Term Sheet vs. Letter of Intent vs. Purchase Agreement

I am in the middle of a transaction in which a fairly sophisticated buyer submitted a Term Sheet for a service business having a value of approximately $3 million. During the process of analyzing the offer with my client, the Seller (who is also a fairly sophisticated business man), a number of questions came up regarding the differences between a Term Sheet, a Letter of Intent ("LOI"), and a Purchase Agreement ("PA"). Note: the Purchase Agreement can be either a Stock Purchase Agreement or an Asset Purchase Agreement.

Below is a brief discussion of the use and differences of the three types of documents. Sometimes the lines can get blurred between the various types of documents and an experienced advisory team is important for both the Buyer and Seller.

Term Sheet: The Term Sheet is a non-binding expression of interest by a buyer that outlines the price and structure of a transaction. It is typically used in larger transactions where the parties are more sophisticated and where a business is marketed without a price. Its function is to determine if the parties are in agreement on the price and structure of the transaction before both parties invest significant time and money on professional fees. Assuming that they are in general agreement, the buyer will either submit an LOI or a PA. A Term Sheet will usually be one to five pages in length.

Letter of Intent: The LOI is also typically used in larger, complex transactions by sophisticated parties. Similar to the Term Sheet, the LOI will specify the terms of the transaction, but in greater detail. Unlike the Term Sheet, portions of the LOI, such as Confidentiality and Exclusivity, may be legally binding. Transaction attorneys are often involved in the drafting of LOI's, as there are traps for the unwary in the use of LOIs. After an LOI is fully executed, due diligence and obtaining financing get serious and the attorneys will start on preparing the APA. An LOI is usually between 3 and 15 pages in length.

Purchase Agreement: The PA can be either straight forward or complex. For example, in less complex transactions, many buyers will submit a PA without the interim use of a Term Sheet or LOI. In more complex transactions, the PA usually follows an LOI. Both the Buyer and Seller should have experienced transaction attorneys advising them in the drafting of the PA. A PA usually has a minimum of about 6 pages, but may reach 50+ pages and have hundreds of pages of exhibits in more complex transactions.

Normally, summer is one of the slower times for activity in the M&A industry; however, we are experiencing one of the most active Augusts in our 33+ year history. We attribute the activity to the demographics of retiring baby boomers, the strong Colorado economy, the availability of low cost capital, and a good selection of appealing businesses for sale. 

(originally published in August 2015 eNewsletter)