A term sheet is a vital tool utilized in numerous types of business transactions.[1] In its simplest form, a term sheet—also known as a memorandum of understanding or a letter of intent—is an agreement in principle, on the intended terms of a transactions. They usually have very little legal weight behind them and are mostly intended as a means of summarizing the fundamental points of the agreement and demonstrating that both parties are serious about making a deal.
Term sheets come in many styles, and can be as complex or simple as the parties to the transaction desire them to be. Term sheets are generally optional, so it is important for any company that is seeking to execute a transaction with another company carefully consider the pros and cons of using this summarized agreement.
Here are some of the pros and cons of beginning your transaction with a term sheet. Please keep in mind that this blog is not intended as legal advice for your specific circumstances. If you are planning a business transaction with another party, you should always allow a skilled business attorney like those at Muir & Associates to advise you on the best course of action for your situation.
The Pros:
Pro #1 – Term sheets are usually non-binding, which means you can demonstrate that you are serious about conducting the transaction without getting locked into the deal or risking too much too soon. On the other hand, you also have the flexibility to include binding obligations within your term sheet if they would be more beneficial to the negotiations.
Pro #2 – A term sheet includes the various terms and requirements of a deal that are agreed to in principle by both parties. By writing up a term sheet, you can single out points of dispute or contention, and focus your negotiations on those areas. The term sheet will help clarify expectations and make it clear what obstacles must be overcome in order to make the deal happen.
Pro #3 – Even when the term sheet does not containing binding obligations, simply signing on to a term sheet can cause both parties to feel more committed to the deal at hand. Term sheets carry an inherent moral obligation to live up to your word, which can help stabilize an otherwise shaky transaction.
Pro #4 – A term sheet that includes all important terms and relevant information regarding the deal will help ensure that every party understands exactly how the deal will move forward. This will help you avoid misunderstandings that can be incredibly detrimental when discovered later on in the transactional process.
The Cons:
Con #1 – Creating an effective term sheet is usually going to require preparation and negotiations conducted by professionals. This is not free. Depending on the complexity of your deal, writing up a term sheet could become very expensive.
Con #2 – Including a term sheet in your deal can lead to unintended legal consequences. For example, depending on your wording and the circumstances of your deal, you could accidentally create a binding obligation to negotiate in good faith or become committed to other inadvertantly binding conditions within the term sheet.
Con #3 – Sometimes in a business negotiation, it is the things left unsaid that give you the most leverage.[2] By including a term sheet, you may be showing your cards and weakening your negotiating position. Even if there are no legally binding terms, it could be damaging to your reputation to go back on things agreed to in the term sheet during the negotiation process.
Con #4 – Using a term sheet can cause one or both parties to get bogged down in minor details. Sometimes it is more efficient to skip the term sheet and hammer out small details as you go rather than bringing them up so early in the transaction.
This blog is by no means a comprehensive list of pros or cons relating to the use of a term sheet in a business transaction. Always consult with a business attorney on the specifics of your deal and the benefits or detriments of using a term sheet. J. Muir & Associates can help! Give us a call today!
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