Things to include in a term sheet
By Lawfarm Team December 14, 2021
There are various types of pre-contractual instruments, a term sheet being one of the types. The term sheet is a document that includes information about the main terms and conditions of a transaction the parties wish to enter into, but such a transaction hasn’t reached the stage of a formal contract yet. Term sheets help to note down in brief, the preliminary discussion between the parties and the terms they’ve agreed upon. Based on the term sheet, the negotiations between the parties take place and it aids in the preparation of the formal contract between the parties. Term sheets are usually used for business transitions. Therefore, the term sheet is a very important document that should be drafted carefully.
Depending on the type of transaction the parties are entering into, the items to be included in the term sheet may vary. However, there are a few things that are usually included in a term sheet.
Description of the parties
It is necessary to clearly identify and describe the parties who wish to enter into a contract for a transaction for which they’re using a term sheet as the basis. This is because the term sheet records the preliminary discussion between the parties regarding the transaction they wish to enter into and hence it is necessary to provide for identification and description of the parties.
Description of properties involved
If a property is involved in the transaction the parties wish to enter into, then the details about such property or properties (if there are multiple) should also be mentioned in the term sheet.
Amount of investment
Term sheets are mainly used when transactions regarding investment are involved. It is important to mention what is the amount of investment being demanded by the party seeking it since it is the absolute core of such transactions and would form a part of the preliminary discussion.
In transactions wherein a party is seeking investment from the other party/parties, the pre-money and post-money valuation need to be mentioned in the term sheet. Pre-money valuation is the value of a company excluding investment received from other investors and Post-money valuation is the value of the company after receiving the investment.
Price per share
Companies raise capital by issuing shares and hence when the transaction is related to receiving investment by way of shares, the price per share should be mentioned as well.
The period of duration an investor is required to remain vested should be mentioned in the term sheet.
Holders of different types and classes of shares have different voting rights. In the term sheet details about what would be the voting right the investor would get and in which matters the voting right given would exist needs to be mentioned. Voting rights are quite a delicate matter and companies try to concentrate voting power amongst those who are leading the company.
Anti-dilution provisions or Pre-emptive rights
Anti-dilution provisions are used to protect the investors and prevent the value of their investment from losing its value. When new shares are issued, dilution would occur which would lead to the decrease of the ownership percentage of the earlier shareholders. In order to protect them, such provisions are used. Pre-emptive rights, which is the right of such shareholders to buy additional shares in the event that the company issues new shares in the future before these shares are available to others i.e the general public, is a type of anti-dilution provision. These provisions should be included in the term sheet.
Right of First Refusal (ROFR)
If someone who is an existing shareholder wishes to sell their shares, then ROFR gives the right to the other investors to buy this stock before it can be sold to any new party.
In the event of a company going bankrupt or being sold, which shareholders would get paid before the others and how much they would be paid is extremely important since investors wish to protect their investment and reduce the degree of risk as much as possible. For this reason, it is important to mention liquidation preference details in the term sheet itself.
The main point of attraction for investors is their share in the profits of the company and how much money they would be earning out of it. How the profit would be distributed, whether it would be paid on regular basis or not, whether it would be cumulative or non-cumulative, et cetera, such details regarding dividends should be mentioned in the term sheet.
Initial Purchase Price
In transactions between parties for merger or acquisition, the initial purchase price of the company is mentioned in the term sheet, along with any contingencies that might affect it. The initial purchase price is fundamental to such transactions and the main point of negotiation between the parties.
Nondisclosure clause and confidentiality clause
The transactions such as the ones talked about hereinabove, often involve sensitive information which should not be known by anyone else except the parties identified and described in the term sheet. For protecting this information, the inclusion of such clauses is necessary.
The document is Non-binding
It is necessary to explicitly state that the term sheet is non-binding. Although a term sheet is generally non-binding, it is safer to explicitly state the same.
Certain other details such as percentage stake, the preferred mode of payment, the timeframe of response, splitting of costs & expenses between the parties, any important date(s), et cetera should be mentioned as well. The term sheet does not include the minute details of the transaction, but these above mentioned clauses are the very base of business transactions and hence necessary to be mentioned. These would then serve as the foundation of the final contract, which would be binding and legally enforceable, between the parties.
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