While receiving a term sheet from your banker may seem like good news and a sign that your funding request is on the right track, it is important to know what the purpose of this document is and above all, how to decipher it.
What is a Term Sheet?
A term sheet is a document intended to define the main terms and conditions under which a prospective lender intends to engage with a prospective borrower. It ensures and confirms that the parties are on the same page before beginning the due diligence and statutory audit, if any. It should be noted that the term sheet is NOT a final agreement and is not binding.
At a minimum, when a borrower receives a term sheet from a lender, special attention should be paid to the following considerations:
1. Credit Facilities
Type of facility: Is it a term loan or revolving credit? If it is revolving credit, what is the limit? Is the product adapted to the nature and/or seasonality of the borrower’s operations?
Availability: There may be a difference between the borrowing limit and the amount of the credit facility. This difference is explained by the calculation of margination. It is important to pay attention to these details because the available funds may not be as important as you would think otherwise. With respect to borrowing power, does the lender impose a cap on advances on receivables or inventories that would limit growth opportunities? What assets are excluded from the calculation of margination that can significantly reduce borrowing power?
Refund: When is the refund due? Is there a clause specifying that the lender can demand a refund at any time? At maturity, will the credit facilities be refunded or refinanced?
2. Interest Rate and Fees
The amounts can quickly add up. All costs to be incurred from signing the term sheet to repaying the loan must be identified: monthly fees, renewal fees, annual review fees, availability fees, evaluation fees, etc. It is important to understand their applicability and the impact on financial results (especially on profitability and cash flow).
3. Surety Bond
Attention must be paid to bonding requirements. In many cases, an entrepreneur can personally endorse the obligations of his or her company, in other cases, a company not covered by the term sheet could come to endorse the obligations of the first. In the event of default by the borrower, the guarantor may have to overcome these deficiencies which could lead to significant consequences. It is therefore essential to surround yourself with seasoned professionals in the process.
Throughout the term of the loan, the borrower must meet certain commitments. They may be of financial nature (the debt service coverage ratio), or they may be related to the various reports to be submitted to the lender. The lender could also ask the borrower to subrogate any payment to related companies. This could also bring a lot of complications.
When the term sheet is misinterpreted, unfortunate consequences can happen. The borrower must therefore be diligent and thoroughly analyze the conditions mentioned in the term sheet before committing with a lender.
If you have received a term sheet or need help in your search for financing, do not hesitate to contact one of our advisors.