An investor has sent you a term sheet – when is the document binding and when is it not
A term sheet arrives as a non-binding summary and companies sign it without a lawyer. Yet this is where the price is set, where you agree how long you may not talk to anyone else, and who pays the costs if the deal never happens. This article sets out what to watch for before you sign.
Key takeaways
Decision-making framework: what you are actually signing
A term sheet, letter of intent, and memorandum of understanding are not legal types of contracts. They are business documents, and their legal nature is determined by their content, not their title. In practice, there are three variations, and you need to know which one you want.
The first is a truly non-binding document. It describes the price, structure, and timeline but explicitly states that it does not bind any party to conclude the transaction. Its value lies in the parties clarifying essential points before they start paying for advisors. We discuss where this document fits into the overall business process in the article How to Sell a Company: The Phases of a Company Sale from LOI to Post-Closing.
The second is a document that already contains a commitment to carry out the transaction. Depending on the specific structure, it is either a preliminary agreement where the parties commit to concluding the main contract upon request, or it is a direct transaction agreement with conditions precedent, where nothing further will be concluded and the parties are just waiting for the conditions to be met. It is necessary to distinguish between these two variants because they have different enforcement methods. This path is chosen by sellers in auctions and by investors in subsequent rounds.
The third and most common in practice is a mixed document: the business part is non-binding, while the procedural part is binding. The binding parts usually include exclusivity, confidentiality, cost allocation, governing law, and sometimes penalties for walking away. This is where most disputes arise—a company signs a document titled "non-binding" and overlooks that three of its articles are, in fact, binding.
The decision-making process includes one more question that is often forgotten: who will sign the document. If your holding company will be a party to the future contract, it makes no sense for only the operating company to sign the term sheet.
Step-by-step procedure
Negotiating a term sheet has a sequence that is worth following because each subsequent step builds on the previous one.
The first step is to identify the parties. On your side, this is the entity that will be selling or issuing the shares; on the investor's side, it is the fund, its SPV, or both. The difference between a fund and its SPV is not a formality: an SPV is often an empty company with no assets.
The second step is to divide the document into two parts and state this explicitly. The binding part includes confidentiality, exclusivity, costs, governing law, and dispute resolution. Everything else should be designated as non-binding, including the price and structure.
The third step is to negotiate exclusivity. It is agreed for a period corresponding to the scope of due diligence, with an exception for cases already under negotiation and with the option to terminate it if the investor ceases to proceed according to the plan. Exclusivity without an end date and without exceptions is the most expensive provision in the entire document for the owner.
The fourth step is to describe the pricing mechanism, not just the number. The term sheet should include whether the price is fixed or adjusted for net debt and working capital, how any earn-out is calculated, and what happens to the management option plan. Company valuation is discussed in the book on selling companies.
The fifth step is the scope and process of due diligence: what data the investor will receive, at what stage, who will have access to it, and what will happen to it if the transaction does not go through. If the investor is a competitor, it is not enough to simply postpone sensitive data to the final stage—a clean team is set up, data on prices, margins, and customer conditions are aggregated or anonymized, and access is denied to people who decide on prices and strategy. We cover the employee-related aspects in the article Due Diligence of Employees in a Company Sale or Acquisition.
The sixth step is the conditions precedent and what will terminate the transaction. This includes third-party consents, financing, the outcome of the due diligence, and any necessary regulatory notifications. A condition formulated as "a due diligence outcome satisfactory to the investor" gives the other party a free pass to walk away until the last day.
The seventh step is a timeline with milestones and cost allocation; it is advisable to link the duration of exclusivity to the investor's adherence to the plan, not to a calendar date. And finally, the operational side: who knows about the transaction, who communicates with employees, and who ensures that the company behaves as usual until closing.
What is standard in the market and what is a warning sign
In healthy transactions, the standard is that the term sheet has explicitly separate binding and non-binding parts, the exclusivity has an end date tied to milestones, and each party bears its own costs until the main agreement is signed. It is also standard to settle the structure of the company's future governance: who appoints the statutory body, which decisions require the investor's consent, and how deadlocks are resolved.
There are three warning signs. The first is a document labeled as non-binding that nevertheless contains a commitment to conclude the main agreement in the wording of an annex—such a document is a preliminary agreement regardless of its title. The second is exclusivity with no end date or with automatic renewal until the investor themselves says it ends.
The third sign is a one-sided penalty. If you pay for walking away from negotiations and the investor does not, it is not about protecting the transaction but an option on your company. A provision stating that you bear the investor's advisor costs even if the investor terminates the transaction has a similar effect.
Where the legal line is drawn
Negotiation is free, but not without rules, and in this case, there are two boundaries: liability for the manner of negotiation and the risk that the document is binding even if you don't want it to be.
According to Section 1728 of the Czech Civil Code, anyone may conduct negotiations for a contract freely and is not liable for failing to conclude it—unless they initiate or continue negotiations without the intention of concluding the contract. The parties are obliged to inform each other of the factual and legal circumstances they know or must know, so that each party's interest in concluding the contract is clear to the other.
According to Section 1729 of the Czech Civil Code, a party that terminates negotiations without a just cause at a stage where the conclusion of the contract seemed highly probable and the other party reasonably expected it, acts in bad faith. Furthermore, compensation is capped: at most to the extent corresponding to the loss from the non-concluded contract in similar cases. In court practice, therefore, claims are primarily for costs incurred during negotiations, i.e., for legal, economic, and financial advisory services.
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The Supreme Court added two points to this in its judgment 25 Cdo 1085/2025. First, it reiterates that this liability should be the exception rather than the rule, as negotiations are always accompanied by uncertainty. Second, and this is crucial for the structure of signatures, it concluded that the person entitled to compensation for damages is only a party to the intended contractual relationship—not a company that participated in the negotiations and influenced the content of the documentation but was not intended to be a party to the future contract.
The second boundary is typological. According to Section 1785 of the Czech Civil Code, a preliminary agreement obliges at least one party to conclude a future contract upon request within an agreed period, or otherwise within one year, the content of which is agreed upon at least in a general manner. If this condition is met, the entitled party may, under Section 1787, request that the content of the future contract be determined by a court or a person designated in the agreement. Conversely, under Section 1788, the obligation to conclude the contract ceases if the request is not made in time, or if circumstances change to such an extent that the conclusion of the contract cannot reasonably be required—however, if the obliged party fails to notify the other party of the change in circumstances without undue delay, it shall compensate the other party for the resulting damage. If the commitment to transfer a share is to be truly judicially enforceable, it also has a form requirement: the main agreement on the transfer of a share in a limited liability company (s.r.o.) requires officially certified signatures, and enforcement is therefore complicated with a simply signed term sheet. We discuss claims from these agreements in the article Receivables from a Preliminary Agreement.
Two rules remain that indirectly affect the term sheet. According to Section 1730 of the Czech Civil Code, a party that obtains confidential information during negotiations must ensure it is not misused; if it enriches itself through its misuse, it must surrender what it has gained. And according to Section 1746 of the Czech Civil Code, parties can also conclude a contract that is not regulated as a specific type—which is why a mixed term sheet is valid and enforceable in its binding part, provided it is sufficiently specific.
Potential problems | How ARROWS can help (consultation@arws.cz) |
|---|---|
A non-binding document that is binding: the content corresponds to a preliminary agreement | We will assess what the document actually establishes and divide it into binding and non-binding parts. For a signed term sheet, we will evaluate the extent of its binding nature |
Open-ended exclusivity: the owner cannot talk to other investors and has no way to terminate the negotiations | We will negotiate a duration tied to milestones and exceptions for unsolicited offers. We will also prepare conditions for early termination |
The investor walked away after due diligence: you were left with the advisor costs | We will evaluate whether it was a termination without just cause and pursue the claim. We will ensure that the correct entity makes the claim |
The wrong entity signed: the term sheet was signed by a different company than the future party to the contract | We will structure the signatures according to the future transaction. For a transaction already under negotiation, we will rectify the document with an addendum |
Due diligence data with a competitor: the investor owns a competing business | We will set up a clean team, aggregate sensitive data, and define the circle of people with access. For a transaction subject to approval under Czech legislation, we will also monitor the prohibition on premature implementation of the concentration under Section 18 |
Final summary
Negotiate the term sheet as two documents in one. First, clarify what should be binding—which includes confidentiality, exclusivity, and costs—and only then negotiate the price and structure, which should not be binding. The party to the term sheet must be the future counterparty, and the exclusivity should have an end date tied to the other party's progress.
The legal boundaries are asymmetrical. The non-binding nature of the business part will not help you if the document contains a commitment to conclude a contract described at least in general terms. Conversely, compensation for terminated negotiations is an exception, the amount of which is limited by law with a special cap, and it is only awarded to the future counterparty. The Prague-based law firm ARROWS negotiates transactions as part of its Company Sales, Transaction Advisory service and is insured for professional liability with a limit of CZK 350,000,000. Write to us at consultation@arws.cz.