In essence, a term sheet outlines the terms, conditions and covenants of a debt transaction between a company and an investor. Each term sheet contains the full legal name of the issuer and the jurisdiction of incorporation. The term sheet is a valuable tool to gauge whether the level of agreement between two parties is sufficient to proceed to the execution and due diligence stages.
Some of the most common aspects within a term sheet are described below, which may vary slightly depending on the nature of the transaction:
Type: The type of security is identified clearly, whether it is a debenture, promissory note, or credit facility. If the debt is convertible (can be exchanged for borrower’s equity under certain conditions), the term sheet may include an attached exhibit showing the convertible form and structure.
Amount: The investment sum sought by the company.
Pricing: The term sheet includes the pricing of the security. For example, if the security is a promissory note, it would be provided at an interest rate such as 12% per annum.
Target Date: The target close date of the transaction. This term may present itself on the sheet as "Maturity Date" or "Term".
Use of Proceeds: A brief outline of the use of funds. For example, the borrower may require funds for working capital for inventory, or growth financing for equipment.
Repayment Schedule: The conditions that govern the repayment of the principal of the security. A repayment schedule can be structured differently depending on whether the loan is amortizing (principal paid down over the life of the loan, with equal payments or otherwise), or is a bullet repayment at the end of the term, or "at maturity".
Events of Default: The predefined conditions, which if met, allow the lender to ask the company for full repayment of its debt obligation.
Covenants: Covenants may be negative or positive. Restrictions or prohibitions that the company must comply with as part of the terms of the security are negative covenants. These are commonly quoted in the term sheet using "thou shalt not". Positive covenants are guidelines the company must adhere to often identified using "thou shalt".
Observer Rights: Whether the company allows the investor to assign an observer to the Board of Directors or not.
Information Rights: The inspection and information rights the investor is allowed, including but not limited to financial statements, budgeting documents, 1 - 5 year company plan, and other documentation. This is often quoted in the term sheet as "customary inspection rights and information rights." The information rights are usually accompanied by a standard form of confidential information and inventions agreement.
Exclusivity & Lock-Up: The duration of time after signing the term sheet for which the company grants exclusivity of financing to the investor.
Duration: The duration for which this term sheet remains valid for consideration and signing.
The term sheet is used to define a summary of the important conditions and terms of the transaction. However, as it reflects the key terms only, the agreement is non-binding. The term sheet often uses phrases such as “negotiate in good faith” or “use best efforts” in regards to reaching an agreement. While it is non-binding, abandoning the agreement still poses some costs for the two parties. Moreover, if one party breaches the contract, there may be additional punitive conditions outlined in the agreement.
Therefore, the conditions laid out in the term sheet and the costs spent on due diligence, negotiation, and legal counsel become a consideration which incentivise further negotiation rather than abandonment of the deal. Once signed, the term sheet also serves as a guide for legal counsel to draft the final documentation.