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When entering a transaction with another party, you want to agree on the key commercial terms before a formal contract is drawn up. A term sheet, also commonly referred to as a heads of agreement, memorandum of understanding or letter of intent, is used to outline the key commercial terms of the sale and assist both parties to agree on these before formal documents become involved. This article will explain: 

  • what a term sheet is;
  • what it is used for; 
  • if it is legally binding; and
  • what is included in a term sheet.

What is a Term Sheet? 

A term sheet is a pre-contractual document that is used by both parties to outline and agree upon the key commercial terms of a business transaction. The form of the document will typically be in a table or dot-point form to ensure it is clear for the parties to understand.

What Is it Used For?

Parties commonly use a term sheet in business sale and purchase transactions. It can also be used in: 

  • commercial leasing negotiations; 
  • selling or purchasing shares; 
  • capital raising; 
  • joint venture or partnership arrangements; and 
  • other business transactions. 

The key purpose is to ensure that the key terms are documented and agreed upon before both parties have their lawyer prepare or review the formal contract. This is to minimise protracted negotiation and ‘red-lining’ of the formal agreement once prepared. 

Example

John is selling his floristry business and is currently in negotiations with Mary for the purchase of this business. They have discussed the key terms and now want to have these all compiled into a document. Therefore, John will prepare a term sheet so that he and Mary can both sign and show they are happy with the commercial terms. John will then instruct his solicitor to prepare the contract for the sale of the business based on the terms agreed upon in the document. 

Is it Legally Binding?

A term sheet will not be legally binding unless both parties expressly agree to this. If the parties would like the document to be legally binding, they should write this into the agreement. If it is binding and only subject to the preparation of formal legal documentation, then the term sheet should be detailed. Further, it should, so far as is possible, outline all the clauses to be included in legal documentation to be subsequently prepared by the parties (or their legal representatives). If it is non-binding, then there may be in principle agreement of the parties in relation to fundamental terms, or it may be in the form of a proposal, not a document agreed by both parties, setting out the terms proposed by one of the parties in relation to the proposed transaction.

What Is Typically Included in a Term Sheet?

The content of a term sheet is important to get right. If the document does not have enough information, it can cause uncertainty in the transaction. However, too much detail can also increase the chance of delay in the negotiation process. Depending on what the term sheet is used for, different terms will be required. However, the key inclusions of a term sheet for a sale of a business are as follows:

Assets to be Purchased

You will want to define the assets that are going to be included in the purchase or sale. It is important to outline what the buyer will be getting. It is equally important to outline any items that are excluded from the transaction to avoid any ambiguity.

Conditions Precedent to Completion

There may be certain conditions that are required to be met before the transaction can be completed. These should be outlined in the agreement. They typically include the signing of a formal agreement and obtaining finance. 

Key Terms

The key terms will usually outline when liability is transferred between the parties.

Enforceability 

You should specify whether the term sheet is legally binding. Either way, this should be clearly expressed in the document to avoid any disputes. 

Confidentiality 

You may have already signed a non-disclosure agreement, but it is prudent to have a confidentiality clause in the term sheet. This ensures that both parties keep each other’s confidential information confidential. 

Costs

This should clarify that both parties are responsible for their own costs in connection with the business transaction. You can also include a clause that states the purchaser must pay reasonable legal and third-party transaction costs if they breach the sale agreement. 

Termination 

This should specify when and how you can terminate the agreement. 

Key Takeaways

When you are a party to a business transaction, a well-drafted term sheet will be an important step towards successfully completing the sale. When agreeing on the key commercial terms for the sale of a business, there are numerous matters which must be considered. These include: 

  • what assets are to be included in the sale;
  • how and when the purchase price will be paid; and 
  • the conditions precedent required for the particular transaction.

A term sheet can be binding or non-binding, depending on what is specified by the parties in the agreement. For assistance drafting or reviewing your term sheet to ensure you are well-protected, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page. 

Frequently Asked Questions

What is a term sheet?

It is a pre-contractual document used by both parties to outline and agree upon the key commercial terms of a business transaction.

What is the purpose of a term sheet?

It is to ensure that the key terms are documented and agreed upon before both parties have their lawyer prepare or review the formal contract. This aims to minimise protracted negotiation and ‘red-lining’ of the formal agreement once it is prepared. 

Is a term sheet legally binding?

It is not legally binding unless both parties have expressly agreed to this. If the parties would like the document to be legally binding, they should write this into the agreement.

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