M&A and VC not just for startups: Letter of Intent vs. Term Sheet. What are they for and what are the differences between them?
After reaching an informal agreement on the commercial parameters of the transaction (e.g., an investment in the target company through new business shares/shares, or the acquisition of business shares/shares from the founders and other shareholders of the target company), this agreement is typically documented in writing through a Letter of Intent or Term Sheet, which then serves as the basis for drafting the final binding transaction documentation.
A Letter of Intent (LOI) is a document in which one party expresses a preliminary commitment to enter into a transaction with another party. An LOI outlines the main (though still only preliminary) terms and conditions of a potential transaction and is therefore generally non-binding. LOIs are commonly used in major acquisitions, and their content closely resembles that of a Term Sheet.
In terms of format, a Letter of Intent (LOI) takes the form of a letter, whereas a Term Sheet is typically structured as a bulleted summary or form.
In the context of M&A, an LOI is iterative in nature. One party submits an LOI, to which the other party usually responds with a revised version. An LOI may also include a basic non-disclosure agreement (NDA) specifying the information both parties undertake not to disclose.
An LOI is typically drafted and signed during ongoing negotiations between the parties, meaning the final terms of the agreement may partly differ from what was agreed in the LOI—especially if due diligence was not completed prior to signing the LOI and new facts come to light.
Thus, an LOI serves primarily to express a serious intent to proceed with a transaction (e.g., the acquisition of business shares/shares from the founders and other shareholders of the target company) and to capture the fundamental terms of the transaction before the parties negotiate and finalize all details as part of drafting the final transaction documentation.
Key terms in such an LOI include the purchase price for the business shares/shares, payment terms, the retention of key personnel (in the case of startups, usually the founders) for a certain period post-exit to ensure a smooth handover to professional management, a timeline of individual transaction steps, and similar provisions.
In contrast to an LOI, in the Slovak business environment, a Term Sheet is frequently associated with startup investments. It is a key document for Venture Capital investors who may offer funding to a startup.
Such a Term Sheet summarizes the key economic and legal aspects of the investment for the parties without overwhelming them at that stage of negotiations with excessive detail, which is addressed later when drafting the final binding transaction documentation.
An "investment" Term Sheet typically outlines the following key terms in a bulleted format:
- Valuation of the target company (Valuation / Pre-money and Post-money);
- Investment amount and structure – equity investment vs. convertible loan;
- Anti-dilution mechanism to prevent excessive dilution of the investor’s shareholding/shares;
- Governance and voting rights, including investor veto powers (Voting rights / Reserved matters);
- Payout order (and potential caps) for shareholders/investors in the event of a sale of the target company (Liquidation preference);
- Retention commitments requiring founders (and potentially the investor) to remain with the target company for a specified period (Founder’s vesting / Investor’s commitment);
- Dividend policies, contrasting dividend payouts with agreements to reinvest profits into company growth;
- Drag-along rights, obligating minority shareholders to join in a sale of the target company under terms agreed by majority shareholders (Drag-along clause);
- Exclusivity restrictions, preventing the target company from seeking third-party investments or negotiating with other investors for a specified period (No-shop agreement);
- Participation rights, granting the investor the right to participate in future investment rounds (Pro-rata rights);
- Valuation cap for convertible loans, setting the maximum company valuation applicable when converting debt into equity/shares (Valuation cap);
- Conditions precedent, outlining conditions that must be satisfied before the investment funds are disbursed (Conditions precedent);
- Transaction timeline, setting a realistic timeframe for completing the investment.
In startup investments, the Term Sheet is typically prepared by the Venture Capital investor.
Under Slovak law, we recommend explicitly stating in both the LOI and the Term Sheet that they are legally non-binding documents for the parties, with the exception of clauses regarding confidentiality and, in cases with an international dimension, governing law and dispute resolution jurisdiction.
Although an LOI and a Term Sheet are generally drafted as non-binding documents, we advise against underestimating their preparation. In later stages of negotiation, the parties rely heavily on their contents, and reopening preliminary agreements contained therein without good reason is often problematic and damages the credibility of the party attempting to do so.
While LOIs and Term Sheets serve a similar purpose—establishing the framework for drafting the final binding transaction documentation—they differ primarily in their degree of formality and structure.
In practice, it is crucial to select the appropriate document type based on the nature of the transaction and the level of consensus reached between the parties.
When drafting these documents, consulting with a lawyer is recommended to avoid common pitfalls such as excessive vagueness, over-detailing, or unintended legal bindingness.