When requesting a quote from your lawyer for a finance transaction, you'll likely be asked if you have a Term Sheet available. A Term Sheet can not only lower legal fees but also reduce the risk of obstacles during the documentation phase, saving time, cost, and effort. Thus, having a well thought out Term Sheet can be highly advantageous for borrowers and financiers in financing transactions.
What is a Term Sheet?
In essence, a Term Sheet is a document setting out the key commercial (and sometimes legal) details which will form the basis of the loan transaction. It will typically be non-binding and will reflect the key terms which the parties have negotiated in the early stages of discussing the loan.
What matters should a Term Sheet cover?
As one would expect, the level of detail included in a Term Sheet can vary greatly from one transaction to another. How detailed a Term Sheet is will also likely reflect the extent to which the Parties engaged in robust discussion prior to beginning the documentation process.
That being said, the foundational matters which one would expect to see be covered in a Term Sheet are:
Commitment: the amount of the facility being offered by the financier.
Pricing: the interest rate (if fixed) or the margin and reference rate (if applicable).
Term: the tenor of the facility.
Repayment Profile: whether the loan is to be repaid by way of a bullet repayment at maturity or whether there will be scheduled amortization during the life of the loan.
Fees: Any upfront or commitment fees that will be payable by the Borrower.
Security: If the loan is to be secured, which assets will be subject to the security.
Guarantors: whether any other entities within the Borrower’s group will guarantee repayment of the loan.
Purpose: how is the Borrower permitted to use the proceeds of the loan.
Key Covenants: Any specifically negotiated covenants which the parties have agreed to, for example financial covenants.
Beyond these high-level terms, there are a range of additional matters which the parties may wish to agree upon during the Term Sheet stage, rather than delaying this until after the documentation process has begun. These matters include:
Base documentation: will the transaction documents be based on specific precedents / LMA templates.
Definitions: it is often useful to agree on important definitions early rather than waiting until the documentation stage. Some examples of key definitions which the parties may want to consider are:
o What constitutes a Change of Control.
o What definitions will apply to Financial Covenants (e.g. we’ve all seen many different definitions of EBITDA!).
o In the event that restrictions are to be placed on other entities within the Borrower’s Group, which entities will constitute “Material Subsidiaries”.
Voluntary Prepayment: are there any restrictions on the Borrower’s ability to prepay the loan early.
Mandatory Prepayment: under what circumstances will the Borrower be obligated to prepay the loan early.
Key covenants: some examples of specific covenants the parties may want to consider are:
o Information Undertakings: which information and financial statements will the Borrower be required to provide.
o Disposal Restrictions: what restrictions on the Borrower’s ability to dispose of assets will apply and what (if any) are the carve outs from this.
o Additional Indebtedness and Security: what restrictions on the Borrower’s ability to incur additional debt or grant security will apply and what (if any) are the carve outs from this.
o Distributions: what restrictions on the Borrower’s ability to pay dividends to its shareholders will apply and what (if any) are the carve outs from this.
Conditions Precedent: Any specifically negotiated conditions which the Borrower will need to satisfy prior to it availing the loan.
Interest Rate Fallback Provisions: if the rate of interest is calculated using a reference rate plus a margin, which provisions will apply in the event that the reference rate is unavailable.
Governing law and Dispute Resolution: which law will the finance documents be governed by and which forum will be chosen to resolve any disputes.
Should I engage legal counsel before or after I have a signed Term Sheet?
A question you may be asking yourself is whether you need to engage legal counsel prior to having an agreed Term Sheet. The answer to this is, again, likely to depend on whether the parties want to have a comprehensive Term Sheet or whether they only want to pre-agree on some very high-level matters.
If the Term Sheet only covers key commercial terms, it’s probably not necessary to engage lawyers prior to having the Term Sheet signed. If, however, the parties want to mitigate the risk of protracted negotiation (or running into potential non-starters) by having a more fulsome Term Sheet, involving lawyers early might make sense. Some examples of the ways that lawyers might be able to add value during the Term Sheet stage are by:
Drafting key definitions which will ultimately be used in the Loan Document (for example, the definitions which will be used in financial covenants).
Providing perspective on what they are seeing in the market on specific issues.
Identifying legal issues with the structure of a transaction to avoid the parties needing to go back to the drawing board at a later date (e.g. if the proposed security structure doesn’t work under local laws).
Maximizing Efficiency
One major concern which clients have with engaging lawyers during the Term Sheet stage is the fear that the expanded scope of work will result in higher legal fees overall. This is a real concern and might often be the case, even though there are clear efficiencies in identifying and resolving issues prior to the documentation stage.
One way that borrowers and lenders can address this is by working with their counsel to prepare a pro-forma / template form of Term Sheet which already includes all the key legal provisions which the client wants to include in its loan documentation, helping to ensure upfront alignment between a client's commercial objectives and risk appetite. Lawyers can also prepare a pro-forma Term Sheet to include optionality for the client, enabling them to select from various positions based on where they land in their negotiation with the counterparty on a specific transaction. Whilst this will likely mean there is an initial upfront cost, it will often result in cost savings and overall efficiency in the future.
Key Takeaways
Having an agreed Term Sheet prior to commencing the documentation process on a financing transaction will often result in considerable time and cost savings, whilst also mitigating the risk of parties running into deal-breakers after they’ve already committed time, money and energy to a transaction.
Lawyers can be useful during Term Sheet negotiations, though ultimately the extent to which they will be able to add value will largely depend on how compressive the parties want the Term Sheet to be. One way that parties might be able to improve the efficiency of their transactions without needing to engage external counsel for every Term Sheet will be to have their counsel prepare a pro-forma Term Sheet which they can use during Term Sheet negotiations. If this is something you would like to explore further, or you would like to learn more about how Support Legal can assist your business, please reach out for a free consultation.
For more information contact David Wloszczowski, Principal.
This material is provided for general information only. It should not be relied upon for the provision of or as a substitute for legal or other professional advice.
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