The Anatomy of a Business Sale Term Sheet

Dan Norris Headshot
Daniel J. Norris
Director, Corporate Department
October 1, 2004

If you are marketing your company for sale or otherwise appear to be an attractive acquisition target, you may receive inquires from potential purchasers seeking to learn more about your business and your willingness to sell. After the initial inquiries and the potential buyer’s evaluation of the value of your company, the buyer may make a formal offer to purchase your business. The offer is often in the form of a term sheet (also called a letter of intent or LOI, if it is in the form of a letter). The term sheet is typically the document by which the prospective buyer proposes (or offers) the basic economic terms and material conditions and provisions of an acquisition to the potential seller. The term sheet can be only one page or it may be as long as five to ten pages. (If it is any longer than that the term sheet is too long for its intended purpose–to summarize material terms of an offer-and may be a waste of time to review other than the essential economic terms.) Although, there is no single “form” for a term sheet, you should expect any term sheet to include the same basic anatomy. The term sheet should, at a minimum, describe what is being purchased, the offered price and how the price is to be paid.

You can sell your business by either selling all of the stock (or limited liability company or partnership interests) of the company or by selling the company’s assets. There are other ways to accomplish a sale such as through a merger or share exchange, but stock or asset sale alternatives are the most common and are likely to be the alternatives you see if you are ever presented with a term sheet.

Generally, buyers like to buy assets and sellers want to sell their stock. Buyers want to buy assets because they can buy assets clear of the selling company’s known or unknown liabilities. The Seller wants to sell stock because all of the corporate liabilities follow the ownership of the stock. There are important state and federal tax considerations that can also play a role in determining whether assets or stock is sold. You should seek the advice of your tax advisors to assist you with this analysis.

Once the buyer describes what is being purchased in the term sheet, the purchase price is described (although many sellers will admit to reading the purchase price paragraph first). A potential seller needs to consider many factors when evaluating the price offered for a business in a term sheet. Some of those factors include any business appraisals that the seller may have received (that are not too stale), the appraised value of any real estate that may be part of the sale, buildings, equipment, fixtures, equipment, inventory, customer contracts, leasehold rights, the ongoing potential of the company to make money, its earnings for the last few years, projected earnings, the terms of payment, and, in an asset transaction, the allocation of the purchase price among the various assets. The company’s accountant can be helpful in evaluating the proposed price and the purchase price allocation.

After the purchase price, the part of the term sheet of greatest interest to the seller is how the purchase price is to be paid. To the seller a short payment section is best-it only takes one line to say “in cash at closing.” Unfortunately most payment sections are longer and include a mix of cash at closing and other forms of payment. Part of the purchase price may be paid with a loan from the seller. This might happen if the buyer does not have enough cash to pay the whole purchase price or cannot or does not want to seek bank financing. To document the seller loan, the buyer delivers a promissory note to the seller at the sale closing. To protect itself against nonpayment of the loan, the seller should take a security interest in the assets of the business and/or personal guaranties. The seller should note, though, that its security interest would be subordinated (or behind) any bank financing that the buyer may have.

Part of the purchase price may also be paid as an “earn-out.” An earn-out is a payment or series of payments made to the seller over time after the closing that is typically based upon the company’s post-closing performance. Sellers should be aware that earn-out payments are conditional. If the business does not hit the designated performance targets, the payments are not made. Therefore, sellers should be happy (or almost happy) with their financial deal assuming that little to no earn-out payments are made. The payment section of the term sheet may also propose a “holdback,” which is a portion of the purchase price either not paid or paid into escrow at the closing that would be paid back to the buyer if certain bad events described in the purchase agreement happen to the business during a limited time period after the closing.

There are numerous other provisions of a term sheet that have not been discussed such as seller non-competition covenants, protections for seller’s employees, closing conditions and the obligation of the parties keep the term sheet confidential. The buyer may also describe its rights to conduct due diligence and have access to information about the company and company officers. The buyer may also seek to have an exclusivity or “no-shop” provision whereby if the seller accepts the term sheet it cannot have discussions with other potential buyers while the term sheet is effective. Finally, the term sheet may include a sunset date. A sunset date says that if the closing does not take place by a particular date, then the parties will not go through with a transactions and have no further obligations to each other, except for confidentiality and other obligations that should appropriately survive the termination of a term sheet.