M&A Term Sheet: A Beginners Guide

18 January 2024
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The world of business is an ever-evolving and dynamic place. Especially when two companies come together in mergers and acquisitions (M&A). They serve as tools for companies that wish to expand their footprint, become more competitive, and capture synergistic opportunities.
two people discussing negotiations over a sheet of paper
The M&A process involves several intricate stages, one of which is negotiations. At the heart of these negotiations lies a crucial document, the M&A term sheet.

An M&A term sheet is a preliminary document outlining the terms and conditions of the proposed transaction. While not binding from a legal standpoint, the term sheet is a foundation upon which the formal acquisition agreement will be built.

Understanding term sheets is vital to get right, especially:

  • In the context of negotiations
  • Exploring their components
  • The pivotal role they play in shaping the future of business partnerships
Let's take a look at why they matter.

Understanding Mergers and Acquisitions

Before delving into M&A term sheets, you must understand mergers and acquisitions.

Mergers occur when two similar-sized companies decide to combine their operations. They create a single, stronger entity. Acquisitions involve one company purchasing another, usually smaller, company.

Both strategies aim to achieve growth, optimise resources, and gain a competitive edge in the market.

Negotiating M&A Transactions

Negotiating M&A transactions is a complex process involving many rounds of discussions. Between the acquiring and target companies, negotiations revolve around crucial aspects.

Elements like valuation, terms of payment, due diligence, and post-transaction integration. Both parties seek to strike a balance between their interests, to reach a joint beneficial agreement.

The Role of M&A Term Sheets

This is where the term sheet comes into play.

Think of it as a roadmap. It guides the negotiation process by identifying key points that need agreement. It acts as a tool to ensure both parties are on the same page before investing significant time and resources into the due diligence and legal phases.

Components of M&A Term Sheets

Here's what you can find on a term sheet. Each part plays an important role in the M&A process.

Price and Payment Structure

The price is a critical component of any M&A transaction. The term sheet outlines whether the deal will be an all-cash transaction, stock-for-stock exchange, or a combination of both.

Let's take a look at an example:

Company A might propose to acquire Company B for $50 million, with 60% of the payment in cash and 40% in Company A's shares. This information is present on the term sheet for both parties to see.

Due Diligence and Conditions Precedent

The due diligence involves a thorough assessment of the target company's financials, operations, legal status, and other pertinent factors.

How does this relate to the term sheet?

The term sheet specifies the scope and duration of due diligence, along with any conditions before the transaction proceeds.

For instance, Company A might stipulate that the acquisition is contingent upon Company B's passing of financial and legal due diligence within 60 days.

Representations and Warranties

Representations and warranties are assurances made by both parties concerning the accuracy of information shared during negotiations. These ensure that both sides are transparent and honest about their financial and operational status.

Employee and Management Matters

The term sheet addresses the treatment of employees and management post-acquisition. This may involve decisions about retaining key personnel, providing employee benefits, and addressing potential redundancies.

For example, Company A might promise to keep Company B's management team for at least one year following the acquisition.

Governing Law and Dispute Resolution

Determining the jurisdiction whose laws will govern the agreement and the mechanism for resolving disputes is crucial. The term sheet may specify who the agreement will be governed by, and any disputes will be resolved through arbitration.

Examples of M&A Term Sheet Clauses

You might be wondering if there are any clauses in an M&A term sheet. Here's the breakdown:

No-Shop Clause

A "no-shop" or "exclusivity" clause prevents the target company from seeking out other potential buyers during the negotiation period. This gives the acquiring company a fair chance to complete its due diligence and complete the deal.

For instance, the term sheet might include a clause stating that Company B will not entertain offers from other parties for 90 days.

Breakup Fee

In some cases, if the target company backs out of the deal after the term sheet is signed, it may have to pay a breakup fee to the acquiring company. This fee compensates the acquiring company for the time, effort, and resources invested in the negotiation process.

An example could be a breakup fee of 3% of the final buying price if Company B terminates the deal without valid reasons.

Earn-Out Provision

In situations where the target company's future performance is uncertain, you might see an earn-out provision.

This clause allows the acquiring company to pay extra consideration based on the target company's future financial performance.

For instance, the term sheet could outline that Company A will pay an extra $10 million if Company B achieves a certain revenue target within two years post-acquisition.

Why Are M&A Term Sheets So Important?

We've seen what a term sheet can offer. But what is the often unseen benefit of using one?

M&A term sheets serve several crucial purposes in negotiations:

Clarity and Alignment

Term sheets help both parties gain a clear understanding of the fundamental terms of the deal. Addressing key points early on reduces the likelihood of misunderstandings and misinterpretations during later stages of negotiations.

Efficiency

Negotiating an M&A deal involves a significant investment of time, money, and resources. Term sheets act as an efficient checkpoint to ensure that both parties are in agreement on the fundamental terms. All before proceeding with more time-consuming activities like due diligence and legal drafting.

Framework for Legal Documentation

While not a legal document, term sheets provide the foundation for drafting the acquisition agreement, which is legally binding. They guide lawyers in structuring the agreement and help ensure that all agreed-upon terms are included.

Reduced Risk of Failed Deals

By outlining key deal terms, term sheets reduce the risk of a deal falling through in later stages due to disagreements on essential issues. If the parties can't see eye-to-eye on fundamental aspects, the term sheet stage provides an opportunity to address and resolve these issues before proceeding further.

What Else Matters in the M&A Negotiation Process?

The M&A term sheet is a pivotal instrument in the landscape of negotiations surrounding mergers and acquisitions.

These documents act as guiding frameworks. They assist parties in achieving a shared understanding of crucial deal terms.

By clarifying elements like price, due diligence scope, and conditions precedent, term sheets pave the way for smoother negotiations and help the creation of acquisition agreements.

While not binding themselves, these documents hold significant weight in shaping the course of M&A transactions and play an indispensable role in ensuring successful business partnerships.

This is one step in the big picture of mergers and acquisitions. Be sure to check out our Advanced Negotiation Issues in M&A course and become a master of the trade.

FAQ

What is the Difference Between a Term Sheet and a MoU?

A term sheet outlines key points of a deal, like investment terms in a startup. An MoU (Memorandum of Understanding) is a step before a formal agreement, showing a party's intent to work together. A term sheet is specific, whilst the MoU is preliminary.

Eager to learn more about the M&A negotiation process? Click below to find out more about Redcliffe Training’s Advanced Negotiations Issues in M&A Course:

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