Setting the Right Foundation for Your Business Deal: Term Sheets vs LOIs
Acquiring or selling a business is one of the most exciting decisions an entrepreneur can make. You’ve either found the perfect company to acquire or received an offer that validates all the hard work you’ve poured into building your business. But with the excitement comes uncertainty: what happens next? How do you get from initial interest to closing a deal?
Perhaps there’s been conversations ending in a handshake deal, or even conference calls with interested parties (even lawyers!). One way or another, certain key terms have been offered and accepted, and it’s time to put things in writing. The process begins with setting the right foundation, and that’s where understanding term sheets and letters of intent (LOIs) comes in.
Setting the Right Foundation
Sales and acquisition negotiations are delicate at every stage, but especially when transitioning from initial interest to a written agreement. At this stage, the parties often have no intention of being legally bound but use preliminary agreements as a way of memorializing where the negotiations stand.
When setting the foundation for a deal, using the right document from the start can make the difference between a smooth transaction and one that drags on unnecessarily. Term sheets are often the better tool for most deals because they provide a clear, efficient way to align key terms without getting bogged down in excessive drafting or negotiation too early. While LOIs may be appropriate in certain highly regulated industries or deals requiring lender approvals, they can create unnecessary complexity at the preliminary stage.
What are Term Sheets and LOIs?
Term sheets and letters of intent (LOIs) serve to outline the core aspects of the business deal. They act as the bridge between an informal conversation and a formal contract. They provide a framework to explore the deal’s feasibility while setting the stage for the rigorous process of due diligence, negotiation, and drafting definitive agreements. Both term sheets and LOIs outline the major, key terms of a deal, but they look different and function in distinctly different ways.
A term sheet is a concise, non-binding document that outlines the major deal points in an easy-to-read format, often in table form. It’s useful when parties want to quickly align on key terms without getting caught in lengthy negotiations over wording
A letter of intent (LOI), on the other hand, is more structured. It often includes detailed descriptions of the deal terms and may incorporate legally binding provisions, such as confidentiality, exclusivity, or where regulatory approval or lender financing is required. LOIs can be beneficial when parties need a formalized commitment before incurring significant due diligence costs.
While term sheets are flexible, they can still provide the necessary clarity for complex transactions when drafted properly. Even when regulatory approval or lender financing is required, key terms can be outlined in a term sheet without forcing the parties into legal negotiations too early. Overcomplicating early discussions with an LOI often wastes time and money instead of moving the deal forward efficiently.
Avoiding a Negotiation Before the Negotiation
When it comes to laying the groundwork for a business deal, clarity and efficiency are paramount. The parties are free to give the preliminary agreement whatever meaning they think will fit their special needs.
Consider a business acquisition where the parties opt to use an LOI instead of a term sheet to outline preliminary deal terms. Because an LOI typically requires detailed language to ensure clarity, the parties can become bogged down in drafting provisions that might otherwise be summarized in a simple table of key terms. For example, instead of quickly agreeing on the purchase price, payment structure, and key conditions for closing, the parties might spend weeks debating the payment of the price (e.g., lump sum, installments, earn-outs, etc.), or the wording of exclusivity clauses, termination rights, or dispute resolution mechanisms—all before they even begin drafting the definitive agreement.
Clients may find themselves paying for extensive back-and-forth negotiations over a document that was intended to be non-binding and meant to be preliminary. In the meantime, the excitement of the deal can fade, and momentum can be lost. This is why careful drafting is critical to ensure the document aligns with the parties’ intent.
While a term sheet’s streamlined, high-level format allows parties to align on essential points and move forward efficiently to the actual contract phase, saving time, money, and frustration, a term sheet that is too vague can also create problems. If intellectual property rights, customer contract transfers, or non-compete terms are involved, a well-drafted term sheet can outline these key points clearly without turning into a full contract too soon. If a term sheet is too vague, parties may have different expectations when drafting the purchase agreement. Instead of resorting to an LOI, businesses can avoid this by structuring their term sheet with the right level of detail from the start.
In certain industries such as technology, healthcare, or finance, clauses related to confidentiality, exclusivity, or dispute resolution can make or break a deal. If key terms such as these are left ambiguous, the parties may have vastly different expectations when drafting the purchase agreement. Getting these details right in the preliminary documents can prevent costly disputes later.
Conclusion
Acquiring or selling a business is an exciting and complex process. For most business sales and acquisitions, a term sheet is the smarter choice. It aligns key terms efficiently, prevents premature legal expenses, and avoids the risk of unintended obligations. Business owners should avoid overcomplicating negotiations with an LOI when a well-structured term sheet can accomplish the same goals more efficiently. At Kadian Law, we help you choose the right tools to protect your interests and close deals smoothly.