One of the most important deliverables in Private Equity Training Courses is to convey how to construct thoroughly effective term sheets.
What Is a Term Sheet
A term sheet is how the mutual intentions of a private equity investor – the lead investor if there are several - and a target coalesce.
Once agreed, the term sheet forms the basis for the legally binding Sale and Purchase Agreement for the investment as well as any amendments to the company’s Articles of Association and by-laws.
Sale and Purchase Agreement
The agreement should contain, in clear and unequivocal language, all the major terms of the transaction. These include the quantity of financing, assets or shares, agreed pricing structures of pre- and post-money,
the capital structure of the company’s pre- and post- financing, including existing share issuance and whether new shares will be issued, so a proposed vesting timescale, dilution such as share splits, antidilution clauses for additional share issuance after the deal, pre-emptive investment rights such as tag-along and drag-along rights for subsequent funding rounds or rights issues, liquidation preferences, IPO registration rights, and share options with associated conversion provisions.
Critical valuation questions many years later will be heavily dependent on technical drafting here: path-dependent options valuations, for example, earn-out provisions for another.
Other clauses will cover who pays fees and other costs and when, negotiation exclusivity clauses and their duration – typically between one to three months – and all the proposed rights of investors, including the information, such as the annual operating plan, decision-making, the size and composition of the Board, and Board participation by the investor.
Term Sheets Sections
Private equity investors need the confidence that they can intervene when they deem necessary in business plans, investment, disposal, any dividends payable, key HR decisions and even social or environmental goals.
The term sheet must contain all of these control issues, hence the proposed allocation of rights to different classes of shares.
Finally, most term sheets contain a timetable (with time limits) for the transaction and allocate tasks between the parties.
Term Sheets and Law
Understandably, private equity houses generally outsource drafting to their lawyers, because the use of templates, especially in cross-border transactions, can pose significant problems.
Term sheets themselves used to be immune from the law, especially in England, where there has been a longstanding presumption against negotiation in good faith, and the term sheet itself does not constitute an agreement in itself, only ‘an agreement to agree’, usually ‘subject to contract’. Hence any risk related to misrepresentation or a negligent mis-statements should be minimised and the Petromec (2005) case should not apply to term sheets, where only clauses relating to confidentiality and exclusivity were binding.
The wider perspective provided by private equity training indicates, however, that elsewhere, for example in Delaware since the SIGA (2013) case, recent court cases have already brought this principle into question and allowed for at least the in-principle recovery of damages using the term sheet as a basis.
If documents are not properly drafted, this rule is now even applying in English courts (New Media Holding LLC vs Kuznetsov 2016).
The Future of Term Sheet
This, and the additional vigilance entailed from the minority stakes, most private equity investments outside Europe and the US is now moving in 2017 to settle the debate about how detailed a term sheet should be in favour of tightly negotiated, detailed term sheets, with all terms explicitly spelled out, rather than the old practice of a vague term sheet with the significant terms left for agreement in the actual asset or share purchase agreement.