Term Sheets Explained: The Deal Before the Deal
- Insights & News
- March 26, 2025
Term Sheets Explained: The Deal Before the Deal
A term sheet is a simple document that outlines the basic terms of a deal before the full contract is written. It’s like a roadmap that helps both sides see if they’re on the same page before spending time and money on detailed negotiations and legal work.
People often call it a Letter of Intent (LOI) or a Memorandum of Understanding (MOU)—these are just different names for the same idea: putting the main deal points in writing early on.
The goal of a term sheet is to show that both sides are serious about the deal and agree on the big-picture terms. Most of the time, a term sheet isn’t legally binding, which means either side can still walk away. But sometimes, it includes a few binding promises—like keeping the deal confidential or not negotiating with anyone else for a certain period.
Term sheets are most common in private business deals, like buying or merging companies (M&A), starting joint ventures, or raising private investment money. They’re usually not used in public deals because that might require public disclosure before the parties are ready.
Uses and Advantages
Term sheets are helpful for a number of reasons, especially when used at the start of a deal. First, they help both sides confirm that they agree on the key parts of the deal “in principle”—even if they haven’t figured out every little detail yet. It’s a way of saying, “Yes, we’re on the same page about the main stuff.”
They also help uncover any major disagreements—called “deal breakers”—before too much time or money is spent. For example, if one side insists on a price that the other side can’t accept, it’s better to find that out early. Another big advantage is that a term sheet helps keep negotiations on track. Once everyone agrees on the basic structure, it becomes easier to write the full legal contract. This can save time, reduce costs, and cut down on unnecessary back-and-forth.
Even though a term sheet is usually not binding, it still gives both sides a sense of commitment. It shows that each party is serious, which can build trust and give both sides confidence to move forward.
A term sheet can also be useful when outside people—like lenders, boards of directors, or government regulators—need to review or approve the deal. Having a clear summary makes it easier to explain what’s going on. Sometimes, the term sheet includes specific binding promises, even while the rest of it stays non-binding. These might include agreeing not to talk to other potential partners (exclusivity) or deciding who will pay what during negotiations.
In complex deals, a term sheet can be a helpful tool for someone who isn’t very familiar with how deals like this usually work. It simplifies things by laying out the basics in a way that’s easier to understand. Finally, in some industries, using a term sheet is just standard practice. If everyone else is doing it, it often makes sense to follow the same steps.
Disadvantages and Risks
While term sheets can be very useful, they also come with some downsides. For starters, drafting a term sheet adds extra work. You’ll need to spend time negotiating and writing this initial document, and that often involves lawyers or other specialists. This can mean more legal fees and higher overall costs—especially if the term sheet ends up being just the first round of negotiations, and you still need to go through it all again when writing the full agreement.
Term sheets can also slow things down. Sometimes people get stuck trying to agree on too many small details too early, and that can drain the energy and momentum from the deal. If negotiations drag on, one side may lose interest or confidence. This is especially risky if there’s a deadline or a limited exclusivity period. Another risk is that parts of the term sheet might be seen as legally binding—even if you didn’t mean them to be. If the wording isn’t crystal clear, a court could decide that you made a legal commitment without realizing it.
There’s also the issue of an implied obligation to negotiate in good faith. Even if you don’t include that duty in the term sheet, a court might say you still have to act in good faith during negotiations. This could limit your flexibility if you decide to walk away or change direction. Also, once you put something in writing—even if it’s non-binding—it can be hard to change it later. The other side may hold you to it, and you might lose leverage if you try to renegotiate those terms later.
Finally, if one of the parties is a public company, a term sheet can trigger legal duties to disclose the deal to shareholders or the public. That kind of early publicity can complicate things, especially if the deal later falls through.
Binding vs. Non-Binding Terms
When parties sign a term sheet, they need to be clear about which parts are legally binding and which parts are not.
Most of the time, the main business terms—like the price of the deal, the type of transaction, or how the company will be structured—are non-binding. These terms are meant to guide the discussion, but either side can still walk away or suggest changes later.
However, some parts of a term sheet are often binding, even if the rest of the document is not. These usually include:
- Exclusivity – an agreement that one party won’t negotiate with anyone else for a certain period.
- Confidentiality – a promise not to share any sensitive information that gets exchanged during negotiations.
- Payment of costs – deciding who pays for what during the deal process, like legal or consulting fees.
In rare cases, the entire term sheet can be binding, but that usually only happens in very simple deals where the parties want to skip writing a full contract. This might happen when one party has strong bargaining power and pushes for a quick, firm commitment.
In short, the parties need to spell out exactly which parts of the term sheet are binding and which are not. This avoids confusion later and helps everyone understand their rights and obligations during the deal process.
Unintentional Binding Obligations
One major risk with term sheets is that a court might treat something as legally binding—even if that’s not what the parties intended. This usually happens when the language in the term sheet isn’t clear or when the behavior of the parties suggests they were acting like they already had a firm agreement.
To avoid this, it’s very important to clearly mark which parts of the term sheet are binding and which parts are not. If this isn’t done properly, a judge might later decide that you accidentally created a binding contract.
When courts look at whether a term or the entire term sheet is legally enforceable, they consider several factors:
- The wording used – if the language sounds definite or firm (like “shall” or “agrees to”), a court may see it as a promise, not just a discussion point.
- The overall context of negotiations – if the parties acted like they had a deal, even without signing a final contract, that behavior may carry weight.
- How detailed the terms are – the more complete and specific the term sheet is, the more likely it is to be viewed as enforceable.
- Whether either side has started performing – if one party begins to carry out parts of the deal, that may signal that both sides treated the term sheet as binding.
- The complexity of the deal – for complex transactions, courts are more cautious and usually expect a formal agreement. But if all the key points are nailed down, a term sheet might still be enforced.
Bottom line: if you don’t want legal obligations, make that absolutely clear in both the wording and your actions. Being vague or casual about it can cause serious trouble later.
Duty to Negotiate in Good Faith
Even if a term sheet clearly says it’s not a binding contract, there’s still a risk that a court might say the parties had a duty to negotiate in good faith—meaning they were expected to be honest, fair, and serious in trying to reach a final deal.
Courts don’t all agree on when this duty applies. Some courts say it only exists if it’s clearly written into the term sheet. Others say the duty can be implied—based on how the parties acted, what was discussed, or how far the negotiations went. So even if the term sheet doesn’t include a line about “good faith,” a court might still find that this obligation existed.
Courts sometimes classify early agreements like this into two types:
- Type I agreements are basically full agreements where all the essential terms have been worked out. Even if the parties say they’ll draft a more formal contract later, these can still be fully binding.
- Type II agreements are different. Here, the parties agree on some terms and agree to keep negotiating the rest in good faith. These aren’t full contracts, but they may still carry an obligation to negotiate seriously and not walk away without a good reason.
If a party fails to negotiate in good faith, the other side might be able to sue for money damages. That could include costs they incurred during the process (called reliance damages) or, in rare cases, even the lost profit from a deal that was expected to go through (expectation damages). Courts usually don’t order specific performance—they won’t force someone to finish negotiating or sign a deal—because it’s hard for a judge to monitor and evaluate the quality of ongoing negotiations.
To avoid problems, it’s smart to clearly say in the term sheet whether or not there’s any obligation to negotiate in good faith. If the parties want that duty to exist, they should spell out what it means. If they don’t, they should consider explicitly disclaiming any such duty in the term sheet.
Content of Term Sheets
What goes into a term sheet depends on the deal and the parties involved, but there are some common items that usually show up.
First, a term sheet should include a basic description of the deal—what kind of transaction it is, what’s being bought or sold, and how the deal is structured (like whether it’s a stock sale, asset purchase, or joint venture). It also lays out the main financial terms: the price, how it will be paid, and any extras like earn-outs (future payments based on performance). This section gives a clear picture of what each side is expecting to get out of the deal.
The term sheet usually includes a timeline, including important deadlines like when due diligence needs to be done and a target date for closing. It also explains how that due diligence process will work—what information will be exchanged, who’s responsible for what, and how long the review will take. It’s also common to include who pays for which costs and fees—such as lawyers, consultants, or brokers.
One important section clearly says which parts of the term sheet are binding and which aren’t. This helps prevent misunderstandings and legal disputes later.
There may be confidentiality clauses (to keep the deal private), exclusivity provisions (to stop either party from negotiating with others), and limits on what can be publicly shared about the deal. The term sheet can also touch on tax treatment, especially if the structure of the deal affects how it’s taxed.
If there are key conditions that must be met before the deal can close—like getting government approvals or third-party consents—these should be spelled out. It’s also smart to list any big assumptions behind the deal (for example, that a major contract will transfer or that financing will be available).
Finally, if the deal will include related agreements—like employment contracts, intellectual property licenses, or non-compete agreements—the term sheet should list those and give a short description of what they’ll cover. This helps everyone see the full picture from the beginning.
Conclusion
- Term sheets serve as a powerful tool to structure early negotiations in private transactions. They help parties align on key deal terms, clarify expectations, and build mutual trust—all before entering into binding contracts. While not usually legally enforceable in full, term sheets often include critical binding clauses that support smoother, more focused dealmaking
- The real value of a term sheet lies in clarity and communication. By thoughtfully drafting and reviewing each term—especially distinguishing between binding and non-binding provisions—parties can avoid misunderstandings, reduce legal risk, and negotiate more efficiently. Understanding how and when to use a term sheet empowers you to manage complex transactions with greater confidence and strategic insight
