The Acquisition Term Sheet
The term sheet is a brief document submitted by the acquirer to the target company, in which it states the price and conditions under which it offers to acquire the company. A draft of the term sheet is usually circulated among the parties and their attorneys for changes to be negotiated before a final version is signed.
The key elements of a term sheet are:
- Binding. The term sheet will state whether the terms in the document are binding. Usually, they are not, and it will go on to state that the terms are subject to the eventual negotiation of a purchase agreement.
- Parties. This states the names of the acquirer and the target company.
- Price. This is the total amount of consideration to be paid to the seller. There should be a statement that the stated price will vary, depending upon information uncovered during the due diligence process.
- Form of payment. This states whether the price will be paid in cash, debt, stock, or some mix of these elements.
- Earnout. If there is to be an earnout, this clause states how the earnout is to be calculated.
- Working capital adjustment. This states any changes in the purchase price that will be triggered if the seller’s working capital varies from a certain predetermined amount as of the closing date.
- Legal structure. This states the form of the legal structure to be used, such as a triangular merger or an asset purchase. The legal structure can have profound tax implications for the seller, so this item may require considerable negotiation.
- Escrow. This states the proportion of the price that will be held in escrow, and for how long.
- Due diligence. This states that the acquirer intends to conduct due diligence, and may state the approximate dates when this will occur.
- Responsibility for expenses. This states that each party is responsible for any legal, accounting, and other expenses related to the acquisition transaction.
- Closing. This states the approximate date when the acquirer expects that the purchase transaction will close.
- Acceptance period. This states the time period during which the terms stated in the term sheet are being offered. The recipient must sign the term sheet within the acceptance period to indicate approval of the terms. Limiting the term of the offer allows the acquirer to later offer a different (usually reduced) set of terms if the circumstances change.
The term sheet may go no further than the preceding points, or it may include a number of additional clauses, such as:
- No shop provision. The seller agrees not to shop the price given in the term sheet to other prospective bidders in an effort to find a higher price. This clause can be legally binding.
- Stock restriction. If payment is to be in stock, the acquirer will likely require that the seller cannot sell the shares within a certain period of time, such as six or 12 months.
- Management incentive plan. There may be a bonus plan, stock grants, stock option plan, or some similar arrangement for the management team of the seller. This clause is intended to quell any nervousness among the managers, and may gain their support for the deal.
- Announcements. Either party may feel that it would be damaging to announce the term sheet to the general public or news media, so this clause states that doing so must have the prior approval of both parties.
- Conditions precedent. This states the requirements that must take place before the acquirer will agree to complete the purchase transaction. Examples of conditions precedent are having several years of audited financial statements, the completion of due diligence, the approval of regulatory agencies, the completion of any financing by the acquirer to obtain the funds to pay for the transaction, and/or the condition of the seller being substantially as represented to it. The acquirer includes these items in the term sheet to give itself a reasonable excuse to extricate itself.
- Representations and warranties. This is a short statement that the acquirer will want representations and warranties from the seller in the purchase agreement, under which the seller essentially creates a warranty that the business it is selling is as represented to the acquirer. This clause technically applies to both parties equally, but the real legal burden is on the seller.