These six simple words, often said during key moments of a negotiation, carry significant weight.
Whether you are buying or selling, the term sheet plays a vital role in shaping expectations and outlining the key terms of the deal, so it is important to get it right.
In this article, we explore the role of term sheets in M&A transactions focusing on important components and common pitfalls.
Seek advice before signing
One common pitfall we often see as M&A advisers is parties signing the term sheet without seeking professional advice. This is often driven by a desire to save costs or a misconception that the term sheet is only focused on the commercial aspects and can easily be changed because it is “non-binding.”
Although a term sheet is generally considered to be non-binding, it sets the expectations and forms the foundation of the deal between the parties. Once these expectations are established, it becomes challenging to deviate from the agreed framework. Any attempt to do so may be seen as backtracking from the original position, leading to a loss of valuable goodwill. Any subsequent negotiations and delays that arise from such departures are likely to significantly outweigh any initial cost savings and, in some instances, may place the transaction at risk.
Take your time
To ensure timely commitments in transactions, parties often rush to outline high-level terms with the intention of working out the details later. While this approach can be suitable in some cases, it is generally better to take the time to clarify key terms from the outset.
A well-drafted term sheet brings clarity and certainty by addressing crucial aspects of the transaction. It not only streamlines the preparation and negotiation of detailed transaction documents, but also helps avoid additional questions, prolonged negotiations, increased costs and delays. On the other hand, an unclear or incomplete term sheet often leads to complications and further complexities in the process.
What should it cover?
We would generally expect a term sheet to cover the following key elements:
| Transaction structure | The term sheet should clearly specify what is being acquired or divested. Is it the shares of the operating company or the underlying assets themselves? Will the transaction result in 100% ownership or is it a partial sale? These distinctions impact the required documentation, terms and often the tax implications. |
| Purchase price | The term sheet should clearly state the purchase price, including the manner in which it is to be calculated and paid. If the purchase price is to be adjusted (for example, based on factors such as net debt and working capital), providing detail around the adjustment framework reduces the likelihood of disagreements in later stages of the transaction. Similarly, to ensure transparency surrounding the valuation, the term sheet should outline any underlying financial assumptions on which the purchase price is based. If these assumptions cannot be supported through financial due diligence, the term sheet will serve as a reference point for both parties in any re-pricing discussion. If the purchase price will be paid over time, the term sheet should specify the timing of any deferred payments and any associated conditions. Any conditions relating to financial performance of the business (for example, revenue, annual recurring revenue, EBIT) should be clearly defined to avoid ambiguity. Consideration should also be given to whether financial statements should be normalised to include or exclude the impact of certain items, how performance conditions will be tested, whether there are any events that should accelerate the payment and whether any controls should be imposed on the operation of the business during the earn out period. At this stage, referencing the required principles at a high level will generally be sufficient, with the transaction documents to contain the detailed drafting. |
| Conditionality | The term sheet should outline any conditions that need to be fulfilled before the transaction can proceed. These conditions may include regulatory or internal approvals, due diligence, finance approval or consents from third parties (such as landlords or material customers or suppliers). In some instances, a pre-completion restructure condition may also be appropriate. Buyers should carefully consider whether they require a material adverse change condition. This condition allows them to withdraw from the transaction if an unforeseen event arises which negatively affects the value of the target business. Without any forewarning at the term sheet stage, such inclusion in the transaction documentation will almost certainly be resisted by a seller. |
| Liability regime | While a term sheet is unlikely to provide fulsome details of the warranties and indemnities required from the seller, it is helpful to establish some guidelines to set expectations for the transaction documents. These guidelines may include specifying claim periods and providing a general description of the expected warranties and indemnities. If there are multiple sellers, the term sheet should address how liability will be apportioned between them. If there is an expectation that warranty and indemnity (W&I) insurance will be obtained, it is important to identify this early to help manage any associated timing and process implications. |
| Restraints | The term sheet may cover the duration and extent of restraints on sellers, as well as any necessary exceptions, depending on the transaction and parties involved. |
| Indicative timetable | Providing an indicative timetable for the transaction sets expectations and helps both parties manage their resources accordingly. While subject to change, a well-defined timetable promotes efficiency and transparency. It is also helpful to outline the next steps following the entry into the term sheet, including the party responsible for the preparation of the transaction documents. |
| Exclusivity | Where the buyer has been afforded a period of exclusivity to undertake due diligence and negotiate the transaction documents, the terms and duration of that exclusivity should be outlined. Generally speaking, alongside confidentiality, this is one of the few provisions in a term sheet that is expressed to be legally binding. |
| Confidentiality | The term sheet should specifically provide that its terms are confidential and governed by any non-disclosure agreement the parties may have entered. |
| Nature of the term sheet | In order to provide flexibility and facilitate the negotiation process, with the exception of the exclusivity and confidentiality provisions, term sheets are typically not legally binding. To ensure the parties have sufficient clarity as to their legal obligations, it is essential that the non-binding nature of the term sheet is specifically addressed. This is of particular importance where a party is listed on the Australian Securities Exchange and does not intend to disclose its entry into the term sheet to the market. |
Our corporate team has significant experience in drafting and reviewing term sheets for a range of corporate transactions. For further information or advice in respect of term sheets or transactions more generally, please contact Steven Wambeek and Matthew Burge.
