During a potential M&A transaction, it is standard practice for the prospective buyer and seller to sign a term sheet or letter of intent. This article will review the importance, purpose and anatomy of M&A term sheets while providing a simple term sheet template for common use.
Term sheet definition: A term sheet is a non-binding agreement of basic terms between a prospective buyer and seller during an M&A deal.
A term sheet is one of the first documents presented and negotiated on during any serious M&A deal.
A term sheet, also known as a letter or intent (LOI), is a good-faith contract signed between the prospective buyer and target company. The contract outlines the key terms of the intended merger or acquisition. While most define term sheets as non-binding, they are an important step in the M&A process. Both sides agree to key provisions that allow for a successful and equitable deal.
Although an M&A term sheet or LOI is non-binding, the contract plays an extremely important role in overall deal success.
M&A transactions are an all-consuming process with great risks present. Term sheets allow stakeholders to review and negotiate key deal terms early in the process. Doing this grants them the ability to discover major deal breakers or issues before devoting significant time and resources.
Term sheets or letters of intent also provide structure and security to an M&A deal. These contracts also give both the buyer and target company peace of mind to conduct the deal with an agreement to look back on while progressing forward.
As previously stated, term sheets reflect the key concepts of an M&A transaction and act as guidance to affect the certainty of closing and ultimate deal success. Negotiators can ultimately put whatever they feel appropriate in their term sheet or LOI, but generally most contracts include the following:
This aspect of a term sheet is where the purchase price is defined along with what is being purchased. The form of payment is also included, such as cash or stock. The prospective buyer also commonly add a working capital peg. This means that at the time of close, the seller must provide the buyer with an agreed amount of working capital and may not extract additional value. The seller may then add a net working capital number. This means the purchase price will be adjusted dollar for dollar based on the final working capital balance sheet. This protects both the buyer and seller, adding trust and good faith to the deal process.
During a term sheet negotiation this provision will typically cover how the target company’s employees will be transitioned post-close. The clause may also discuss basic human resource matters such as non-compete agreements and potential severances. On the buy-side, the buyer may like to set aside additional money outside of the purchase price to retain key employees.
The buyer will often ask for a holdback or escrow clause. This allows them to hold back a portion of the purchase price from the seller as security against any misrepresentations, undisclosed liabilities or breaches of warranties. Generally, this ranges from eight to 15 percent of the purchase price and is held for one to two years.
Exclusivity is an essential provision in a term sheet or LOI and is actually one of the only portions that is binding once signed. This provision restricts the seller from negotiating offers from other prospective buyers for a specific period of time. This is done in order to complete due diligence and finalize any definitive agreements.
A term sheet or LOI will often include a confidentiality clause. This clause means the terms of the deal and any information shared during due diligence must be held in confidence between the two parties. Like exclusivity, this provision is often binding as well.
In the case of mergers and acquisitions, term sheets and letters of intent are very much alike. Both contracts convey the key terms of a deal between the seller and prospective buyer with corresponding provisions and clauses. The format is the only real difference between these two non-binding contracts. A letter of intent is written in the form of a letter, whereas a term sheet outlines deal agreements in the form of bullet-points.
An M&A deal term sheet sample will look more informal than a LOI. However, both hold the same meaning and are typically the first step in any serious M&A discussion.
Following the correct term sheet format and a standard term sheet template will ensure nothing essential is missed during the process. While the following are non-binding term sheet templates, be aware that some clauses like exclusivity and confidentiality may be binding.
DealRoom Due Diligence Software provides the term sheet example below in order to give practitioners a term sheet template for acquisitions and a starting-off point. However, remember that every deal is different and may require additional or revised provisions.