Term Sheet vs Letter of Intent vs Purchase Agreement

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December 9, 2024
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16 min read
Term Sheet vs Letter of Intent vs Purchase Agreement

Term sheets, letters of intent, and purchase agreements are key business documents used in negotiations, acquisitions, and investments. Each document serves a distinct purpose and is important for successful business transactions.

Understanding these documents is crucial for effective deal-making. The term sheet sets the roadmap. A letter of intent provides a preliminary agreement structure, while a purchase agreement signifies the conclusion of the deal-making process.

This article provides insights into these documents, including their differences, distinct roles, and importance. You will also understand when to use each to master the negotiation strategies they foster.

Are you an entrepreneur, business owner, startup founder, legal professional, business advisor, investor, or corporate professional in M&A (mergers and acquisitions) involved in negotiating or structuring business deals or transactions? This article is for you.

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Key takeaways

  • Term sheets, letters of intent, and purchase agreements are key business documents used in negotiations, acquisitions, and investments.
  • The term sheet outlines the deal's roadmap, the letter of intent (LOI) establishes preliminary agreements, and the purchase agreement completes the transaction.
  • Valuations, equity percentages, and investment terms are some common term sheet elements.
  • Terms and conditions, timeline, and confidentiality are‌ some of the common elements of the letter of intent.
  • The key components of a purchase agreement include the assets or shares being purchased, the price, post-transaction obligations, and disclosures. 

What is a term sheet?

 Definition and purpose

A term sheet is an initial document outlining key terms and conditions of a potential deal. It is a non-binding document in business negotiations. Lead investors, angel investors, venture capitalists, financial institutions, and acquiring companies in a merger and acquisition transaction usually issue this business document.

It serves as a roadmap for both parties during negotiations, ensuring that everyone agrees regarding the basic terms of the investment or agreement. 

Although a term sheet is not legally binding, it lays the groundwork for further discussions and helps parties assess the feasibility of proceeding with the deal. The non-binding nature of term sheets allows for flexibility and encourages open communication between parties.

Term sheets usually contain information on the assets, the initial purchase price, any contingencies that may affect the cost, a time frame for a response, and other important information.

When is a term sheet used?

A term sheet is often used when a startup raises funds at a specific valuation, known as a priced round. Here, an investor exchanges money for preferred stock in your startup at a price per share based on the valuation. A term sheet is sometimes used in seed rounds but is more common in Series A rounds and beyond.

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A term sheet details the investment amount and outlines the detailed terms for calculating the price of the preferred shares the investor will receive in exchange for their capital. It also defines the investor's rights within the agreement.

A team sheet for startup investment includes the startup’s valuation at the time of investment, how much equity the investor will receive in exchange for their funding, the number of seats the investor will hold on the board of directors, terms for selling the company or going public, preferred rights and conditions under which the founders' equity vests over time.

  • Mergers and acquisitions (M&A):  A term sheet covers the terms for a proposed acquisition or merger, which may include the price, structure of the deal, and any due diligence that must be addressed before the completion of the deal. The term sheet acts as a blueprint for the final merger or acquisition agreement, addressing key issues like the purchase price, closing conditions, non-compete clauses, and employment terms.

Common elements of a term sheet

Below are the common elements of the term sheet

  1. Valuation

Valuation is one of the most common elements of the term sheet. It is the estimated worth of a company as an investment. It is expressed as a price per share on a fully diluted basis, calculated by dividing equity value by all issued shares and convertible securities. 

Valuation can be presented in two forms:

  • Pre-money valuation: This represents the company’s value before the new investment. 
  • Post-money valuation: This reflects the company’s value after the new investment.

As Valuation in a term sheet is critical to the deal's fairness and the future distribution of returns, startups should carefully consider the valuation and ensure it aligns with their growth plans while also providing a fair return for the investor.

  1. Equity percentage

Equity percentage represents the investor's ownership stake in the company, determined by their investment amount and the company's post-money valuation. Investors may seek a certain percentage to secure a board seat or voting rights. 

The term sheet should specify the amount of equity the investor will receive in exchange for their investment, and the startups should negotiate to minimize the dilution of their equity.

  1.  Investment terms

These terms in a term sheet outline the investment's financial details, including the amount invested and how it will be structured.  The investment can be a one-time infusion or split into multiple tranches based on certain milestones or timeframes. 

Startups must assess their funding requirements and align them with the investment structure proposed by the VC. 

  1. Rights of investors 

This protects the investors' interests. It includes anti-dilution protection, voting power, board representation, access to company information, pre-emptive rights, drag-along rights, and the right of first refusal.

  1. Liquidation preference

This represents how the sale proceeds will be distributed between the entrepreneur and the investors. 

While VC investors often negotiate for preferred returns, meaning they get their capital back before other shareholders, startups should balance these terms to avoid favorable liquidation preferences that could limit potential returns for founders and other shareholders.

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What is a letter of intent (LOI)?

Definition and purpose

A letter of intent is a non-legally binding document between two parties that intend to enter a business transaction. It helps clarify intentions and expectations, guiding mergers, acquisitions, and partnership negotiations and real estate transactions. 

While LOIs are typically non-binding, they may include binding clauses (e.g., confidentiality or exclusivity agreements) These clauses protect sensitive information and restrict parties from considering other offers.

LOIs often include provisions stating that a deal may only go through if financing has been secured by one or both parties or that it may be canceled if papers are not signed by a certain date.

The LOIs outline the key terms and conditions, providing a basis for detailed agreements. It ensures all parties are aligned with goals and expectations before committing significant resources and identifying potential deal-breakers early, saving time and costs.

When is a letter of intent used?

Below are the common uses of LOIs:

  1. Mergers and acquisitions

LOIs often come into play when a buyer and seller wish to outline the key terms of a proposed acquisition, including the purchase price, due diligence period, and exclusivity terms. It sets expectations before drafting the final purchase agreement.

  1. Real estate transactions

LOIs help real estate transactions by outlining important details like price, payment terms, and contingencies before a sales contract. LOI functions in real estate transactions in case of complex negotiations. 

LOIs get drafted after a property viewing and initial discussions with the seller or broker. They serve as preliminary offers, outlining the buyer's interest based on the information gathered.

Common elements of an LOI

  • Confidentiality: An LOI may include provisions regarding the confidentiality of information shared during negotiations.
  • Terms and conditions: An LOI outlines the key terms and conditions the parties wish to negotiate further, including financial terms and the deal structure. 
  • Exclusivity: It may contain clauses restricting the parties from negotiating or engaging with other potential partners during the negotiation period.
  • Timeline: It specifies circumstances under which the LOI may terminate or expire.

H2: What is a purchase agreement?

Definition and purpose

A purchase agreement is the final, legally binding contract that outlines the terms of a completed business transaction, detailing payment terms, representations and warranties, and conditions precedent. It outlines the specifics of selling, purchasing, or transferring assets, goods, services, or other properties. 

A purchase agreement protects buyers and sellers by ensuring compliance with terms, outlining payment processes, and defining liability and termination conditions. If the terms change, it can be amended with mutual consent.

When is a purchase agreement used?

Purchase agreements are used in the final stages of a transaction once negotiations and due diligence are complete. You can use this document for equity Sales, asset sales, acquisitions, and customer agreements. 

Common elements of a purchase agreement

  1. Assets or shares being purchased: The purchase agreement details the item purchased. For real estate, it includes the property address. It includes the equipment’s model number, serial number (if applicable), and a brief description.

It also includes the number and class of shares being purchased, the percentage of ownership the shares represent, and any restrictions or rights attached.

  1. Price: The document includes the final purchase price, usually pre-tax. If taxable, the agreement spells out which party (typically the purchaser) is responsible for paying the tax. 
  1. Disclosures:  A purchase agreement should disclose any information from the seller that could affect the buyer after the transaction. This includes revealing hidden obligations tied to the startup, such as outstanding debts.
  1. Post-transaction obligations: 

This section outlines the post-transaction responsibilities of both parties. The seller's responsibilities may include assisting with the transition, adhering to non-compete agreements, and handling disclosed liabilities. The buyer's responsibilities may involve completing deferred payments and maintaining employee benefits or agreements.

H2: Key differences between a term sheet, LOI, and purchase agreement

What makes each document unique?

Term SheetLetter of IntentPurchase Agreement
High-level framework, non-binding.Preliminary agreement, non-binding, that can include binding termsA legally binding contract that completes the transaction
Provides a broad overview of terms but may lack detailed specificsProvides more detail than a term sheet, outlining key terms and conditions.Comprehensive and detailed terms, conditions, and obligations.
Lacks legally enforceable rights or obligations and parties rely on a future formal agreement.Offers limited enforceable rights, often based on good faith negotiations.Provides legally enforceable rights and obligations.
Minimal commitment makes parties assess feasibility before in-depth talks.Expresses serious intent to proceed, indicating the intention to work together.Legally binds parties to fulfill obligations.
It involves basic terms like price, key dates, and parties involved.It has more detailed terms, intentions, and conditions for the transaction.It covers comprehensive details of the transaction, warranties, representations, etc.

Which comes first: LOI or term sheet?

Term sheets and letters of intent are key to a successful business deal. While a term sheet may precede an LOI in some instances, it’s common for an LOI to come first, especially in mergers and acquisitions or larger transactions, followed by more detailed terms outlined in a term sheet.

The sequence of the two documents often depends on the type of the transaction. The LOI usually comes first in complex transactions, like M&A. while a term sheet is more common in private equity or venture capital contexts.

Template and examples

Term sheet template

Below is a term sheet template. This template is not automatic and can be adjusted based on your specific deal. Meanwhile, reach out to a lawyer or financial advisor to ensure that everything is legal and protects your interests.

Issuer:

[Name] (the “Corporation”)

Nature of the Offering:

[Brokered or non-brokered] [private placement] (the “Offering”) of [Common Shares].

Type of Security:

[Common Shares]

Offering Size:

[$xx million]

Valuation:

  • Pre-Money Valuation: $[XX million]
  • Post-Money Valuation: $[XX million]

This is the valuation of the Corporation before and after the investment is made, based on the agreed investment amount.

Investment Amount:

Total Investment: Investor(s) will invest $[XX million] for [XX]% of the equity in the company post-investment at the Issue Price.

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Issue Price:

$[xx. xx] per [Share] (the “Issue Price”).

Commission:

[x.x]% of the total offering size.

Capitalization:

Approximately $[xx,xxx,xxx]. 

Dividends:

[Describe the dividend policy.]

Preferential Liquidation Rights:

[Describe any liquidation preferences]

Definition of Liquidation Event:

[Include definition from legal counsel]

Conversion rights:

[Describe, if applicable, the conditions under which preferred shares may convert to common shares.

Anti-Dilution:

[The shares shall have certain customary anti-dilution protection for any share issuances at prices less than the Issue Price based on a weighted average formula and subject to standard exceptions.]

Voting Rights:

[Describe the voting rights of the investors, e.g., investors may have the right to vote on major corporate decisions, such as mergers, acquisitions, or electing directors.]

Use of Proceeds:

[The proceeds from the Offering shall be primarily used for general corporate purposes, including working capital, debt reduction, or expanding operations.]

Closing Conditions:

[Closing of the offering shall be conditional upon the completion of satisfactory due diligence, the execution of requisite definitive agreements for completion of the Offering, receipt of all requisite corporate approvals, and third-party consents for the offering. Etc.]

Terms of agreement:

  • Exclusivity: The company agrees to not seek offers from other investors for a period of [XX] days from the execution of this term sheet.
  • Confidentiality: Both parties agree to maintain the confidentiality of all terms and any sensitive information shared during the negotiation process.

Agent:

[Generic Capital Corp.] or [Specific Broker/Agent Name]

Closing Date:

[Date] (Target closing date for the offering).

Note: This term sheet template is for educational purposes and not intended for other use.

Letter of intent template

Below is a letter of intent template. This template is not automatic and can be adjusted to fit your specific deal.

Introduction

The introduction indicates the relevant parties and explains why the potential buyer wants to do a transaction. It may also discuss the buyer’s operations and how the proposed deal adds value. Below is an example of the introductory remarks in a letter of intent.

Date

NAME

ADDRESS

Dear [Name],

We are writing to provide a letter of intent from OUR NAME Inc. (“Shorter Name”) in respect of a transaction (a “Transaction”) with TARGET NAME Inc. (“TARGET NAME” or the “Company”).  We appreciate the time and energy you and your team have afforded us in discussing this opportunity and the information that has been provided thus far.

As we continue to spend time evaluating TARGET NAME, we believe that OUR NAME will bring unique value and capabilities to the Company, accelerating the development and growth of TARGET NAME.  We believe we could drive TARGET NAME’s growth strategy, by doing X, Y, and Z.

Transaction overview and structure

Here, the potential buyer outlines its proposed deal structure and payment method, communicating whether the deal would be an asset or stock deal.  The buyer will also give an indicative offer value as a fixed amount or based on a valuation multiple. This section also includes details on financing the transaction. Below is an example of this section.

Based on our preliminary review of the information provided and subject to the conditions set forth below, OUR NAME is pleased to submit this non-binding letter of intent (the “Proposal”) for a transaction with TARGET NAME.  We propose purchasing 100% of the equity of the Company, including all assets and liabilities, in such a way that TARGET NAME still has significant exposure to future upside.

We believe that in order for this transaction to be successful our interests must be aligned.  With that in mind, we have designed a compensation structure that allows all parties to benefit from our future success equitably.

We offer a total purchase price of $XXX million consisting of:

  • $XXX of cash on closing
  • $XXX – shares of OUR NAME, issued immediately upon closing and not subject to any vesting period representing approximately XX% of OUR NAME;
  • $XXX of performance upside – performance shares of OUR NAME (an additional XX%, approximately), issued upon achieving the following targets/milestones:
    • Milestone #1 in year 20XX
    • Milestone #2 in year 20XX
  • The final purchase price will be adjusted for customary changes in net working capital which will be reflected in the cash component of the purchase price.

Illustrative timeline

This section outlines the illustrative timeline and steps needed before a final offer, including due diligence and legal document preparation.

Given the importance of timing for TARGET NAME with respect to this transaction, we have proposed a high-level timeline as follows:

  • Date: Financial due diligence and valuation work
  • Date: Operational due diligence and OUR NAME visit to TARGET NAME’s head office
  • Date onward: Drafting of Definitive Agreement

Due diligence process

Since this LOI is not a final binding offer, the buyer will spend time and resources reviewing the target company. While some due diligence has been performed before the LOI is sent, further diligence is required so the buyer can become comfortable with the transaction and narrow down a purchase price.

This Transaction is our highest priority, and we are prepared to proceed as quickly as possible; you must make that same commitment to us before we expend additional time and resources pursuing this opportunity. OUR NAME has developed an investment thesis and an understanding of the business through our initial due diligence, which included several conversations with management and a preliminary data review.  

We envision our remaining due diligence including, but not limited to, commercial, accounting, and financial due diligence, as well as customary legal, tax, and regulatory work.  

With the Company’s full cooperation, we believe we can expeditiously complete our due diligence and present TARGET NAME with a definitive agreement within eight weeks from the date our Proposal is accepted.

Exclusivity & confidentiality

Since the buyers commit significant time and resources during due diligence, they often request exclusivity, preventing the target from engaging seriously with other parties.

However, If the target receives an unsolicited offer, the LOI may include terms requiring the target to inform the buyer and discuss whether the buyer will match the offer. If the target accepts the unsolicited offer, the LOI is terminated.

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The buyer (and target) will also ask for confidentiality about the transaction and due diligence.

Below is an example of this section. 

If the Company is interested in pursuing the proposed Transaction, we would require sixty days of exclusivity (the “Exclusivity Period”) to finalize our due diligence and negotiate definitive documentation, subject to a 60-day extension if OUR NAME is working in good faith to consummate the transaction at the initial expiration date.  

In light of our Proposal’s premium valuation, we believe that granting exclusivity at this stage will benefit the Project and its Shareholders.  To complete our due diligence and secure the additional requisite capital, we will need reasonable access to Company information and the ability to share that information with our prospective equity partners and debt financing sources in a manner that protects the confidentiality of your information and our discussions.  

A draft form of the exclusivity and confidentiality agreement is enclosed as Exhibit A for your consideration (the “Exclusivity and Confidentiality Agreement”).  We emphasize our desire to complete the proposed Transaction expeditiously and efficiently and our readiness to mobilize resources to move ahead quickly.  To that end, and assuming we sign this letter in advance, we would suggest an organizational meeting as soon as possible to agree on the work plan during the Exclusivity Period.

Non-binding commitment

This part of the LOI indicates the document is non-binding with regard to completing the transaction. However, the Exclusivity and Confidentiality provisions will be legally binding. 

This non-binding indication of interest is confidential and may not be disclosed other than to you, the Company, and its advisors on a strictly need-to-know basis.  It is not intended, and shall not be deemed, to create any binding obligation on the part of OUR NAME, or any of its affiliates, to engage in any transaction with the Company or to continue its consideration of any such transaction.  Subject to the immediately following sentence, none of the parties shall be bound in any way in connection with this letter unless and until the parties execute a definitive agreement and then shall be bound only under the terms of such agreement.  

Notwithstanding anything contrary in this letter, the Exclusivity and Confidentiality Agreement, once executed by the parties thereto, shall constitute the parties' binding obligations.

We are very excited about the potential opportunity and hope that you are equally interested in proceeding in a constructive and expeditious dialogue.  We look forward to working with you to complete this transaction.

Very truly yours,

[Signature]

Name

Company Name

Note: This letter of intent template is for educational purposes and not intended for other use.

Purchase agreement template

Below is a purchase agreement template commonly used in transactions. This template is not automatic and can be customized to fit your specific deal. Legal counsel is also recommended to ensure accuracy and enforceability.

Parties and date

This section identifies the buyer and seller:

This Purchase Agreement is made and entered into as of [Date], by and between [Buyer Name], a [State] corporation ("Buyer"), and [Seller Name], a [State] corporation ("Seller").

Assets being purchased

Specifies the items being transferred:

  • Include descriptions of the technology, intellectual property, patents, software, hardware, and associated documentation.

Purchase price and payment terms

Outlines the total price and how payments will be made:

The purchase price for the Assets shall be [Amount], payable as follows: [Payment terms, such as a lump sum, installments, or stock compensation].

Closing conditions

Defines requirements for completing the transaction:

  • Regulatory approvals.
  • Delivery of intellectual property documentation.
  • Fulfillment of due diligence.

Representations and Warranties

Provides assurances by both parties:

  • Seller:
    • Has clear title to the assets.
    • Assets do not infringe on third-party rights.
    • Technology is operational and maintained as agreed.
  • Buyer:
    • Has the financial capacity to fulfill the payment obligations.

Covenants

Outlines promises made by the parties:

  • Non-compete agreements.
  • Confidentiality obligations.
  • Transfer assistance post-closing.

Indemnification

Addresses liabilities arising after the transaction:

The Seller shall indemnify and hold the Buyer harmless from any claims, losses, or damages related to the ownership or use of the Assets before the Closing Date.

Governing law and dispute resolution

Specifies the jurisdiction and method for resolving disputes:

  • Arbitration or litigation.
  • State or country laws that govern the agreement.

Miscellaneous provisions

Covers additional terms:

  • Amendments.
  • Severability.
  • Entire agreement clause.

Signatures

Confirms agreement by all parties.

Note: This letter of intent template is for educational purposes and not intended for other use.

FAQs about term sheets, LOIs, and purchase agreements

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

A term sheet often involves basic terms like price, key dates, and parties involved with minimal commitment, and a letter of intent includes more detailed terms, intentions, and conditions for the transaction with a more serious intent to proceed.

What is the difference between a term sheet and a purchase agreement?

A term sheet is an initial document outlining key terms and conditions of a potential deal. It is a non-binding document in business negotiations, while a purchase agreement is a legally binding contract that completes the transaction.

Is a term sheet legally binding?

A term sheet is not legally binding but may contain binding clauses, like confidentiality or exclusivity. The non-binding nature allows for flexibility and encourages open communication between parties.

What are the key clauses in a purchase agreement?

The key components of a purchase agreement include the assets or shares being purchased, which detail the item or share purchased. The agreement also includes the price, post-transaction obligations, and disclosures. 

Conclusion

Summary of key differences

Term sheets, letters of intent, and purchase agreements are key business documents in negotiations, acquisitions, and investments. Each document plays a unique role in the deal-making process. While the term sheet sets the initial framework, the letter of intent outlines the preliminary agreement, and the purchase agreement completes the deal.

While the term sheet lacks legally enforceable rights or obligations and parties rely on a future formal agreement, the letter of intent offers limited enforceable rights, often based on good faith negotiations, and the purchase agreement provides legally enforceable rights and obligations. 

Except for the purchase agreement that completes the deal, the sequence of the term sheet and letter of intent often depends on the type of the transaction. The LOI usually comes first in complex transactions, like M&A. while a term sheet is more common in private equity or venture capital contexts.

Final tips for business owners

As a business owner, understand when and why these documents are necessary for successful transactions. But as you do this, ensure that all legal aspects are properly addressed before signing any agreements.

Seek professional legal and financial advice when drafting or reviewing these documents for successful transactions.

Most importantly, seeking professional advice and guidance helps you to achieve clarity, compliance with laws, risk management, and balanced agreements.

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