Understanding Term Sheets: Legal Essentials for Business Agreements

Negotiating documents that could have legal implications is a key part of running a business. It is essential to take the time to understand these documents and their implications before you sign them. A ‘term sheet’ is a key document that your business may come across during an early stage of its growth, for example, when discussing key investment terms with potential investors. This article explores what term sheets do, why it is vital to get this documentation right, and why legal advice is a critical tool to protect your business from risk.

Why Should You Understand the Implications of Legal Documents?

As a founder, you must fully understand the implications of any legal documents you encounter and that others ask you to sign. Misunderstanding or overlooking points in a term sheet can leave your business bound by legally enforceable provisions (such as confidentiality or exclusivity obligations) that may be binding, even if the rest of the document is non-binding. 

Without clarity on what you agree to, you risk accepting potentially challenging or hindering obligations (such as those restricting your ability to grow or pursue new opportunities). You might also find yourself legally committed to obligations you cannot fulfil, exposing your business to breach of contract claims.

Therefore, you should approach all legal documents with caution. Ensure you fully understand them and assess how they might affect your business before rushing to sign on the dotted line.

When Might Your Business Come Across a Term Sheet?

Term sheets commonly appear in business-critical negotiations, such as business funding rounds and significant commercial projects. They lay out the key terms both parties agree on before drafting more detailed contracts.

Term sheets can be especially valuable during investment negotiations. For example, they can allow you to agree on essential terms (such as funding amounts) before committing to the entire contract. Addressing these headline terms early on can help you streamline the negotiation process and ensure all parties align right from the start.

Resolving key issues at the term sheet stage can save you significant time and money. By clarifying expectations upfront, you will be better positioned to minimise delays during drafting and negotiating the final transaction documents. A well-negotiated sheet can help simplify the process of agreeing on a deal, avoiding prolonged arguments or revisions later.

How Does a Term Sheet Typically Operate?

A term sheet acts as a roadmap for your deal. It sets out the essential terms agreed upon between the parties and provides a framework for more detailed negotiations. This helps ensure that both parties understand clearly before finalising the contract.

While parties often intend term sheets to be non-binding, this intention is not always the case. Whether a term sheet is legally enforceable depends on the wording, the parties’ intentions, and the surrounding circumstances. Whilst term sheets may be non-binding in the investment context, you must review the document in full to identify if any parts of the sheet are legally binding. 

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For example, agreeing to an exclusivity clause (depending on its wording) might stop you from pursuing specific other opportunities. Ensuring these clauses are fair and do not place your business at risk is vital. Binding provisions in a term sheet often include confidentiality, exclusivity, costs, or governing law, which carry legal enforceability even if the rest of the document is non-binding. As such, if you wish to avoid enforceability, you must ensure the term sheet explicitly states that it is non-binding.

It is also vital that you clearly understand the practical implications of a term sheet. This includes the powers it could give investors over your business. There is the need to ensure that any terms agreed to do not have negative long-term consequences for your business. 

What are the Benefits of Legal Advice When Negotiating a Term Sheet?

Negotiating a term sheet can feel overwhelming, especially when managing other demands on your time. A lawyer’s input can significantly help you reduce risk and protect your best interests. 

Many businesses sign term sheets quickly, assuming they are just informal agreements. Without legal advice, however, you might commit to terms that are difficult to renegotiate later. With the right legal advice, you can confidently approach your investment deal and ensure it aligns with your business’s needs and long-term strategy.

After signing the term sheet, a lawyer can guide you in ensuring that the final legal documents accurately reflect the agreed terms and help you navigate any further negotiations.

Key Takeaways

Term sheets help provide a clear framework for commercial negotiations. They allow you to address key terms early, helping to align all parties before moving to the detailed contract drafting stage. However, you must understand the extent to which sheets are legally binding. You should also understand how the document wording could impact your business in the long run. 

If you need legal advice on a term sheet document that someone has asked you to review or sign, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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