deals of the planned asset purchase should remain non-binding, meaning nobody is obligated to close the deal with the terms contained in the term sheet. There should be specific language in the term sheet stating something like this:
This Term Sheet represents Purchaser’s intent to acquire all of the assets of Seller but does not constitute a contract or agreement or an agreement to negotiate in good faith or otherwise, is not binding, and shall not be enforceable against Purchaser or Seller.
Usually, the following terms are listed in a term sheet, but are made not binding:
- Name of the Seller and Purchaser;
- That the transaction is an asset purchase and a description of the assets included or excluded; for example, even if all assets of a business are purchased, the parties usually exclude “cash on hand” or in the Seller’s bank accounts;
- What if any liabilities are assumed by the buyer
- That the seller shall cooperate in showing buyer any documents and information buyer wants to see to conduct its due diligence; sometimes you may even give an example of the types of information you would like to review
- the purchase price for the assets and how it is to be paid; for example, all of it in cash or some of it financed by the seller via a promissory note
- Conditions that have to be fulfilled prior to the buyer making the final commitment, for example, sometimes the buyer would like to have financing in place prior to closing
- What sort of representations and warranties the seller is expected to make about the assets to be sold
- Who is having their lawyers prepare the first drafts of the transaction documents? (usually the buyer’s attorney)
- Any non-compete obligations of the seller after closing or obligations of the Seller to help the PUrchaser to learn the business and facilitate the transition in business ownership
Watch out for Good Faith negotiation obligations
Even if a term sheet is non-binding, every agreement under the sun contains a “covenant of good faith and fair dealing.” If you abruptly cancel the deal for no good reason after the other party has spent a lot of money and time bringing the deal forward, they may try to hold you responsible for damages based on their reliance that you would at least negotiate “in good faith” or tell you earlier that they were never serious. To prevent this sort of claim, I include the language quoted above, which specifically excludes a claim like that. If you want to prevent a seller or buyer from walking away for no good reason, you could agree to a “break up” fee, which would cover your projected expenses in case the other party walks away.
Some terms should be Binding
Hold on though, some terms in the term sheet should be binding, which is why it is a good idea to have a term sheet in the first place.
You would want any confidentiality provision in the term sheet to be binding.
If you want to hold the seller to a certain period of time during which they cannot shop around for another buyer, the term providing for that exclusivity should be binding.
If you want a break-up fee in case of the other party dumps you after you spent significant time and expense on making the deal happen, that also has to be binding.
Signing a Termsheet before having spoken to the Seller
Sometimes you have not even spoken to the seller directly and only dealt with a business broker. Still, the broker encourages you to come forward with a letter of intent or term sheet. In those cases, I recommend that you put language in your term sheet that explicitly say something like this:
The proposed purchase price and the other terms contained herein is being made based upon the financials and other information provided by [name of business broker] transmitted to [your name] on [date]; if during the course of due diligence, it is discovered that the financials and other information are materially different, then this Term Sheet, the purchase price and the other terms will be subject to adjustment.
Form of the Term Sheet
I personally prefer a term sheet set forth in a chart with two columns with an introductory paragraph introducing the parties and the transaction. But it could also be written out in a letter.