Acquisition Financing Term Sheets: Key Clauses that Make or Break Your Deal

Acquisition Financing Term sheets are creative portrayals of lender interest, part-legal document and part sales presentation. Lenders use them to show their formal interest in a deal. They contain all the important information needed to assess an acquisition financing being offered such as loan amount, interest rate, amortization, maturity and fees. The acquisition financing lender sometimes uses terms and provisions that appear benign but are problematic upon closer examination.

In all deals, the true meaning of a term sheet needs to be clearly understood by a borrower prior to lender selection. Some term sheets contain a cash flow sweep which means the lender gets extra repayment based on the level of excess cash flow. In concept, these are fine, however in practice, they are very difficult to implement. The definition usually is insufficient to measure the real excess cash flow, leaving borrowers with a big extra payment and little cash in the bank to make it.

Prepayment penalties are also an area of definitional deception. Some prepayment fees are simple but others that involve a make whole provision require a degree in advanced mathematics to decode. If the language is hard to understand, then it usually means it will cost you a lot of money to prepay early.

Hidden Risks in Acquisition Financing Structures

Floating interest rates is a term that sounds simple but needs refinement to fully understand. All bank lenders will quote in a floating index but then require a swap to a fixed rate which will cost extra.
Minimum EBITDA levels are also a bone of contention in acquisition financing term sheets. This is a level that the lender requires to make the loan. If the lender sets this at too high a level, and the EBITDA shrinks through diligence or performance, they will likely increase the pricing.

Covenanting levels and definitions are a perennial graveyard for deals that die. Acquisition financing lenders may try to force a deal into a very tight covenant framework. Once the deal closes, the borrower may struggle giving the lender the right to charge exorbitant waiver fees.

The most important clause outside of standard terms is the conditions for closing and the costs thereof. If the lender utilizes multiple third-party advisors, the lender approval is more uncertain, and the company has to foot the bill. The process of underwriting and credit decision needs to be clearly understood by the company before executing the term sheet.