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The Anatomy of an M&A Term Sheet

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.

We at DealRoom work with dozens of companies helping them organize M&A and this article will review the importance, purpose, and anatomy of M&A term sheets while providing a simple term sheet template for common use.

What is a Term Sheet?

Term sheet definition:  A term sheet is a non-binding agreement of basic terms between a prospective buyer and seller during a deal. A term sheet is one of the first documents presented and negotiated on during a deal and 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.

A term sheet, also known as a letter of intent (LOI), is a good-faith contract signed between the prospective buyer and the 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.

Why are Term Sheets Important?

Although an M&A term sheet is non-binding, the contract plays an extremely important role in overall deal success.

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 also provide structure and security to 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.

How to Write a Term Sheet and What to Include

As previously stated, term sheets reflect the key concepts of a transaction.

Negotiators can ultimately put whatever they feel appropriate in their term sheet or LOI, but generally include the following:

Term Sheet Information

1. Value or Purchase Price

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.

Prospective buyers also commonly add a working capital peg. This means that at the time of close, a seller must provide a buyer with an agreed amount of working capital and may not extract additional value.

A 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 buyers and sellers, adding trust and good faith to the deal process.

2. Employee Matters

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, buyers may like to set aside additional money outside of the purchase price to retain key employees.

3. Holdback or Escrow

Buyers 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 fifteen percent of the purchase price and is held for one to two years.

4. Exclusivity

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.

5. Confidentiality

A term sheet or letter of intent 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.

Term Sheet Meaning vs. Letter of Intent Meaning

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.

A deal term sheet sample will look more informal than an LOI. However, both hold the same meaning and are typically the first step in any serious M&A discussion.

Merger and Acquisition Term Sheet Template Download

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's 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.

due diligence software

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