The terms, “Letter of Intent” (or, “LOI”) and “Term Sheet” are sometimes used interchangeably. There is no hard-and-fast rule as to which is right. But, in my experience, there is a general convention among business lawyers, investors, and buyers and sellers of businesses.
This short article will answer the following questions:
1. Are there any differences between a Term Sheet and an LOI?
2. Why is a Letter of Intent or Term Sheet so important?
Click on these links for easy-to-read articles discussing a typical venture capital Term Sheet and a typical business merger or acquisition Letter of Intent, including what is customarily included and why they are needed.
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What are Some Differences Between a Term Sheet and an LOI?
In practice, the name “Term Sheet” is commonly used in the context of a financing transaction. For example, a “Term Sheet” would be a used to outline the important, high-level legal and economic terms of a private-equity investment in a company (be it a startup or a growth-stage company). A Term Sheet would also be used to outline the key provision of a credit facility or other loan arrangement. On the other hand, a “Letter of Intent” or “LOI” is generally prepared by a would-be purchaser in connection with the proposed acquisition of a business (either asset purchase or stock purchase deal), or in connection with another proposed business combination (e.g., a merger).
The structural formats of an LOI and a Term Sheet tend to differ. A Letter of Intent is, as its name suggests, often prepared in the form of a letter from one party (typically the would-be Buyer) to the other (the Seller or target company). On the other hand, a Term Sheet is generally crafted in a sort-of outline format, sometimes even in bullet points. Either way, both set forth the key terms of the proposed deal.
I have seen some articles suggesting term sheets are generally not signed, while LOI's are. That is not my experience. In either case, there is no rule; it is up to the preference of the parties (hopefully on advice of legal counsel). You may also run across the term, “MOU” (for “Memorandum of Understanding”). In my experience, MOU's may not be signed, and this term is used more commonly in the context of a proposed joint venture, strategic partnership or other alliance, rather than in a merger, acquisition or venture capital deal. Still, Term Sheets, LOI's and MOU's are all designed to find common ground, clarify expectations, and avoid “speed bumps” when negotiating and preparing definitive deal documents before the parties invest serious time and costs of due diligence review and preparing the definitive documents.
Why Is A Term Sheet or Letter of Intent So Important?
By whatever name called, these documents have the potential to be among the more important legal documents a company or investor will sign. There are a number of reasons they are so important (and therefore why should be carefully prepared with the assistance of legal counsel on both sides), including the following.
First, these documents prepare a road map for the corporate attorneys and their clients to prepare the definitive deal documents. By discussing and agreeing to material deal points in the LOI or Term Sheet, the process of preparing documents is streamlined (potentially resulting in less overall billable time incurred by lawyers and accountants). This also allows the parties to spot any “deal-breaker” issues or differences they may not have otherwise considered before having invested in due diligence and preparing a voluminous set of deal documents.
Second, an LOI or Term Sheet should provide that neither party is obligated to actually do the proposed deal (that is, the LOI or Term Sheet is “non-binding”). But, they should also specifically provide that certain provisions are binding and enforceable. Those provisions in particular should be drafted very carefully. Parties considering a Term Sheet or LOI should also give thought to which state's law will govern the document. Some jurisdictions have taken the position that, even though a Term Sheet / LOI states that it is non-binding, the parties may nevertheless have a legal duty to negotiate definitive documents in good faith in order to proceed to closing.
Third, the process of negotiating the Term Sheet or Letter of Intent allows each party to get a sense of who the other side is ... who they will be dealing with during the due diligence process, who they will be sharing confidential information with, and who they may have to work with after the closing. This is especially important where the nature of the transaction means that the closing is just the beginning of a long-term, business relationship. Examples include the ongoing relationship between an angel investor or venture capital fund and the company in which it invests; or the relationship between the management teams of a buyer and seller in a merger, or in a business acquisition that includes post-closing obligations and rights.
What Should an LOI or Term Sheet Include?
Read more about what is normally included in a Letter of Intent for a business acquisition. Read more about the provisions typically included in a Venture Capital Term Sheet.
DO IT RIGHT
Term Sheets and Letters of Intent are important legal documents. There are a number of legal and related tax, accounting, and business issues that are usually implicated in them. Contact an experienced business / corporate attorney if you have been presented with an LOI or a Term Sheet, or are contemplating negotiating a Letter of Intent or Term Sheet. Make an appointment now for a free consultation.
This article is not legal advice, but is provided for general information purposes only: see the disclaimer in the footer of this site, and read Legal Notices here.