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What Is A Term Sheet? | Alker Law Group

What Is A Term Sheet? | A…

What Is A Term Sheet?

A term sheet is a document that outlines the terms and conditions of an investment. One important distinction to note, however, is that it is not necessarily a binding contract. While a term sheet should contain some of the basic terms of the investment, it does not typically include all of the details, as a contract would. The general purpose is to ensure that both parties agree on the basic structure of the investment. If you are in the process of an M&A (mergers and acquisitions) transaction, you may need to understand and sign a term sheet as part of this process. Contact an experienced business attorney at Alker Law Group at 626-252-0683 to ensure your legal and financial rights remain protected.

Understanding Term Sheets

A term sheet is most often used in the context of venture capitalists considering investments in startup companies. The term sheet is used as a guide in preparation for the final investment agreement. A term sheet is a preliminary document that includes the basic terms of an investment in a business. It also can serve as a guideline for drafting the final agreement, once both parties have agreed on the general structure and basis of the investment.

Why Should You Care About a Term Sheet

Term sheets are often the basis upon which an investor will decide whether to invest in a company. If the term sheet does not accurately reflect what is discussed and agreed upon, it may be difficult for either party to make claims during or after the agreement has been finalized.

A term sheet should contain some basic terms but still leaves room for negotiation on more specific details of the investment, such as percentages, ownership stakes, and the term of the agreement. It should also include a timeline for drafting the final agreement once both parties agree on general terms to ensure that negotiations never drag out too long or get stalled by minor details.

Again, while a term sheet is not binding, it is important because it lays out what each party agrees to prior to the finalization of the contract.

Common Terms in an M&A Term Sheet

The term sheet will vary depending on the type of investor in question - it is important that you are aware of this before drafting your term sheet as some terms may not apply in every situation. The following are some common terms found in an M&A Term Sheet.

Binding

There are some instances where a term sheet would be binding on both parties. Depending on how it is written, the term sheet can actually function as either a proposal or a contract. Additionally, certain portions of the term sheet can become binding if both parties agree.

Valuation

Valuation is one of the most important aspects of any term sheet. The valuation will determine how much money will exchange hands in the event that a contract is finalized. The valuation of the company will determine the price per share that the investor will ultimately pay when they purchase the company. The term sheet should indicate whether the valuation done is either pre-money or post-money, as this can directly affect the total amount of equity an investor will have in a company.

A valuation will also take into account option pools (the amount of stock that will be reserved for employees) and dilution of stock. Additionally, the term sheet will indicate whether an investor will include an ESOP (employee stock ownership plan), which could impact the overall value of the company. Consider visiting with an experienced business attorney that understands term sheets at Alker Law Group today to ensure your valuation is done properly and fairly.

Sale Price

The sale price refers to the value at which your company or asset would sell for on public markets, if available.

Purchase Price

If the term sheet is binding, the purchase price will be what the investor pays to acquire your company.

Board of Directors

The composition and responsibilities of your board are typically outlined in a term sheet as well since they can affect how you operate.

Protective Provisions

You may also find provisions that protect investors from certain liabilities if something goes wrong.

Repurchase Option or Right of First Refusal

Often, the term sheet will include a repurchase option for an investor to buy more shares at a set price over time. The right of first refusal is similar but

Liquidation

A liquidation preference or preferred share typically states what will happen if the company does not make it through its challenging transition stage. If a term sheet includes a liquidation section, it may specifically address that when a company's assets are sold, or a merger occurs, it may become a qualifying event for the purposes of an investor's liquidation.

Issues Regarding Control

Many term sheets will address the issue of control. It is important for an investor to make sure that they have a controlling interest in the company if this has not been previously agreed upon with other investors. In some cases, a term sheet will indicate if the investor has one (or more) seats on the board of directors in order to significantly impact the vote on major company decisions.

Valuation Cap

A valuation cap or price floor provides some protection from dramatic increases in share values, which can be harmful to an early investor.

Additional Common Provisions

Every merger and acquisition is unique, and the term sheets for every type of M&A transition will also be unique. However, some of the other types of common provisions often found in a term sheet include:

  • Informational rights
  • Length of investor commitment
  • Redemption rights
  • Schedules related to vesting
  • Tax information

When Do I Sign A Term Sheet?

After reading and understanding what a term sheet is, both parties will need to make the decision when to sign this document. Typically, term sheets will be signed by both parties in a deal after the negotiation process is complete and before any company changes have been made to either party's financials or valuation.

Contact an Experienced Business Attorney To Learn More About Term Sheets

If you are wondering what a term sheet is, or what you should include in this critical document, consider visiting with an experienced business attorney in order to have all of your questions answered, and ensure your rights remain protected throughout the M&A process. Term sheets are business documents that outline the terms and conditions of an investment. We negotiate, review, and draft term sheets to ensure the maximum amount of legal and financial protection. Contact our experienced business attorneys at Alkers Law Group at 626-252-0683 to schedule your visit today.

Click on the following link for a great video about Term Sheets: https://www.alkerlawgroup.com/wp-content/uploads/sites/339/2021/07/ALG_-_Term_Sheets-Video.mp4

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