Buying or selling a business usually starts with a document most people have heard of but few fully understand: the term sheet, also called a heads of agreement. In plain terms, it is a written record of the main commercial terms the parties have agreed on for a proposed business sale, prepared before the formal contract is drafted. It is not required by law, and in most cases it is not intended to be the final contract. This article explains what a term sheet is, what it typically contains, when it becomes legally binding, and the common misunderstandings that land business owners in disputes.
What a term sheet is in a business sale
A term sheet goes by several names, including heads of agreement, memorandum of understanding, letter of intent and heads of terms. The name does not determine its legal effect; the contents and the parties' intention do. It is a preliminary document that records the key commercial terms agreed during negotiation, such as the price, the structure of the sale and what is included, so that the parties can move on to drafting the formal business sale agreement without re-arguing every point.
It is not legally required. Parties can go straight from negotiation to a formal contract. But in practice most advisers recommend a term sheet because it does useful work. It shows both sides that the deal is real, it focuses early negotiations on the most important issues, it puts deal-breakers on the table early, and it sets a framework and timetable for what happens next. Writing agreed points down once, rather than rediscovering them during drafting, reduces the time and cost of finalising the transaction.
Because a term sheet often shapes the entire deal and may be treated as important evidence if a dispute later arises, it should be approached as a significant document, not an administrative formality. The way the parties behave after signing it can matter as much as the words on the page, a point that becomes clear below.
What a term sheet records
A term sheet for a business sale will usually record the commercial essentials that will later appear in the formal sale agreement:
- Purchase price and payment: the price, whether it is paid in cash, by instalments or partly by an earn-out, and any deposit.
- Structure of the sale: whether the buyer acquires the business assets (an asset sale) or the shares in the company that runs the business (a share sale), which has very different tax and liability consequences.
- Assets included and excluded: plant, equipment, stock, vehicles, customer lists and intellectual property, and anything that stays with the seller.
- Employees: whether employees transfer to the buyer and how their entitlements will be handled.
- Training and handover: any period in which the seller trains the buyer or introduces them to customers and suppliers.
- Goodwill: how much of the price is attributed to goodwill, which the seller is effectively promising not to take back.
- Restraint of trade: the period and area in which the seller agrees not to compete after the sale.
- Warranties and indemnities: the seller's promises about the state of the business, such as that the accounts are accurate and there are no undisclosed debts, and who bears particular risks.
- Conditions precedent: steps that must happen before the sale completes, such as finance approval, due diligence, landlord consent to a lease assignment or the transfer of licences.
- Timetable: target dates for due diligence, signing the formal agreement and completion.
- Confidentiality and exclusivity: whether the seller is locked into dealing only with this buyer for a period, and who may use the information exchanged during negotiations.
Not every term sheet covers all of these items. It depends on the business and on how far negotiations have progressed. The point of the document is to record what has been agreed so far and what still needs to be resolved before a formal agreement can be signed.
When does a term sheet become legally binding?
Whether a term sheet binds the parties depends on whether they intended to be bound. That intention is judged objectively: a court looks at what a reasonable person would understand from the document, the surrounding communications and the parties' conduct, not at what either party privately intended, and not at the label on the document.
The High Court set out the classic framework in Masters v Cameron (1954) 91 CLR 353. Where parties have negotiated terms and also expect a formal contract to follow, the case falls into one of three categories:
- Immediately binding: the parties have reached final agreement on all terms and intend to be bound at once, with the formal document simply restating the bargain in fuller or more precise form.
- Binding subject to formal contract: the parties have agreed on all terms and intend to be bound now, but the performance of some terms is conditional on a formal contract being executed.
- Not binding until a formal contract is signed: the parties do not intend to make a concluded bargain at all unless and until they execute a formal contract.
Most term sheets are intended to fall into the third category, often signalled by words such as "subject to contract" or "subject to the preparation of a formal agreement". In Masters v Cameron, the High Court held that expressions of that kind prima facie create an overriding condition, so that what has been agreed is the intended basis for a future contract rather than a contract in itself.
That phrase, however, is not a magic shield. Courts look at the whole picture. If the parties agree all the key terms and then start performing, for example by paying deposits, taking possession or ordering stock, a court may find a binding contract even where the document says "subject to contract". A party's conduct after signing can also show that the intention expressed in the document has changed. Inconsistent drafting and behaviour can undermine an otherwise clear intention not to be bound, and the reverse is also true.
A term sheet can also be partly binding. Even where the commercial terms are expressly non-binding, clauses dealing with confidentiality, exclusivity, who bears the costs of the transaction and the protection of information exchanged during due diligence are commonly intended to bind. Those clauses operate regardless of a "non-binding" label elsewhere in the document.
A worked example: the cafe sale
Priya wants to buy Harbour Grind, a cafe run by Dan. After several meetings they sign a one-page heads of agreement recording a purchase price of $180,000, the equipment and stock included in the sale, a two-week training period with Dan, a restraint stopping Dan from opening a cafe within five kilometres for two years, and a statement that the agreement is subject to the preparation of a formal business sale agreement. Priya pays a $10,000 deposit, resigns from her job, arranges finance and orders new signage. Two months later a larger chain offers Dan $230,000. He accepts and tells Priya the deal is off because no formal contract was ever signed.
Where does Priya stand? On the face of the document, the "subject to formal agreement" wording puts the heads of agreement in the third Masters v Cameron category, so Dan may be right that there was no binding contract to sell. Following the reasoning in Masters v Cameron, Priya would be entitled to the return of her deposit, because money paid pending a formal contract is returned if no contract is executed.
That is not the end of it. If the heads of agreement contained an exclusivity clause intended to bind, Dan breached it by negotiating with the chain during the exclusivity period, and Priya can sue on that clause. If Dan made statements that induced Priya to resign and spend money, for example assurances that the sale was certain to proceed, Priya may have claims for misleading or deceptive conduct under s 18 of the Australian Consumer Law (which is Schedule 2 of the Competition and Consumer Act 2010 (Cth)), as well as possible estoppel claims. Had a lawyer reviewed the heads of agreement before Priya signed, she would have known exactly which terms bound Dan and which did not, and could have insisted that the exclusivity period and the deposit terms be made expressly binding.
Common misconceptions about term sheets
Several misunderstandings about what a term sheet can and cannot do recur when business owners rely on one:
- "It is just a draft, so nothing in it can bind me": Labels do not decide the outcome. A court assesses intention objectively, and a document headed "non-binding" can still be a contract if the parties behave as though they are bound. Even a genuinely non-binding term sheet usually contains clauses that do bind, such as confidentiality, exclusivity and costs, and those clauses survive a collapse of the deal.
- "The term sheet is the contract, so once it is signed the deal is done": Usually wrong. The usual purpose of a term sheet is to record agreed terms as the basis for drafting a formal sale agreement, which supersedes it. The term sheet is a guide, not the destination, unless the parties intended immediate binding effect under the first or second Masters v Cameron categories.
- "If the document is non-binding, the other side can walk away and I have no rights at all": Not true. Beyond binding ancillary clauses, a party who induces the other to act to its detriment may face estoppel or restitution claims even where no contract exists. And misleading statements made during negotiations, whether in the term sheet or in the conversations around it, can expose the maker to claims under s 18 of the Australian Consumer Law, because selling a business is conduct in trade or commerce. A "non-binding" label protects a party from being sued on the sale contract itself; it does not protect against misleading conduct or estoppel claims.
- "Any restraint of trade I agree to in the term sheet will be enforced": Restraints of trade are only enforceable to the extent they reasonably protect the purchaser's legitimate interest in the goodwill being bought. A restraint that is too long or too wide can be struck out entirely. In Petersville Ltd v Peters (WA) Ltd [1999] FCA 5, a restraint in a business sale that could run for nearly 30 years was held void. A term sheet that records an overreaching restraint gives the buyer a false sense of protection.
How a business sale lawyer helps with your term sheet
A lawyer's job at the term sheet stage is to make the binding intent unambiguous and to protect you whether or not the deal proceeds. In practice that means several things:
- drafting or reviewing the binding and non-binding clauses so the document says what you actually intend, and checking that your conduct during negotiations does not contradict it;
- identifying which clauses should be binding even in an otherwise non-binding document, such as exclusivity, confidentiality and costs, and making sure they are drafted so they can be enforced;
- testing the restraint of trade against what a court would enforce, so the buyer is not left holding an unenforceable promise;
- flagging the items that drive timing and risk, including employee entitlements, lease assignment, licences and the transfer of the business name on ASIC's register;
- translating the term sheet into the formal business sale agreement so nothing agreed is lost and nothing new silently appears.
Employee entitlements deserve particular attention. When a business changes hands, the transfer of business rules in the Fair Work Act 2009 (Cth) may require the new employer to recognise employees' prior service for many entitlements, including personal leave, while the old employer may need to pay out accumulated annual leave or redundancy. A lawyer can identify whether the transfer provisions apply and make sure the term sheet records who carries those costs.
The clause that decides whether you are bound
The misstep that costs the most in business sale negotiations is a mismatch between the document and the behaviour around it: a term sheet whose words say "not binding" while the parties act as though the deal is done, or a verbal assurance of exclusivity that was never written down as a binding clause. Before you sign a term sheet, ask yourself which sentences you would want to rely on in court if the deal collapsed tomorrow. If the answer includes the deposit, exclusivity or confidentiality, make sure those clauses are expressly binding, and treat every payment, email and handover during the negotiation as evidence a court may one day read.