Below is an excerpt from “Exit Right: How to Sell your Startup, Maximize your Return and Build your Legacy” This is a part from Chapter 7, where Larry Chu, the Co-Chair of Global Tech M&A from Goodwin Procter Law, helps break down what’s inside a term sheet. This was originally posted on Mert Iseri’s personal blog here.
Getting to the term sheet is a real milestone. Most acquisition discussions don’t make it to the stage where a nonbinding term sheet is signed. There will be lots of discussions over the years to build up a strong rationale that justifies a price both sides are happy with. If this is a FAIR deal, prior to a written offer you should have had verbal alignment on the vision for the future, the timeline to close, and most importantly, the final price.
Take a deep breath here. There are many highs and lows in the startup journey, but this is a special one. No matter how you view it, it will be emotional to see a piece of paper that has the potential to create generational wealth. It’s OK to be excited, nervous, scared, or determined — we felt all those feelings too.
Despite the verbal promises you’ve already secured, nothing is real until things are written down. This is the phase when negotiating the particulars of the term sheet kicks into high gear. In order to negotiate well, we first need to learn more about what each of the terms means, what can and should be negotiated, and which points are not worth pushing back on.
When you receive the term sheet, especially if this is your first time, you are going to be experiencing wildly divergent emotions. Both elation and fear. The goal of this chapter is to arm you with knowledge so that when you sit down with your attorney, you will have a good foundational knowledge of what the terms mean and what is important.
We want to give special thanks to the Co-Chair of the Global Tech M&A Practice at Goodwin Procter Law, Larry Chu. As a partner with over $150 billion in transactions under his belt, he generously provided his wisdom in the making of this chapter. He is also an active investor, and we highly recommend working with someone extraordinary like him on your startup.
Ultimately, you, as the leader, need to give your attorney the right directions for what to focus on, and what not to squander time arguing about. The term sheet is by far the most important document in the whole transaction, and it is wise to treat it as such. It outlines the key terms of the deal, and done right, will become the foundation for a smooth process down the road. Signing the term sheet doesn’t mean you will close the final deal — it is usually nonbinding. However, it is the point of no return as it likely will commit you to negotiating exclusively with one party.
We know the feeling well. It is pure bliss to receive any document that says your startup is worth millions of dollars. The euphoria that comes from that tends to make founders overlook the rest of the document. The term sheet includes a LOT more than the final price in question. Here is an overview of what you should expect to find in a term sheet:
Price
a. Calculation
b. Front-end adjustments
c. Back-end adjustmentsClosing conditions and timeline
a. Necessary approvals
b. Due diligence checklist
c. Exclusivity and expiration datePersonnel agreements
a. Organizational structure
b. Governance
c. Retention tools
The fundamental differences between Letters of Interest (LOI), Term Sheets, and Closing Documents
An ideal term sheet sets the stage for the whole process of an exit. A letter of interest is simply a weaker term sheet with way fewer details, usually only indicating a loose timeline and price. The closing documents are outlined in the term sheet, and they get drafted once the term sheet is signed by both parties.
While the M&A term sheet looks similar to a financing term sheet, what’s inside is completely different. For the definitive breakdown of a VC financing term sheet, we recommend Brad Feld and Jason Mendelson’s excellent book that has stood the test of time, Venture Deals.
The M&A term sheet packs a punch in terms of the amount of detail in it and you should want it to — this is how you get full visibility into the material terms of your deal. Generally speaking, there should be no surprises, good or bad. Most often, the buyer will schedule a call in advance to walk through the key points and confirm that everyone agrees. It’s a practice that solidifies trust for both sides. Needless to say, founders should never sign a term sheet they don’t intend to finalize with closing documents. A signed term sheet means all the focus now turns to reflecting the agreed-upon terms to binding closing documents. If the deal falls apart afterwards, bridges are burned.
As a buyer, Gary Johnson always anticipates which parts of the term sheet the founders won’t like. He is a huge proponent of transparency and understands that the perception of a surprising negative term is likely a lot worse than what it actually means. More importantly, he believes that explaining why a term needs to be in there ahead of time helps founders get rid of this terrible feeling: am I getting screwed?
In 2019, Atlassian made a bold, unprecedented move for a seasoned acquirer. They published their standard M&A term sheet publicly and, in doing so, shared with the world what mattered to them most and, most importantly, why it mattered. (You can still see the term sheet itself if you search for the Atlassian term sheet.) Their efforts towards transparency should be highlighted and followed for everyone making an acquisition in the future.
Unfortunately, there is no standard set of documents companies use for acquisitions, since every situation, company, and strategic rationale for doing the deal is different. Picking one apart isn’t necessarily going to help the majority of the situations you can find yourself in, but it is worth familiarizing yourself with the general outline of information.
Instead of publishing a term sheet, we decided it would be much more helpful to share a framework of terms and questions you should familiarize yourself with before accepting your first term sheet. Our goal is to be as generic as possible here so that you can apply the details of your exact situation when the time comes. Then, the more details the term sheet can include, the better.
Remember, as time goes on, the ability to negotiate dwindles and the pressure to close increases with each passing day. The negative feelings that accompany any concession can tank the deal as a whole. Not to mention that changes after the term-sheet stage are not cheap. Once you are into due diligence and the drafting of definitive agreements, the legal bills increase exponentially for any modification. Our recommendation is to negotiate the term sheet in earnest, and as long as the terms are FAIR, sign it with the intention of closing the deal. In this stage, there are three main components in the term sheet you should pay attention to: price calculation, certainty to close, and personnel agreements. Here’s what you need to know about each of them.
The holy trinity of M&A term sheets: price calculation, certainty to close, and personnel agreements
Entrepreneurs should use these three buckets as a mental framework to define what matters to them: price, certainty, and personnel. Signing a term sheet and going into exclusivity with one party means you are foregoing the option to remain independent, raise additional capital, or evaluate other buyers. The details need to make sense!
The worst term sheets are skinny letters of interest — they only indicate price, or worse, a price range in consideration for the purchase. This is rarely the starting point of a FAIR deal. The buyer should have already discussed the rationale, integration plans, and internal alignment needs with the seller; therefore, there should be no issues putting down the important points that frame your deal. Remember that whoever drafts the final documents (most often the buyer) sets the terms. You have maximum negotiating leverage before you sign the term sheet. What’s not inside this document is likely going to be buyer-favorable in the closing documents.
Typically, the term sheet will be accompanied by a cover letter with a few paragraphs on the rationale for the acquisition. This is as important as the document itself because it confirms the document was drafted with the ultimate objective: to actualize the goals embedded in that rationale. This is the moment that will prove that the buyer has thought carefully about the deal and that negotiating will be done in good faith. After all, the shared objective belongs to both parties, and both of you should be motivated to make that happen.
This is a good start as a basic primer — In the next post, we will dig into the most coveted section, the price calculation!