A term sheet is a non-legal binding document, but there are some ways where it can become legally binding. In this article, we are going to dive deep into the legally binding aspect of a term sheet.
As the definition suggests, a term sheet is not a legally binding agreement. Instead, the document contains the terms and conditions of an agreement between a business owner and their potential partner. It is generally seen that a party makes a term sheet legal binding once they are fully satisfied with the terms and conditions of the term sheet.
The term sheet is usually prepared by the lenders and the investors to include details of the funds to be provided, the cost of providing the funds, and other information on funds. But knowing why a party would put themself in a legal binding situation is still a curious standpoint. However, before diving deep into the legal aspects of a term sheet, let us first understand what a term sheet is.
What is a Term Sheet?
A term sheet highlights the basic terms and conditions of an investment agreement taking place between business owners and their potential investors. The document contains basic information on the funds and how the rate of interest will be structured. They create new investment opportunities by generating confidence in potential investors.
It is very hard to say whether all term sheets are binding. There are many scenarios where many non-binding term sheets are converted to legally binding ones. The legal aspect of the term sheet also depends on its various types. Some major term sheet types are discussed below.
Types of Term Sheet
- Equity-Based- Equity-based term sheet is the most common type of term sheet. Such a document is generated when an investor buys an ownership interest in your company in a swap for the fund or equity investment in the company as a whole.
- Debt-Based- A debt-based term sheet is usually generated when an investor provides financing to your venture. Generally, the amount of debt taken by the venture capitalist from investors depends on the number of equity shares purchased by them.
- Mixed– These days, many investors go with a combination of equity and debt in their dealings. In such cases, the terms of the deal highly depend on equity and debt purchased by the investor.
Why Are Term Sheets Non-binding?
In recent times, we are aware of all the short-term non-legal contracts where the purpose of the contract is a simple give-and-take arrangement. There are many one-time agreements as well where both the involved parties fulfill their obligation and dissolve the contract.
However, when it comes to financial markets, the agreements are usually long-term agreements as huge amounts of money are involved. When such large commitments are involved, people often take no risk and bind the contract legally. But before being sure of binding such contracts legally, the parties involved prefer to go with a non-binding in the initial stage.
This non-binding agreement in a non-financial market is referred to as a Memorandum of Understanding. While in a financial market, the same is termed a term sheet. For example, a money lender will generate a term sheet for every person to whom he lends money in the long term. Similarly, an investor will come into a shareholders’ agreement for every investment they make.
Generally, these are the reasons why a term sheet is not binding. However, there are many aspects where a term sheet can be made legally binding even after the rest of the agreement is non-binding. A detailed section below will give you insights into the legal aspects of the term sheet.
Legal Binding Aspects of a Term Sheet
- Validity Period: If the term sheet has a validity period mentioned, then it becomes the whole life period of the term sheet. The same will be expired on the date of the validity with all agreed terms and conditions. However, the parties can anytime renew their contract if they wish to by generating a new term sheet. Thus, the pre-decided validity of the term sheet binds it legally in this way.
- Confidentiality: Often times the details, information, and terms mentioned in the term sheet are not to be disclosed anywhere. They are to be regarded as confidential, and parties involved in the agreement must adhere to maintain the same. Therefore, confidentiality is considered the binding aspect of the term sheet. However, the parties involved can make their negotiations regarding confidentiality. And once all the negotiations are done, both parties will have to adhere to the mandated confidentiality.
- Exclusivity: If there is a clause for the parties not to engage with other competing parties within the course of negotiation, then it is taken as legally binding. The exclusivity aspect has nothing to do with the terms and conditions of the term sheet. In addition, these aspects are more for the principle’s sake. Simply put, exclusivity asks you not to engage with other investing/ lending players while you are in negotiation with other parties. Hence, it is one of the legally binding aspects of the term sheet.
Summing up
The article gives an insight into the various aspects of a term sheet. A term sheet is generally a non-binding document that contains the terms and conditions of a prospective agreement. The concept of the term sheet is most common in financial markets where business owners and potential investors come into a non-binding agreement. The non-binding aspect of the term sheet is there for short-term agreements where both parties take minimal legal risks as possible. But when it comes to the long-term investment time where huge amounts of money are invested, this is where the legal aspect comes into the picture.
Taking a huge financial risk without legal support would be meaningless, which is why many parties bind their term sheet with legal aspects. Such legal aspects are validity, confidentiality, and exclusivity. There are other legal aspects as well, which majorly depend on the type of term sheet you have signed up for. You can also get in touch with our legal advisors at Vakilsearch to know more about the binding term sheets.
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