Don't sign a Term Sheet...

Just yet!

In the process of selling a company, few moments are as critical as receiving the Term Sheet. This document, which can also be called a “non-binding offer”, is often presented as an initial formality, but represents a crucial inflection point in M&A negotiation.

For many entrepreneurs, especially those in their first experience with mergers and acquisitions, the arrival of a Term Sheet may seem like just a moment of celebration. After all, it means that after years of struggle building the company it generated concrete interest for an acquisition. But the timing and conditions defined therein can direct the course of the negotiation, for better or for worse.

In this article, we will explore not only what a Term Sheet is and its main clauses, but mainly discuss an often neglected aspect: the right time to accept it.

What is Term Sheet

A Term Sheet is a document that formalizes the main conditions of a potential M&A transaction. The name is the same as that used in venture capital investment negotiations, although it is common to hear other names in the context of mergers and acquisitions.

It is a document presented as “non-binding”, because it establishes the bases that will guide all subsequent negotiations and the definitive documentation of the business, but it does not itself conclude the M&A process, it only formalizes its beginning.

The Term Sheet works as a kind of transaction map. It establishes not only the price and payment method, but also the main conditions that will need to be met for the transaction to take place.

Despite being called “non-binding”, the Term Sheet often includes some clauses that are, in fact, binding, such as confidentiality and, mainly, exclusivity. 

It is important to understand that, even though it is an initial formal alignment, the Term Sheet creates expectations and establishes precedents that will be difficult to reverse later. Therefore, you must evaluate each condition present (or absent) in it before signing.

Conditions it may include

The Term Sheet typically covers several crucial conditions that shape the transaction. Let's analyze the main ones:

Pricing and Payment Structure 

The total transaction value is obviously a central element, but just as important as the number is understanding how it will be paid. Payment can be in cash, in installments or a combination of both. Each structure brings different tax implications and risks that you will need to evaluate carefully.

Earn Out 

Often present in technology and startup transactions, the earn out is a portion of the payment conditioned on the achievement of future goals. Here, the devil is in the details: the chosen metrics, the measurement period, and the level of control you will have over these indicators are critical aspects that need to be well defined.

Conditions for Signing and Closing 

These are the requirements that need to be met for the signing of the definitive contract (signing) and for the effective completion of the transaction (closing). We will dive deeper into this structure in the future, but for now it is important for you to know that to complete the deal you may need to:

• Perform due diligence 

• Regulatory approvals 

• Acceptance from key customers or suppliers

• Permanence of key people

Exclusivity 

This is probably the most sensitive condition on the Term Sheet. It prevents you from negotiating with other potential buyers for a set period of time. Although it may seem reasonable at first glance, after all, the buyer will invest time and resources in analyzing the business, exclusivity can significantly reduce your negotiating power. Therefore, it must be considered very carefully, both in terms of deadline and scope.

What You Need Before Accepting a Term Sheet

The most important lesson about the right time to receive a Term Sheet was discussed in the conversation with Marcelo Park, former CEO of Plataformatec, the first company acquired by Nubank. The tip he received was:

“The buyer will always try to push a term sheet as quickly as possible, and you want to avoid that.”

Why? The main reason the buyer wants to move quickly to a signed Term Sheet is the exclusivity condition. If you accept this clause you will be prevented from creating competition. This will lower your trading leverage. This means that it will be practically impossible to renegotiate any condition that is explicit in the document and you will have much less negotiating power for anything that is not explicit. It may not seem like accepting these conditions will harm you in negotiating conditions that were not discussed, but it will.

Once you accept an exclusivity, if you do not reach an agreement with the prospect, you will be in a delicate position of interrupting the deal and resuming conversations with other potential buyers. So, leaving the table can be expensive.

If your company is a startup that has not yet reached break even, this situation can become even more dangerous. Your cash flow could dwindle to a deadly point in the meantime. And depending on exclusivity, you won't even be able to raise more money during this period.

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Therefore, the negotiating power lies in the hands of your counterpart. Of course, assuming it really wants to do the deal, you can use your power to refuse the deal to not accept anything too harmful. But this can be quite complicated.

For this reason, it is common for the document to have vaguely defined conditions, to be detailed later. Some of these conditions may be critical for the post-deal life of the founders, such as the specific conditions and deadlines for receiving the earn out. It is not in the founder's interest to accept vague conditions to detail them in a less favorable negotiating position!

So don't accept a Term Sheet, yet. Breathe, negotiate, create competition, and understand whether the interlocutor with whom you are about to sign this document is making you the best proposal: the proposal that makes the most sense to be signed. 

What to do to get it right 

There are three things you should remember when you are at the point in a negotiation where the time to receive a Term Sheet is approaching:

1. Save time

2. Create Competition 

3. Negotiate everything before signing anything