Term Sheet Review: Common Issues For Small Businesses

If you are a founder, operator or small business owner, you have probably come across a term sheet at some point. Whether you are raising funds, entering a joint venture, or negotiating a new commercial partnership, the term sheet is often the first formal document that sets out the key points of your deal. But while a term sheet is usually called "non-binding," it can still have significant legal and commercial consequences. Many business owners make the mistake of treating a term sheet as a casual summary, only to discover later that certain terms were misunderstood or that their leverage has changed. This guide breaks down what a term sheet is, what to look for, common pitfalls, and how to protect your interests before you sign.

What Is a Term Sheet?

A term sheet is a document that outlines the principal terms and conditions of a proposed business deal. It is commonly used in startup funding rounds, mergers and acquisitions, joint ventures, and other significant commercial transactions. The purpose of a term sheet is to ensure that all parties agree on the main points before investing time and money in drafting a full contract or more detailed agreement.

Term sheets are usually labeled as "non-binding," meaning that the parties are not legally obligated to complete the transaction. However, certain provisions, such as confidentiality, exclusivity, or break fees, can be binding, depending on the wording and the applicable state law. It is important to understand which parts of your term sheet are enforceable and which are not.

At the federal level, there is no single law governing term sheets. Instead, term sheets are subject to general contract principles, which vary by state. Some states interpret term sheets more strictly than others, especially if the language suggests a clear intent to be bound. Industry norms and the specific context of your deal can also affect how a term sheet is treated.

For example, in venture capital deals, a term sheet is typically a starting point for negotiation and due diligence. In real estate or asset sales, a term sheet (sometimes called a letter of intent or memorandum of understanding) may be taken more seriously by courts if it contains all material terms.

Key Clauses to Watch in a Term Sheet

Not all term sheets are created equal. The details can vary widely depending on the type of deal and the negotiating power of each party. However, some common clauses appear in most term sheets:

• Valuation and Price: Especially in funding rounds, the term sheet will set out the company valuation, share price, and the amount to be invested. Make sure you understand how these numbers are calculated and whether they are pre- or post-money.
• Scope of the Deal: The term sheet should clearly describe what is being bought, sold, or invested in. Ambiguity here can lead to disputes later.
• Payment Terms: How and when will payments be made? Are there milestones or conditions to be met before funds are released?
• Conditions Precedent: What needs to happen before the deal closes? This could include due diligence, regulatory approvals, or board consent.
• Confidentiality: Is there a binding obligation to keep the deal terms private?
• Exclusivity (No-Shop): Are you prevented from negotiating with others while the term sheet is in effect?
• Termination: How can either party walk away from the deal, and are there any penalties?
• Liability and Indemnity: Who is responsible if something goes wrong during negotiations?

Each of these clauses can have significant legal and commercial consequences. For example, an exclusivity clause may prevent you from talking to other potential partners, limiting your options. A poorly drafted confidentiality clause might not protect your sensitive information if negotiations break down.

Always check which clauses are explicitly stated as binding. Sometimes, only the confidentiality and exclusivity provisions are binding, while the rest are not. But vague language or silence on this point can create confusion and, in some states, even lead to unintended legal obligations.

Common Mistakes When Reviewing a Term Sheet

Many small businesses and founders rush through the term sheet stage, eager to move forward with the deal. This can lead to several common mistakes:

• Assuming Non-Binding Means No Consequences: Even if a term sheet is labeled non-binding, certain provisions may still be enforceable. Courts in some states have found parties liable for breaking confidentiality or exclusivity terms, or for failing to negotiate in good faith.
• Overlooking State Law Differences: Contract law is primarily governed by state law. For example, New York courts may interpret a term sheet differently than California courts, especially when it comes to intent and enforceability. Always consider which state law applies to your deal.
• Ignoring Ambiguities: Vague or incomplete terms can create problems later. For instance, if the term sheet does not specify what happens if due diligence uncovers a problem, you may be forced to renegotiate or even walk away.
• Missing Hidden Costs or Traps: Look for break fees, penalties, or other financial obligations that could apply if you decide not to proceed. These can be significant, especially in competitive deals.
• Failing to Align on Key Business Terms: Sometimes, parties agree on high-level concepts but disagree on details like payment schedules, deliverables, or performance milestones. These details should be clarified in the term sheet to avoid disputes.
• Not Getting Input Early: Waiting until the full contract stage to involve legal or financial advisors can be risky. By then, you may have already lost negotiating leverage or agreed to unfavorable terms.

For example, a founder might sign a term sheet with a "no-shop" clause, not realizing it prevents them from talking to other investors for 60 days. If the deal falls through, they may have lost valuable time and opportunities.

Checklist: What to Review Before Signing a Term Sheet

Before you sign a term sheet, use this checklist to help protect your interests:

• Confirm the Parties: Are the correct legal entities named? Double-check company names and signatories.
• Check the Scope: Is it clear what is being agreed to? Are all key business terms included?
• Understand the Binding and Non-Binding Provisions: Which clauses are enforceable, and which are not? Is this clearly stated?
• Review Payment and Timing: Are payment amounts, schedules, and conditions clear? Are there any milestones or triggers?
• Look for Exclusivity and Confidentiality: Are you restricted from talking to others? For how long? What information must be kept private?
• Identify Conditions Precedent: What needs to happen before the deal closes? Who is responsible for what?
• Spot Break Fees or Penalties: Are there financial consequences for walking away?
• Clarify Governing Law and Jurisdiction: Which state law applies? Where would any disputes be resolved?
• Assess Liability and Indemnity: Who bears the risk if something goes wrong during negotiations?
• Plan for Next Steps: What is the timeline for moving to a full contract? Who will draft it?

It is also wise to keep detailed notes of any verbal agreements or understandings that are not captured in the term sheet. These can be helpful if disputes arise later.

State Law and Industry-Specific Issues

Because contract law is primarily state-based, the enforceability and interpretation of term sheets can vary significantly. Here are a few state and industry-specific issues to keep in mind:

• Governing Law Clauses: The term sheet should specify which state law applies. This can affect how courts interpret the document and which provisions are enforceable. For example, New York and Delaware are popular choices for business deals due to their established commercial law frameworks.
• Good Faith Negotiations: Some states, like California, may impose a duty to negotiate in good faith if the term sheet suggests an intent to proceed. This can create liability if one party walks away without a valid reason.
• Industry Regulations: In industries like healthcare, finance, or real estate, additional federal or state regulations may apply. For example, a healthcare deal may require compliance with HIPAA, while a securities investment may trigger SEC rules.
• Employment and Labor Issues: If your deal involves hiring or transferring employees, consider state-specific employment laws, such as non-compete enforceability or notice requirements.
• Licensing and Permits: Some deals require state or local licenses or permits. Make sure these are addressed in the conditions precedent.

It is important to consult with an attorney familiar with the relevant state and industry rules before finalizing a term sheet. Even if you are using a standard template, local variations can have a big impact.

For example, a tech startup in Texas might use a Delaware governing law clause to attract investors, but still need to comply with Texas employment or tax laws as part of the deal.

When Should You Get a Term Sheet Reviewed?

Not every deal requires a full legal review of the term sheet, but there are certain situations where it is strongly recommended:

• Large or Complex Deals: If the deal involves significant money, equity, or assets, a legal review can help you avoid costly mistakes.
• Unfamiliar Terms: If you do not understand any part of the term sheet, or if the language is vague or ambiguous, get advice before signing.
• Binding Provisions: If the term sheet contains binding clauses (such as exclusivity, confidentiality, or break fees), review them carefully to understand your obligations.
• State-Specific Issues: If the deal involves parties in different states, or if you are unsure which state law applies, a legal review can clarify risks.
• Industry-Specific Risks: If your deal is in a regulated industry, make sure all compliance issues are addressed up front.
• Negotiation Leverage: A legal review can help you identify areas where you can negotiate better terms or protect your interests.

Even if you are comfortable with the business terms, a legal review can catch issues you might not have considered, such as hidden liabilities, conflicting provisions, or state law traps. Many founders and small business owners find that a short review at the term sheet stage can save time and money later in the process.

For example, a founder might think a "non-binding" term sheet is safe to sign, but a legal review could reveal that the exclusivity clause is binding and would prevent them from seeking other investors for a set period.

FAQs

Is a term sheet legally binding?

Most term sheets are labeled as non-binding, meaning the parties are not legally required to complete the deal. However, certain provisions, such as confidentiality, exclusivity, or break fees, can be binding if the language is clear. State law and the specific wording of the term sheet will determine which clauses are enforceable. It is important to review the document carefully and clarify which terms are binding before signing.

What happens if I break a term sheet?

If you break a non-binding term sheet, there may be no legal consequences for not completing the deal itself. However, if you breach a binding provision, such as an exclusivity or confidentiality clause, you could face legal action, including claims for damages. Some states also recognize a duty to negotiate in good faith, which could create liability if you walk away without a valid reason. Always check the specific terms and applicable state law.

Can I negotiate the terms in a term sheet?

Yes, term sheets are typically a starting point for negotiations. You can and should negotiate any terms you are not comfortable with, including valuation, payment terms, exclusivity, and conditions precedent. Do not assume that a term sheet is "take it or leave it", most parties expect some negotiation at this stage.

What is the difference between a term sheet and a letter of intent?

The terms are sometimes used interchangeably, but a term sheet usually presents deal points in a list or table format, while a letter of intent is written as a formal letter. Both documents serve a similar purpose: to outline the main terms of a proposed deal before drafting a full contract. The enforceability of either document depends on the wording and applicable state law.

Key Takeaways

• A term sheet is a critical document that outlines the main terms of a business deal, but it can have legal and commercial consequences even if labeled non-binding.
• Always check which provisions are binding, and be aware of state law differences that may affect enforceability.
• Common mistakes include overlooking binding clauses, ignoring state-specific issues, and failing to clarify key business terms.
• Use a checklist to review the term sheet before signing, and consider a legal review for complex, high-value, or regulated deals.
• Negotiation is expected at the term sheet stage, do not hesitate to ask for changes or clarification.

If you are preparing to sign a term sheet or want a second opinion on your deal, our team can help you spot risks and clarify your options. For a confidential discussion, call (888) 449-8437 or email team@sprintlaw.com. Where legal services are required, they are delivered by licensed lawyers at trusted US law firms through the Sprintlaw platform.