The right term sheet can get you off to a good start in a transaction. The wrong one can result in damage to trust, increased costs and even litigation. Here, we give you some tips on how to get the most out of a small document, which can make a big difference to your deal.

1. Deal efficiency

The term sheet contains the heads of terms of the proposed transaction. It prompts the parties to look at issues such as corporate structuring, location of key assets, likely guarantors and security providers and the inter-relationship with other funding lines or outgoing debt providers at an early stage. This is all in addition to the key commercial terms of the transaction. The time spent on ironing out these issues at the start of a deal typically streamlines the preparation and negotiation of larger documents further down the line. Of course, deal planning can be done informally but the term sheet provides a framework for these issues to be raised and the results captured.

The term sheet will need to fit the transaction. There will need to be a different emphasis depending on whether the facility is bilateral, investment grade or a syndicated leveraged transaction, in which case the Loan Market Association standard forms may be appropriate

Tip: In such a short document it is not possible to capture every nuance of the deal to come. At such an early stage it may not be wise to even attempt to do so. It typically benefits the lender to keep the term sheet wording sufficiently flexible so that it can add detail to its requirements in the substantive finance documents once the due diligence has been conducted.

2. Confidentiality

At the outset of a lending transaction, the borrower will be required to share considerable amounts of confidential and potentially, price sensitive information. The borrower should ensure that it has a binding confidentiality undertaking with any proposed recipients of this type of information. The undertaking can be included in the term sheet if a separate undertaking or confidentiality agreement has not already been provided.

Tip: The parties to the term sheet will not always be the same as the ultimate recipients of the borrower's confidential information. Ensure that onward transmission of material is covered by an obligation on the counterparty to put in place suitable confidentiality arrangements that are satisfactory to the borrower.

3. Should your term sheet be legally binding?

The document should be clear about whether or not it is legally binding. A borrower may need evidence of a binding commitment to fund in an acquisition financing but typically it will not be necessary for the parties to be legally bound into the transaction at this stage. If this is the case, the term sheet may primarily be used as a basis for the negotiation and preparation of the main funding documents and will retain a degree of moral force to keep parties to the terms agreed at the outset.

Tip: Whatever the status of the funding commitment, it is usually recommended that key provisions of the term sheet are binding, such as confidentiality and costs provisions, which require the borrower to meet the costs of preparing and negotiating the facilities, whether or not they proceed to completion.

4. Is it legally binding?

If any part of the term sheet needs to be legally binding, the document must be a properly formed contract or deed and your advisers can check this for you. Be aware that a contract can be accepted by verbal agreement or by the parties' conduct and so does not necessarily need to be signed by both parties before they are bound. Expressing correspondence as being "subject to contract" may not always be sufficient to prevent a contract being inadvertently created and this concept is not recognised in all jurisdictions.

Tip: Care should be taken that the parties' intention to create (or not create) a contractual or legally-binding relationship is reflected in the documents and any correspondence. If terms, parties or contingencies are not yet settled, it may be better to defer circulation of the term sheet.

5. Exit routes

If the term sheet is going to be legally binding, consider what would prevent the transaction from going ahead. Early in a transaction, conditions are likely to include a lender's internal approvals and the outcome of due diligence, amongst other things.

There have been cases where imprecise drafting of conditions in a term sheet has achieved an unintended result. For example, a funder that failed to get internal approval to fund was found to be committed to lend in a transaction where the term sheet was expressed to be legally binding and funding was 'conditional upon satisfactory review and completion of documentation'.

Tip: Ensure that a binding term sheet accurately reflects any element of conditionality of funding to prevent a lender from being committed to lend before it is ready to do so.

Summary

There are plenty of good reasons to set out the parties' intentions in a well drafted term sheet and your advisors can help to avoid the traps outlined above. Early open dialogue is recommended to anticipate and deal with potentially thorny issues at this stage and set the tone for a good future working relationship.