Closing the Deal: Three Steps to Crafting the Right Term Sheet

Procopio, Cory, Hargreaves & Savitch LLP

Procopio, Cory, Hargreaves & Savitch LLP

Many successful legal agreements begin with the term sheet; a document listing the key points of the business deal that has been struck between the parties. A deal point can be as simple as the purchase price, although with large or complex transactions they often include more complicated concepts like risk allocation.

Deal points vary based on the type of transaction. Licensing arrangements could have a heavy focus on royalty arrangements, while joint venture term sheets usually discuss rights and distributions. Regardless of what is included, it is critical to understand the role a term sheet plays in the overall transaction.

Here are three general term sheet rules to follow:

Term Sheet Efficiencies

Drafting legal documents is an expensive and time-consuming process. Lawyers spend time making sure these agreements, which are typically longer and more formal than term sheets, are ready to execute when the time is right. Parties can save significant amounts of time and money by summarizing the deal points in writing in less formal, typically non-binding documents before the lawyers get to work on the definitive agreements. There is, however, a balance to reached. Term sheets should include a list of the core business terms, but any efficiencies that would otherwise be gained will instead be lost if everyone gets caught up on negotiating a long and detailed term sheet that is no shorter than the definitive document would be.

Involve Counsel

Term sheets are highly influential on a deal, even though they usually are (and should be) largely non-binding. Further, there are often options on how to structure a deal that could impact tax or liability. Involving lawyers before the term sheet is signed can help ensure the parties have considered and discussed all the key deal points. In addition, given the term sheet’s influence, it is often difficult to walk back from deal points that a party may not have realized were disadvantageous or even unworkable. We often provide our clients with term sheet samples, examples or forms that they can use even before approaching a potential prospect, but some of the biggest value-adds from attorneys come in the form of comments on a term sheet.

Non-Binding Deal Points

In a term sheet, deal points that reflect the business deal should be non-binding. In other words, do not substitute a term sheet for a fully drafted agreement. While it may feel like the parties have reached agreement when they have decided something like purchase price, a comprehensive document will address issues like payment timing, method of payment, and taxes, for example, as well as how to handle other contingencies.

Term sheets do often include some binding terms but, in general, these should be related only to how the deal will progress rather that what the deal will contain. The most common binding terms in a term sheet are confidentiality, agreements related to the due diligence process, agreements not to negotiate with others for a set period of time, and, sometimes, a “break-up” fee if a party decides not to go forward with the deal.

Overall, term sheets can be a key part of getting a deal off the ground while keeping the whole process as efficient as possible, to the benefit of both parties.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Procopio, Cory, Hargreaves & Savitch LLP

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