Insight Using Term Sheets to Save Time and Money

A term sheet, sometimes called a letter of intent or memorandum of understanding, sets out the key terms of a transaction in summary format. Parties will typically draft a term sheet only once they have determined that they are serious about pursuing a transaction, but before they are ready to commit to a legally binding agreement. Accordingly, a term sheet is usually intended to be a non-binding proposal, but will often include binding provisions such as, exclusivity, confidentiality, and access to information.

The function of the term sheet is to help focus negotiations between the business decision makers on either side of a transaction. The summary format of a term sheet makes it easy for the parties to focus on the substantive issues and identify deal breakers. And, although the deal terms stated in the term sheet are typically non-binding, the parties rarely attempt to re-negotiate the terms of the deal after they agree on the term sheet. Cost savings usually occur because the parties have negotiated the substance of the deal—including agreement on how to resolve the potential deal-breaking issues—before legal counsel begins drafting definitive documents. In most circumstances, this will result in less negotiation and revision of the definitive documents, and thus, lower legal fees.

Term sheets, however, do carry risk. First, poorly drafted term sheets can lead to two unwanted outcomes: (a) a court could determine that the term sheet constitutes a definitive agreement, or (b) a court could determine that the parties had agreed to negotiate in good faith. These outcomes are both problematic to a party who intended to preserve the right to walk away for any reason at all. Second, term sheets have the potential to destroy a deal’s momentum if the parties or, just as likely, the parties’ attorneys get bogged down in negotiation of details that are unnecessary at the term sheet stage. Third, term sheets have the potential to add cost to deals if the deal is a routine or straightforward transaction. In these instances, the term sheet may be an unnecessary step.

In the right circumstances, and in the right hands, term sheets are an invaluable tool in the deal-making process. The key for clients and attorneys is understanding the term sheet’s role in the deal and being careful not to inadvertently create binding obligations.

If you are in need of a term sheet or would like more information about this topic, or other legal issues, please contact a member of our Business Group or call 208.344.6000.