Using Non-Binding Term Sheets in Business Deals (Part 1)
As we all know, non-legally binding term sheets, letters of intent, and memoranda of understanding (let’s just call them all “Term Sheets”) are used in corporate investment and acquisition deals all the time. The reasons for using a Term Sheet in these situations are pretty easy to see: everyone understands that these are major deals that require a lot of time and legal spend to fully negotiate and document out. Using a Term Sheet – even though it is not legally binding -- allows both sides to efficiently work out the major deal points at the start, saving lots of time, legal hassle, and disruptive arguing down the road.
However, in MGLS’ experience, Term Sheets can be used for a lot more than only investment and acquisition deals. In fact, Term Sheets can be an incredibly useful tool for any business working on any unusual and significant agreement or arrangement with one or more third parties.
In this PART 1 on this topic, we discuss what is usually meant when someone talks about a non-binding Term Sheet, when a business might consider using Term Sheets, and why they can be so useful in working out big and/or complicated deals.
In PART 2, we will discuss what sorts of terms you should consider including in a Term Sheet, what sorts of items are probably OK to leave out, and what role your lawyer has in the Term Sheet process.
What Is A Non-Binding Term Sheet?
First, let’s clarify what we mean by a Term Sheet.
A Term Sheet is a document that sets out the important business and legal points for a particular proposed deal in a high level/summary manner so there is an agreed-upon framework to work from to guide the drafting and negotiation of the legally binding documentation for that deal.
When we talk about a Term Sheet being “non-binding (and you could choose to have a legally-binding Term Sheet), what we mean is that, in general, the items agreed to in a Term Sheet are for discussion purposes only and, by themselves, create no contractual rights for either side.
That said, even in a non-binding Term Sheet, it is common to include at least a couple of legally binding provisions. Most common is some sort of confidentiality provision that requires each side to keep the Term Sheet and related discussions private to the parties involved. Another legally binding term you see is a requirement that the deal negotiations must be exclusive between the parties for some period of time.
Unless you want everything in a Term Sheet to be legally binding, a Term should always include clear that language that says that, other than specifically those legally binding provisions that may be included, the Term Sheet is “not legally binding” and neither side is obligated to enter into the proposed deal or any related agreements just because they agreed upon and perhaps even signed the Term Sheet.
2. When Should A Business Think About Using A Non-Binding Term Sheet? When Is It Less Likely To Be Worth The Effort?
In addition to corporate investments and acquisition deals (where non-binding Term Sheets are used as a matter of course), your business should consider using a non-binding Term Sheet for any complicated and/or novel business arrangement that involves a high level of risk or reward.
For instance, a Term Sheet may be very helpful for negotiating that major strategic partnership you’ve been discussing with another company. Or for clarifying what’s required when you engage a key service provider to perform business-critical functions according to some unusual and/or very specific requirements.
On the other hand, a Term Sheet is probably not going to be as necessary when your business is working a deal – even if it's a really big deal, dollar-wise – that involves the same business terms, and the same legal documentation, of the kind your business customarily enters into. For example, you probably don’t need to work out a Term Sheet when a new customer wants to get a ‘50 user’ account for your B2B SaaS platform instead of the average ‘10 user’ account so long as the customer is not insisting on all sorts of unusual extras to close the deal.
3. What Makes Term Sheets So (Potentially) Useful?
First, taking the time to work out a Term Sheet helps both sides identify unspoken and unidentified assumptions about the deal that could have a huge impact.
Second, you can make sure that both sides are on the same page on key items. For example, if the deal is going to have a complicated multi-component fee structure, it’s usually a very good idea for the business teams to work that in the Term Sheet instead of leaving it to the lawyers.
Third, it’s a good way to find out if the other side is not serious about meeting some of your deal requirements. One way to discover this is when you ask to include specific language in the Term Sheet for an item of particular importance and the other side instead pushes to keep the language for that item fuzzy and lacking in detail.
Fourth, it helps you learn if the other side is a bad-faith negotiator. This happens when you agree on a Term Sheet and then, in the middle of negotiating the actual legal documents, the other side tries to suddenly change the deal terms to exploit some perceived advantage. Maybe you’ll do the deal anyway, maybe you won’t, but either way, it is very helpful to know what sort of business you are dealing with and how they play ball.
Fifth, you can save a lot on outside attorney fees and time. By getting the business teams to work out a Term Sheet, you reduce the risk of a lot of complicated and expensive back and forth between lawyers – and that’s something that happens all the time when major deal points have not been identified or agreed upon.
Conclusion
When dealing with any major deal, especially one with novel or unusual business or legal terms, it is easy enough for businesses to get bogged down in a complicated and very expensive legal agreement drafting and negotiation process. Used intelligently, a non-binding Term Sheet can provide a clear roadmap to getting your deal finalized and closed while helping you spot and avoid unexpected deal risks.
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If you’re interested in our other content about major business agreements and arrangements, please see “Indemnification Clauses: What Are They and Why Do They Matter?” , A Client Requires Insurance: What Should You Do?“, or any of the other very helpful articles available at MGLS Insights.
Disclaimer: This article constitutes attorney advertising. Prior results do not guarantee a similar outcome. MGLS publishes this article for information purposes only. Nothing within is intended as legal advice.