Issue 02-2023
This blog post continues our Foreign Direct Investment series for foreign enterprises seeking to enter the US marketplace via an acquisition of or merger with an existing US business. In our first post, we discussed the legal document that opens the door for the foreign suitor’s initial access to some basic information about the target, that is, the Non-Disclosure Agreement or NDA. In this post, we discuss the initial “deal document” commonly referred to as a “Term Sheet”, “Letter of Understanding”, or “Memorandum of Understanding” (collectively referred to as a “Term Sheet” or “Term Sheets”).
Term Sheets usually come into play once the foreign suitor (the “Client”) has contacted the acquisition target (the “Target”) and has engaged in a series of discussions leading to the Target’s interest in exploring a potential sale of its business and the Parties have executed either a Unilateral or Mutual Nondisclosure Agreement.[1] The NDA has allowed the foreign suitor to conduct certain level of due diligence upon the Target so as to allow the Client to formulate a preliminary valuation or range of values as to the Target’s enterprise value, along with certain key terms associated with a proposed transaction. However, at this stage the level of information provided to the Client by the Target is not sufficient to offer a definitive binding acquisition agreement. This is due to the Target often withholding critical business information until later in the negotiations where the Target feels more secure in “getting a deal done”. At the same time, the Client cannot commit to a definitive offer to purchase until this information is provided by the Target.
To bridge this divide, the Term Sheet comes into play as it serves as a “place holder” until the parties finalize negotiations and a definitive merger or acquisition agreement is executed by the Parties. As such, the Term Sheet sketches-out the framework or key economic and business terms of the Client’s proposed purchase offer, such as the following provisions:
- Purchase Price – can be expressed as lump sum or range of valuation
- Manner of payment – cash, stock exchange, debt or combination, or earn-out
- Deal structure:
- Asset Sale –
- identification of assets to be purchased
- Liabilities to be assumed by Client or remain with Target
- Stock Sale – all assets and liabilities acquired
- Merger – variety of forms
- Asset Sale –
- Right of Client’s due diligence investigation with defined expiration date
- Key Target employees to be retained in the sale
- Regulatory approvals needed if any
- Lock-up
- Termination
- Choice of Law
Other key terms may be expressed as well depending upon the particulars of the subject deal. Moreover, a standard Term Sheet should clearly stipulate whether the Term Sheet is legally binding upon the Parties or whether it is nonbinding with clear expression of no liability accruing to either Party upon execution of the Term Sheet.
Of course, a binding Term Sheet locks in both Parties to completing the deal and should the Target refuse to go thru with the sale or the Client reneges upon acquiring the Target, legal liability will accrue to the Party in breach. Thus, in many instances, the Client will stipulate the Term Sheet is nonbinding in order to avoid liability attaching to its Term Sheet. However, the Client may nonetheless qualify the nonbinding nature of the Term Sheet by stipulating a certain provision or several provisions are indeed binding upon the Parties with all other terms having no binding effect.
A key provision which is a Client will want to stipulate as binding is the “Lock-Up”. This provision basically takes the Target off the market for the Term specified in the Term Sheet. Thus, the Target is prohibited from any discussions or entertaining any third party offers to purchase the Target. This gives the Client an exclusive period to complete its due diligence and propose a definitive acquisition or merger agreement. Having this exclusive period to complete a deal is often heavily negotiated as the Target will not want to be “locked-up” for an undue period of time.
Moreover, regardless of the final terms which comprise the Term Sheet, there is no substitute for speed in “getting the deal done”. In reality, time is not a friend of the Client once a Term Sheet is in play. The longer it takes to finalize a deal, business conditions will unavoidably change for both Parties and may over-take the key assumptions underlying the transaction resulting in its demise. Our advice is simple, once the Term Sheet is executed, have your deal team ready to go and complete its due diligence promptly and begin preparation for final negotiations and definitive deal documentation.
A properly drafted Term Sheet sets the stage for the subsequent phases of the acquisition deal, starting with the business, legal and financial due diligence, which we will explore in our next issue. A “do-it-yourself” approach in this area is potentially very ill advised, and the need to use professional assistance for the negotiation and drafting of the Term Sheet cannot be overemphasized.
Next-up in our Series is “Undertaking Due Diligence”
[1] See our 1st blog post in this Series dealing with the Nondisclosure Agreements.
