How to Use a Term Sheet to Make an Offer to Buy a Business
What is a Term Sheet?
According to Wikipedia, “a term sheet is a bullet-point document outlining the material terms and conditions of a business agreement. After a term sheet has been "executed", it guides legal counsel in the preparation of a proposed "final agreement".” When a buyer presents a term sheet, they are presenting a document that lists the basic terms of an offer. The document is negotiated back and forth until the parties reach an agreement on the basic terms. Then, the attorneys draft the legal documents for the parties to sign. Because the term sheet is merely the outline of a deal, it is important that the parties use disclaimers so the term sheet does not become a binding agreement.
Advantages of Using a Term Sheet
Terms sheets are a good way to make an offer to buy a business for a few reasons. They save time and money. Term sheets are usually presented in email format. They are usually drafted by the parties or their brokers, not attorneys. By only including the most important terms of the proposed deal, they can be drafted, edited, and sent back and forth more quickly than legal documents. By not having an attorney draft a complete letter of intent, a buyer can save money, and time, if his offer is not accepted.
It is important, when presenting a term sheet, that there is clear language that it is not a binding agreement. When we are negotiating a term sheet, here is the disclaimer that we start any email with: “The contents of this email are not intended to represent or form a legally binding offer or an acceptance, nor should the contents otherwise be considered as a contract or interpreted to create a contract or other legally binding obligation on the part of the buyer or the seller.” If you are using a term sheet to negotiate an offer, get similar language from your attorney.
What to Include in a Term Sheet
When presenting a term sheet offer, it is important to include all the important terms of the offer:
What assets are included, or excluded? Does the price include accounts receivable, inventory, assumption of any debt? Be clear on what is or is not being bought.
What price is being paid? Is there a deposit? Is all of the price being paid at the closing? Is anything being paid for training? Is any of the price an “earnout” based on sales after the closing?
How is the price being paid? How much is the buyer putting into the deal? Is there any seller financing? If so, how much, what term, at what interest rate, and how is it being paid back? A personal guarantee is usually required by sellers so that should be addressed – whether the buyer will, or will not, give it. What third party financing will the buyer seek to obtain. Again, what are the terms of the third party financing? A seller will want to know that what the buyer is seeking is realistic.
Obtaining a lease on the facility where the business is located is usually a contingency in an offer. The basic terms that the buyer is seeking should be included in the term sheet: The rental rate and term of the lease should be stated. If the buyer is seeking any changes in the basic terms of the seller’s lease, these should be pointed out.
If the business is a franchise, the closing of the sale is contingent on the approval of the buyer by the franchisor. This should be stated in the term sheet as a contingency. The term sheet should state who will pay any franchise transfer fees.
The terms of training and transition, or continued seller employment, should be included in the term sheet. This specifies how the buyer is getting trained and what other post closing support the sellers will provide. It could include how much the seller is being paid for the training if the training will be more than normal.
The Letter of Intent or Purchase Offer
A purchase offer, letter of intent, or non-binding letter of intent should follow the term sheet. The buyer should state which he requests. If the buyer is proposing a non-binding letter of intent with an exclusivity period, the length of the period should be included in the term sheet. The buyer should state what agreement will be the final sale document – such as an Asset Purchase Agreement. The buyer may wish to add that this document will have standard representations and warranties.
Depending on the type of business and the situation of the buyer or seller, more terms can be included in the term sheet. For example, the sale of a liquor store would be contingent on the transfer of the liquor license. The sale of a vocational school would be contingent on approval by various government agencies and the trade association.
This list of what should be included in a term sheet may seem excessive. It isn’t. By having agreement on these basic terms of the deal, it will speed up the process, reduce the risk that the deal will fall apart later, and save money on attorney fees by not using the attorneys to negotiate these substantive parts of the deal. One last reminder, use disclaimer language. And, use your attorney to draft the offer and final purchase document. A term sheet should not replace either.