1. What is a term sheet? 

A term sheet is a document used by those parties who have already started negotiations in relation to an investment transaction and aimed at setting forth and regulating the following matters:

  • confirming the intention of the parties to proceed further in the negotiations;
  • setting those points of negotiations already agreed, at least in principle, between them;
  • defining, inter alia, both the structure and the timing of the envisaged transaction;
  • coordinating the subsequent negotiation phase by establishing the relevant timing and methods of execution;
  • identifying eventual issues to be further negotiated and included within the subsequent investment agreement.

A term sheet is usually the first formal document executed by the parties in a deal and it represents the starting point for the future negotiations that will eventually lead to the finalization of an investment agreement.

 2. In addition to the term sheet, we often hear about “letter of intent”, “memorandum of understanding” and similar documents: what are the differences among them? 

Term sheet, letter of intent and memorandum of understanding are expressions often used in business to identify the same type of document, namely a document which is not intended to be binding vis-à-vis the parties (with the exclusions of few clauses usually regulating confidentiality and exclusivity terms, etc.), but solely intended to confirm their intention to proceed with the negotiations already in place and help them to this purposes.

3. Is the term sheet an absolutely necessary document in the context of an investment transaction?  To which investment phase of the transaction do the drafting and negotiation of a term sheet belong?

For correctly assessing whether the drafting of a term sheet is necessary or not, the parties shall take into consideration, inter alia, the expected timing for the completion of the investment, the complexity of the transaction itself and the type of the parties involved.

In the event that the parties have successfully agreed on all the key points of the transaction during the first phase of the negotiations and are willing to finalize the deal in a timely manner, it might be more efficient and less time- and money-consuming to proceed directly to the drafting of the investment agreement.

The above is possible (and preferable) during the phase of “seed financing”, when business angels become involved.

Otherwise, if the negotiation has lingered for some time and the parties have not yet reached an agreement on the main points of the transaction, it may be useful to take stock of the parties’ mutual interest in continuing the negotiations, so that the key points of the transaction can be defined and the parties can proceed further to future negotiations.

In any case, regardless of the assumptions set forth above, when the counterparties of the transaction are investment funds, usually they need to sign a term sheet to be submitted to their respective committees for obtaining the approval of the transaction.

4. What is the legal effectiveness of a term sheet?

From a legal standpoint, a term sheet may have an impact on the pre-contractual liability of the parties involved in the transaction.

A term sheet, in case it is properly drafted, should not oblige the parties to conclude an investment transaction, though it should oblige them to continue the negotiations in good faith.

Therefore, if a party intends to withdraw from negotiations without just cause or, in any case, a justifiable reason, when such negotiations are in an advanced stage and after having made the other party believing that the transaction would successfully come to an end, the latter may bring an action against the withdrawing party claiming compensation for the damages suffered due to the sudden and unlawful interruption of the negotiations, provided that the claiming party shall prove that, based upon the expecting successful outcome of the ongoing negotiations, it could not step into other business opportunities.

5. Structure and clauses: which clauses are essential and which are the most widespread ancillary clauses?  Is it appropriate to distinguish between binding and non-binding clauses?

Considering the purposes of the term sheet, the most important and sensitive issue in drafting such document is expressly indicating which terms and conditions, on the one side, are binding for the parties and which provisions, on the other side, are not.

The part of the term sheet that describes the transaction and contains some information regarding, inter alia, the value, methods and investment structure should not be binding, since these matters will be subject to further discussions and in-depth evaluation in the course of subsequent negotiations, to be then finalized in detailed provisions included in the investment agreement.

On the contrary, binding clauses should be those that (i) set forth the timing of future negotiations, the timing and costs of due diligence, where required, as well as those obliging the parties not to negotiate with third parties for the entire duration of negotiations; (ii) introduce the term of effectiveness of the term sheet (which usually coincides with the term of duration of the negotiations); (iii) refer to the applicable law and jurisdiction in case of dispute between the parties (e.g., as a result of the sudden interruption of the negotiations or related to the interpretation and execution of the term sheet, etc.); and, (iv) define the methods of calculation and payment of costs that may be incurred by the parties during negotiations.

The above indications are important because the term sheet, drawn up in detail and without a clear distinction between binding and non-binding clauses could (in theory) be intended as a preliminary contract (“contratto preliminare”) and, therefore could oblige the parties to the complete the investment transaction.

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