Term Sheets - Some key considerations
October 2007
Most businesses will operate some form of debt facilities with a bank or financial institution in the ordinary course of business. It may be an overdraft for working capital purposes, or a structured term or revolving credit facility for the acquisition of a company, property or other assets.In each of these cases, discussions with the bank will result in a term sheet (also known as 'heads of terms' or 'outline terms and conditions'), which sets out the principal terms on which the bank is prepared to finance the borrower's debt requirements. Term sheets are generally non-binding, and therefore parties sometimes focus on the 'cost of funds' before proceeding to the documentation stage without detailed consideration of the other terms. However, before embarking on a course of negotiation with a bank which results in an agreement of a term sheet, there are a few useful tips any company should consider in their discussions and negotiations with any potential funders of their business.
Shop around
A business should speak to more than one bank to get a feel for the market. There are many banks in the marketplace keen to lend to businesses as they look to grow and increase their own market share. Banks, in order to distinguish themselves, often operate in particular sectors such as, for example, healthcare, manufacturing, or property and a borrower may find banks with a distinct sector focus more competitive since they are better positioned to understand their business. In fact Bevan Brittan have contacts with many banks and financial institutions in various sectors and would be happy to put people in touch!The long term relationship
Some banks place more emphasis on 'relationship banking' than others. A truly productive and rewarding banking relationship is not just about cost of funds but whether the bank will understand and support the business. Also, once the financing has completed it is important to ask how the bank will now manage the ongoing relationship with the borrower. In the long run if a borrower has a problem, or just needs some flexibility in its financing arrangements due to market conditions, it may find itself speaking to an individual who does not understand the business and may not be as sympathetic as its original contact. Ensure you understand the process and are comfortable with the individuals involved.Bank and expert fees
Paying off debt early can be beneficial to the borrower but there are often hefty prepayment or exit fees attached to any such payments. Therefore, it is always a good idea for the borrower to agree a prepayment clause to allow itself to refinance the debt at anytime, or pay it off early in certain circumstances if it so requires, with minimum or no penalties. If the loan interest is fixed (i.e. hedged whether by a swap or internally fixed) there may be break costs which it should be aware of and which it should clarify with the bank.The borrower should also discuss what other fees may be payable during the operation of the loan such as arrangement fees, commitment fees and non utilisation fees.
Also, it is advisable to check how often the bank can appoint valuers, accountants and other experts to review its business and assets since these fees will be generally for the borrower's account and not the bank’s.
Default interest
It is understandable that a bank may charge default interest in the event of any problems on a loan. Banks may charge anything up to 5% above their Base Rate or LIBOR (as the case may be) as a default rate. Banks are sometimes open to discussing the default rate at the outset of the deal and a business should take this opportunity to do so.Group companies
A bank may often seek undertakings or security from group companies. The impact of this can be far reaching and a borrower should carefully consider which member of the group should be involved in the financing. A breach of a covenant by the borrower could have adverse consequences for all the companies of the group.General, financial and information covenants
A borrower should bear in mind that a loan agreement is a live document and as such must fit its business. Time should be taken to consider if a business can comply with the general, financial and information covenants the bank is seeking for it to undertake. For example, information covenants may prove too burdensome for smaller businesses and should be carefully reviewed. A breach of covenant should be taken seriously since it will constitute an event of default, allowing the bank to charge default rate interest and call in the loan. Furthermore if there is anything in a business plan or forecast that may breach financial covenants, e.g. proposed capital expenditure, then a business should ensure that it agrees suitable exceptions allowing it to comply with the covenants.Security and conditions precedent
The less the better, but this is not always possible! The important point for a business to keep in mind is that whatever it has agreed to provide will be required at drawdown, and a failure to produce such documents could result in a delay.
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