Are you thinking about selling your business? If so, be prepared to be flexible in your negotiations with buyers. After you list your business for sale, there will be a stream of buyers contacting you to inquire about your company. Naturally, they will ask you information about your business, especially financial information. It is okay to share some basic information, but nothing that can be used against you by your competition. For instance, don’t share a list of clients or suppliers until after a contract is signed.
Once a buyer is finished with their inquiries, they may submit an offer to buy your company if they’re still interested. This won’t just be an offer with a price attached to it; they are going to give you a term sheet as their offer. This term sheet is sometimes referred to as a memorandum of understanding or a letter of intent.
There is no set standard for what a term sheet is supposed to include in it. Basically, the buyer will list all their conditions and terms for purchasing the business on the term sheet. And, of course, it will include their offer price and the terms of the payment (e.g. cash purchase, seller financing). The term sheet serves as an outline which must be followed by both parties if a sale were to take place.
The term sheet is not a legally binding agreement. As the seller, you can agree to the terms of the term sheet without committing yourself completely to the deal. Term sheets are meant to be the first step toward the buyer and seller making a formal agreement. If you agree with the buyer’s terms, then you can proceed to the next step of the process. This would be letting the buyer do their own due diligence. Meanwhile, you can supply them with more information about your company as long as they sign a non-disclosure agreement. After their due diligence is finished, the buyer can decide if they want to proceed forward with the final business sale agreement.
Even though a term sheet is similar to a letter of intent, they are not the same thing. It is true that both documents contain a list of terms and stipulations. The only difference is that a term sheet does not need to be signed by the buyer and seller. The letter of intent, on the other hand, does need to be signed by the buyer and seller. However, the letter of intent feels too official for both parties during these early stages of the deal. Buyers don’t like to sign letters of intent until they’ve done their due diligence first. That is why they choose the term sheet over the letter of intent.
Since term sheets don’t need to be signed, buyers may conveniently email them to you. Either that or the brokers of the buyers will email them. You may end up getting dozens of term sheets in your inbox that you’ll need to examine and sort out. If you find the terms of a particular buyer to look good, you will email or call that buyer to discuss the deal. If you’re both on the same page and have verified that you both agree to the terms, then you can proceed with that buyer.
There is no general rule as to who prepares the term sheet. Buyers may have their own terms, which is why they send them to sellers in the first place. But sellers like yourself are obviously going to have their own terms as well. One thing you can do is fill out a blank term sheet with your terms and upload it to your business "for sale" listing so that prospective buyers can see it. You can indicate that your terms are negotiable, which creates a window for buyers to email you their terms or which of your terms they would like to change. Again, term sheets are not a legally binding contract. They are only meant to start a discussion and get a deal going.
If you’d like to create a term sheet, you must know which information to include in it and how these terms are negotiated and managed. Below is a list of tips to help set you on the right path.
You will obviously want to include your asking price for the company in your term sheet. You can expand on your reasoning behind the price by writing a few paragraphs which outlines your company’s strengths.
2) What is Included in the Sale
How are you selling your business? Are you going to sell stock? Partnership interests? Perhaps you own a sole proprietorship and you’re only selling business assets. Whatever it is, you need to list on the term sheet exactly what you’re selling of the company. Most buyers prefer to purchase assets only because they want to avoid taking on the company’s current liabilities.
Related: Selling Asset vs Stock
3) Price Changes
The agreed price of the transaction might fluctuate somewhat near the closing date, or sometimes even after the closing date. This can be attributed to certain factors of the company which change daily, such as the inventory, accounts receivable, working capital, and so on. When these changes occur, the buyer or seller might feel the need to decrease or increase the price; respectively.
4) Keep Price Offer Discrete
On the term sheet, the seller will usually have to agree to keep the buyer’s offered price discrete. A potential buyer is afraid that another buyer will purposely outbid them if they find out their offered price. So, the buyer wants the seller not to publish their offered price to anyone else. A letter of intent might even be used for this term so that it is legally binding. Of course, if you want to get the highest price possible, you can always hold an auction and have multiple buyers place their bids before you sign any agreement. Buyers have a right of rescission anyway, so the auction wouldn’t be legally binding for them if they change their mind.
5) Payment Terms
The payment section of the term sheet can be long or short. If you’re only accepting cash, then you can just write "full cash due at closing". Chances are, you’re probably going to want to accept more payment options in order to attract more buyers. You may offer a 50% cash, 50% seller financing deal. This means that at the date of the closing, the buyer will pay you 50% of the agreed purchase price upfront. The balance will be owed to you in a promissory note which the buyer will give to you. To protect your own interests, specify in the payment terms that you’re going to keep certain assets or ownership interests in the company until the promissory note is paid in full.
Another payment term option is to have an earn-out for some or all of the total purchase price. An earn-out is when the seller receives one or more payments from the buyer after the closing if the company reaches its projected profit target. But if the profits are not earned, then the buyer is not required to pay the seller. This term is a sure way to gain a buyer’s interest in purchasing your business. You just won’t get any upfront money.
An alternative to an earn-out is a holdback. This is where part of the purchase price goes into an escrow or is simply not paid to the seller until the company performs in a certain way. But if the company faces bad circumstances or events, then the buyer either doesn’t need to pay the seller or they get their money refunded to them from the escrow. These terms will be outlined more in the purchase agreement, but the term sheet should mention them first.
Sellers don’t like to use escrows unless they’re desperate to sell their company. The reason is that escrows totally benefit the buyer. When a buyer pays some or all the purchase price into the escrow, they have complete security that their seller will live up to the terms of the purchase agreement. If the seller violates any part of the agreement, then the escrow money is returned to the buyer. So, whenever your buyer insists on an escrow, make sure there is a deadline set in place for it. This will be the day that the escrow ends and the funds in it get paid to you. It is a good idea to know when that day will be. Otherwise, you could be tangled up for months after the sale waiting for your money.
6) Accounts Receivable
Indicate the terms of the accounts receivable. Does it belong to the seller before the closing and the buyer after the closing? Is there a collection fee involved? Be clear about these terms.
7) Client Transition
If your business has a list of clients, there will need to be a transition for them once the new buyer takes over. The term sheet will outline how these clients will be transitioned from the seller to the buyer. Maybe you and the buyer can hold a joint announcement where you tell your clients about the purchase of the company and how ownership is changing hands. The terms should mention how you will assist the buyer in the transition once the closing is over. Does the buyer need to pay you for providing this assistance? If so, mention it.
8) Non-Competition Clause
A buyer wouldn’t want you selling your company and then starting another company to compete with them. In the term sheet, there may be a non-competition clause where you agree not to compete with the buyer for a specified number of years. This only applies to the same geographical location as the business.
9) Exclusivity Clause
The buyer will likely want an exclusivity clause added to the term sheet. If you agree to this clause, you will not be allowed to talk with other buyers or try to strike a deal with them. The exclusivity clause means that your current buyer has the exclusive right to purchase your company within a set time period. Since the buyer is investing a lot of time, money, and resources into researching your company, they don’t want to have you turn around and sell it to someone else without letting them finish their research.
If your company has a team of managers who are running its day-to-day operations, your buyer may want to keep those managers after they take over the company. To give the managers an incentive to stick around, the buyer may be willing to offer them stock options or a cash bonus for staying with the company. This makes it easier for the buyer to take over the management side of things without losing productivity.
As for the employees of your company, you may add a clause in the term sheet which gives them certain protections too. Maybe you have the buyer agree not to replace them for at least one year or more. The employees will also feel better knowing their jobs are secured once the transition is over.
11) Closing Terms
Any additional closing terms you want to mention should be included in the closing section of the term sheet. These could be things like:
- All warranties and terms listed will stay effective on the date of the closing.
- Buyer will have their own financing source available to complete the purchase.
- Seller abides by all known provisions and laws that apply.
- No charge for equity stocks.
- Buyer has conducted their due diligence and is satisfied with the results.
Seller and buyer agree not to disclose the terms of the term sheet to anyone while active negotiations are being made. This also means no public announcements to the news media or social media. The only way this can happen is if both parties agree first.
13) Due Diligence
Set the terms of the buyer’s due diligence rights. List the type of information they will be allowed to have about your company.
14) Sunset Date
Negotiations cannot go on forever. All the terms and obligations of the term sheet need to expire at some point. This date is called the sunset date. If there is not a closing by the sunset date chosen, then the buyer and seller are off the hook. Now you can freely go and find other prospective buyers to purchase your company.
15) Contingency Clause
Contingencies allow the seller or buyer to walk away from the deal if a specified event arises. A contingency clause is typically reserved for the buyer more than the seller. It gives the buyer a way out of the deal if they cannot follow through. For instance, if the buyer cannot secure a loan to purchase your company, they may want a contingency listed on the term sheet which allows them to cancel the deal in this case. That way, they won’t be obligated to purchase a company that they cannot afford. Of course, all contingencies must be listed on the purchase agreement for them to be legally binding. But they should still go on the term sheet just so both parties are aware of them.
The buyer will likely want certain conditions and requirements met before they purchase your company. These conditions are listed on the term sheet by the buyer. Some examples of these conditions may include financial statements of the last 5 years provided, due diligence, secured financing, and regulatory agency approval. If the conditions are not met, the buyer doesn’t have to complete the deal.
The buyer may request that you give them certain warranties and specify them in the term sheet. This gives the buyer more protection and peace of mind.
18) Government & Laws
Which government’s laws apply here? For instance, if you’re living in the U.S. state of Florida, then your term sheet should indicate that the terms of the agreement are governed by the laws of the State of Florida.
Who pays which fees? Common expenses include advisory assistance, due diligence, professional fees, legal fees, negotiations, and more. Describe which parties pay these fees.
20) Legally Binding Terms
You as the seller cannot go to other buyers and ask them to submit offers. If another buyer makes an offer to you on their own, you must write a letter to the buyer which informs them about this. The normal length of time which goes on the term sheet for this clause is 60 days.
21) Time Period of Acceptance
When the terms are written on the term sheet, there needs to be a specified time period of acceptance of those terms. If the buyer doesn’t sign the paper within that time, they are allowed to make another offer.
If you or the buyer wants to terminate the term sheet agreement, it can be done by giving notice to the other party through email. The reasons for the termination do not need to be specified. But the termination letter must be sent before any purchase agreements or legally binding contracts are signed.
The term sheet serves as an outline of terms for your business sale. It doesn’t need to be a detailed document, but it must cover all areas and clauses which are important. If a future deal is ever negotiated, you and the buyer will need to look at the term sheet to understand what each side wants.