Six Good Reasons Why You Should Have a Term Sheet in Your Next M&A Deal

Ever wonder whether it’s worth the cost and headache of negotiating a term sheet? 

 When negotiating the sale or purchase of a company, the question often comes up:  “So should we negotiate a Term Sheet, or just move directly to drafting and negotiating the principal deal documents?”  Seems like a simple enough question, but the answer could have a significant impact on your legal costs and even on the success or failure of your transaction.  It’s worth your time to consider this question and to answer it correctly.  The best answer in most situations is:  YES, by all means, take the time to negotiate a reasonably detailed, (mostly) non-binding Term Sheet.

A Term Sheet is worth the upfront investment of time and expense, because it will:

 1)      Quickly surface “deal-killer” issues.  Use the process of drafting and negotiating the Term Sheet as an opportunity to put on the table all of the business and legal terms that are most important to you.  If the other side simply refuses to enter a deal including one or more of those terms, it’s far better to learn that now and walk away from the deal, than it is to learn that later after you’ve spent many thousands of dollars on advisors and disrupted your business in order to try to get the deal done.

 2)      Make the drafting process more efficient.  Assuming you can reach some consensus on the principal deal terms, the lawyer working nights and weekends drafting the definitive legal agreements will be able to work much more efficiently (read: less expensively) if he or she has a concrete list of terms that need to be reflected in those agreements.  There will still be plenty of opportunities for the draftsman to take creative approaches in favor his client, and the parties will still have to negotiate, revise, and re-revise, but the initial draft agreements will be much closer to “final” if they reflect terms that the parties see as mutually acceptable, than they will if every deal term, big and small, has to be argued over.

 3)      Create a duty to negotiate in good faith.   While most well-drafted Term Sheets are “non-binding” by their express terms, they nonetheless impose a duty to negotiate in good faith.  This principle was articulated by the Delaware Chancery Court in the 2009 Rubicon case, but is a principle that plenty of deal makers fail to appreciate.  Before you spend too much on your legal and financial advisors to get a deal done, you ought to know if your counterpart is as serious and committed as you are to closing a deal.  If he’s not willing to spend the time on a Term Sheet, or the Term Sheet takes an unreasonably long time to complete, that could be a sign that you’d be better off finding a new buyer or seller. 

 4)      Set general parameters.   Although most of the Term Sheet terms are “non-binding,” they inevitably impose an unwritten “moral” prohibition on funny business.  By that, I mean that a party who might otherwise feel free to propose new or significantly different deal terms after the Term Sheet is executed, will feel hemmed in to some degree by what was previously negotiated and reflect in the Term Sheet.  In brief, the Term Sheet can act to prevent “re-trading” of the deal.  This may not sound all that valuable but considering the importance of moving any deal along quickly, for any number of reasons, eliminating rude surprises late in the process is a tremendous benefit.

 5)      Impose certain critical binding terms. Yes, most provisions in the Term Sheet are non-binding, but at least one provision should be binding:  the confidentiality provision, which typically protects the confidentiality of any information shared between the parties and often provides that even the existence of the Term Sheet and the fact that the parties are discussing a possible transaction are confidential.  In addition, prospective buyers often include  a binding “no shop” (or “exclusive dealing”) provision that prohibits the prospective seller from “shopping” the proposed deal terms to other prospective buyers who may be willing to offer superior terms.  These are sometimes accompanied by a “break-up fee” provision that requires a seller to pay the buyer a painful amount of money if the seller does walk away into the arms of a more attractive suitor.

 6)      Set a time line.  Time is almost always a critical factor in a deal.  Sellers want to minimize disruption to the business caused by the sale process, buyers want to move quickly to close and integrate the target business, and both sides realize that an efficiently run transaction process will cost far less in advisor fees than will a long, drawn-out, and disorganized sale process.  How can a Term Sheet help?  By providing deadlines and timelines for the completion and execution of the principal documents. 

But not so fast!  There could be good reasons not to spend time and money on a Term Sheet.  Those reasons will have to wait for a future post but, suffice it to say for now that there may be better reasons not to spend time on a term sheet.  View the decision as an important strategic step in the negotiation process, consult your legal counsel concerning the pros and cons, and keep your eye on the prize:  completing the transaction in a way that accomplishes your business objectives at a reasonable cost.

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One Response to “Six Good Reasons Why You Should Have a Term Sheet in Your Next M&A Deal”

  1. This posting conveys sound strategic advice, that if followed will surely save a purchaser many dollars and much time.