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It is often said that where you end up depends on where you begin, and this is especially true in dealmaking. Most large financial transactions begin as a term sheet — that deceptively short document where one or both parties plainly lay out the most important terms of the transaction. The term sheet is not an end unto itself but does serve an important function. If the parties can agree to the listed terms, it makes sense to continue to devote substantial time and resources to the transaction.

Both term sheets and letters of intent outline a future agreement between two (or more) parties, but a letter of intent is written in letter format. A term sheet, on the other hand, typically lists the major points of the agreement to be negotiated.

Who is involved in term sheet negotiation?

Whoever is involved in negotiating the term sheet for any major deal depends on the stage of the company and the type of transaction involved. There are some general rules of thumb, however. 

For startup capital raises, it is often the CEO or founder who leads the negotiations alongside the Board and/or major investors. For M&A deals and/or large capital raises (debt or equity), an experienced outside advisor may also serve as the “front person” with input from other major stakeholders.

What can be negotiated?

Everything is negotiable, of course. What you negotiate will depend on how skillful you are and how strong of a hand you’re holding. Before submitting a term sheet, understand the industry norms so you don’t ask for something outrageous. Keep in mind that the tone and manner of the ask are often just as important as its substance. 

In addition to headline valuation, major terms that may be negotiated include percentage shares, exclusivity timing, indemnity, and who pays the legal fees, among other things. In any event, a successful negotiation typically follows three steps:

Step 1

Listen. Rather than making assumptions, let your counterparty walk you through their term sheet. Ask about areas of ambiguity. If they have missed an area of importance to you, ask them to provide color on those aspects. For example, if the valuation comes in lower than expected, ask about the main factors driving valuation. This could provide fodder for future negotiations, including deal structure. 

Step 2

Digest. Resist the urge to respond on the spot or off the cuff. Let the other side know that you will further consider what’s been discussed and deliver a comprehensive response. There may be a deal-breaker such as warrants or post-transaction roles, but rather than calling out the most important issue, reverting with a comprehensive response provides the counterparty additional flexibility to craft a compromise. Try not to expose your most critical points, which will result in lost leverage.

Step 3

Respond. Posturing and bluffing is typically not effective negotiation approach, though both are common. Go through your list of requests, looking for the other side to reciprocate, and listen through the whole thing first. Then, ask for feedback on possible sticking points. Finally, form a consensus on what is achievable.

After these steps are complete, you should send back a final redline which both parties can agree to and sign. Keep in mind that this seldom occurs after just one back-and-forth, but a healthy verbal dialogue will enable a faster and smoother path to agreement.

Getting it right the first time

While time is the enemy of all dealmaking, it is extremely important not to move past the term sheet stage with a misaligned understanding of the deal, or to leave things on the table that you will regret later. You must have absolute clarity on important terms, especially those related to the economics between the buyer and seller. Asking the prodding question may be uncomfortable, but it’s also essential. I’ve often heard people say “we’ll figure it out later,” and, “I’m sure it will be fine” at this stage. Neither proves a good approach in hindsight, nor is assuming that the buyer is looking at the issue the same way you are. 

Usually, it is the opposite. We all tend to think of what is better for us, and negotiations are often a zero-sum game. This is what makes it difficult to reach a consensus, but failing to get alignment on the issues during the term sheet stage will come back to bite you later in the process. As they say, ownership is 99% of the law. After a deal is signed, the pendulum swings to the buyer/investor. Make sure you’ve ended up close to where you began.

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