Almost every businessperson has had this experience: you're super excited about landing a new contract with an important partner, supplier, or customer – at least until you receive a draft agreement from the other party which is so dense, convoluted, and/or inconsistent with your initial business discussion that you are suddenly unsure about how to proceed. When this happens, hopes of finalizing a mutually satisfactory agreement may start to fade.
Where do you go from here? Consider putting aside the draft agreement and preparing a term sheet for further discussion with the other side. A term sheet is a document that summarizes the key terms and conditions of a proposed transaction. Although generally nonbinding, a term sheet can be a useful tool for guiding negotiations and serving as a blueprint for the definitive agreement between the parties.
A term sheet can help facilitate a more successful transaction by:
- Focusing the parties on the key elements of the business deal. This helps each side formulate and refine its own position on important contract terms. Without this focus, it can be easy to overlook key provisions, especially when pressure to close is added to the equation. A term sheet can minimize this risk by keeping everyone concentrated on the most important aspects of the transaction.
- Creating a more level contractual playing field. When a term sheet is prepared, the potential advantage that one party may have by using its own form agreement is effectively eliminated, leading to a more balanced agreement.
- Identifying areas of misalignment during the negotiation phase. Otherwise, discussions may veer off course, becoming drawn out over a long period of time, or worse, caught up in impasse. In this way, a term sheet can reveal immutable obstacles, saving you and your company valuable time (and money) from going multiple rounds with the other side.
- Accelerating negotiation momentum, and ultimately, the closing of the deal.
Anatomy of a Term Sheet
Since a term sheet is intended to provide an overview of the parties' intent and a summary of key contractual provisions, the language used in a term sheet does not need to be the same words that will be used in the final contract. Rather, more complete and developed language consistent with the term sheet will be included in the agreement.
A term sheet is typically formatted in a two column layout, as shown in the below example, with the left-hand column listing the categories of contract provisions, and the right-hand column containing the specific terms desired by the parties. Depending on the business deal, a term sheet can be anywhere from a couple of pages to several pages in length.
| Parties | List your company and the other company (individually a "Party" and collectively, the "Parties"). |
| Summary | Provide a fairly robust summary of the proposed transaction, indicating the key activities/deliverables of each party and the overall purpose of the transaction. |
| Services | Define "Services" in detail. Usually means all services to be provided by one party under the Agreement, including [list the services]. |
| Deliverables | List any deliverables to be provided by either party. |
| License Rights | Describe any licenses that one party will provide to the other, such as software, trademark, and trade secret licenses. |
| Term and Termination | Provide details regarding the length of the agreement [e.g., 12 months, 3 years from the Effective Date], as well as renewal terms, termination rights, and notice required to exercise such rights. |
| Financial Terms | Provide complete financial terms (e.g., all amounts due and all payments made will be in US dollars). |
| Other | Any additional terms and conditions agreed to by the Parties, including representations and warranties, indemnification provisions, and dispute-resolution provisions. |
Once the term sheet is agreed upon, the parties can get to work drafting an agreement which more accurately and thoroughly describes the points covered in the term sheet, along with other contractual provisions and attachments necessary to complete the transaction.
Exceptions
Some transactions do not benefit from preparing a term sheet. For example, short agreements (e.g., a non-disclosure agreement or product evaluation agreement) or agreements whose provisions are fairly common (e.g., a business associate agreement required under HIPAA – The Health Insurance Portability and Accountability Act of 1996) are unlikely to be advanced by a term sheet.
Similarly, if the bargaining power between the parties is so disparate and imbalanced that one side can force the other to negotiate from – or simply accept – its proposed agreement, preparing a term sheet would be a useless exercise and waste of resources.
In sum, term sheets can be a very useful tool in promoting contract negotiations. If you find yourself blocked by the other side in moving a transaction forward, or if the other side puts forth an agreement that fails to capture the essence of the business deal, or if you need your own side to focus better on a transaction, consider using a term sheet to capture the key elements of a deal. It can greatly improve your chances of successfully negotiating the agreement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.