By Alon Harnoy, Sabari Bagchi & Daniel Friedman
When two or more parties express an interest in working together, through a partnership or joint venture, a Company seeking an investor or purchaser, or some other transaction, oftentimes their discussions result in an agreement on a few major business points. At this stage the parties may believe that they have an agreement in principle, and are eager to begin drafting the definitive transaction documents without having worked out much of the “nuts and bolts” of the transaction. As parties delve deeper into the nuances and detailed considerations inherent in most transactions, they come to realize that there are many points that have not yet been discussed or even considered. Once drafting has begun, much time (and legal fees) can be expended on back-and-forth revisions to specific provisions concerning business points that have not been negotiated in advance. This inefficiency is costly and frustrating to the parties involved and can be easily prevented. At Shiboleth, we have found that parties can save a significant amount of time and legal fees by agreeing upon a well thought out and negotiated term sheet prior to drafting any definitive agreements. Reaching an agreement on critical business and legal terms in advance provides an important and efficient framework for lawyers to follow in drafting or reviewing definitive documents, and in all cases provides a cost savings to the client.
What is a Term Sheet? A term sheet is a document which sets forth the material terms and conditions of a proposed transaction. A term sheet can be only a few pages or many pages, depending on the complexity of the transaction. For example, in an investment transaction, the term sheet may include the amount of the proposed investment, the valuation of the company, the type of securities to be issued, a short summary of the rights and protections granted to the investor, and any conditions to closing. For a joint venture, the term sheet may include the scope of the project, the ownership of the joint venture, governance and management of the joint venture, the financing conditions, the allocation and distribution of profits, restrictions on transfer, and exit or termination rights. Many times a term sheet will also include a list of the definitive documents that are anticipated for closing, which can be a very important consideration for the parties. For instance, if one party is requesting that the other party provide an opinion of counsel, such a request can affect the scope of the due diligence to be conducted, as well as increase legal costs.
How Does a Term Sheet Save Costs? While a term sheet may be perceived as an additional document with additional legal costs, in reality a term sheet saves time and legal fees. By setting forth the material terms of the transaction in a straightforward and concise manner, the parties are able to easily focus and negotiate the transaction without becoming bogged down by cumbersome “legalese” often necessary in the definitive documents. Once the term sheet is finalized, the drafting process is streamlined and the definitive documents can be reviewed to ensure consistency with the term sheet. If, in the worst case scenario, the transaction falls apart, it is much cheaper for the parties if only the term sheet has been drafted, rather than the definitive documents. Therefore, as a term sheet can streamline the drafting process of a successful transaction, as well as lower the costs expended in a failed transaction, it is beneficial whether the transaction is ultimately consummated or not.
While term sheets are used as a guide for the transaction, other than in rare circumstances, the parties are not bound to enter into a transaction simply because they have agreed on a term sheet. However, even though term sheets are generally non-binding with respect to the material terms of the transaction, it is critical that every term sheet still contain certain binding provisions. At Shiboleth, we recommend including the following binding terms in a term sheet whenever possible:
Exclusivity – A term sheet should provide a window of exclusivity for one party to pursue the transaction. Knowing that it has an exclusive opportunity to pursue a transaction and that such opportunity will exist for a specific timeframe gives a party the comfort to expend the costs and man-hours necessary to determine whether to ultimately consummate the transaction, as parties are much less willing to engage in the costly due diligence process for an opportunity that may disappear without warning.
No Shopping – A No Shopping clause prevents a counterparty from using the offer as a means to procure a better bid from a third party. It incentivizes the two sides to enter into a contract with each other, while providing each the security that their counterparty is also interested in consummating the transaction.
Expenses – It is important that each party understands who will bear the expenses of the transaction, and the term sheet should reflect the parties’ understanding with respect thereto. This understanding is especially important if the transaction is never consummated. If each party is to be responsible for its own costs and expenses incurred in pursuing the transaction, a binding expenses provision can preclude one party from seeking due diligence expenses or attorneys’ fees from the other party if the transaction falls through.
Confidentiality – A binding confidentiality clause prevents the parties to the term sheet from disclosing information about the transaction, the negotiations, or the identities of the parties for a certain period of time. However, if the parties will be exchanging sensitive confidential information, such as financial information or proprietary information related to the parties’ respective businesses, we recommend that the parties enter into a separate Confidentiality and Non-Disclosure Agreement to afford fulsome protection, which is especially important if the transaction is not consummated.
Having been educated in the importance of term sheets, we hope that you will take a step back before entering into your next transaction, make sure that all parties are on the same page with respect to the material terms, and enter into a term sheet that is binding in the critical areas highlighted above. We are confident you will find that the use of a term sheet facilitates negotiation of material terms, and that once the term sheet is finalized, that it provides a streamlined framework for drafting the definitive documents in a timely and cost-effective manner.