Understanding the Term Sheet Process
Receiving a term sheet is a key milestone in the loan application process. It follows a predictable path:
- Application & Underwriting: You submit your loan application with all required financial documents. The lender’s underwriting team assesses your creditworthiness and business viability.
- The Offer: If the review is positive, the lender extends a term sheet as a formal, preliminary offer.
- Review & Negotiation: This is the most critical stage for you. Carefully review every term. Now is your opportunity to negotiate the interest rate, fees, or covenants. Don’t be afraid to ask for more favorable terms; lenders often expect some back-and-forth.
- Acceptance: Once you agree to the terms, you’ll sign the sheet to signal your intent to proceed. Be aware that you might be agreeing to a binding “no-shop” or exclusivity clause, which prevents you from seeking other offers for a set period (e.g., 30–60 days).
- Final Loan Agreement: The lender’s legal team drafts the final, legally binding loan documents. These should mirror the points agreed upon in the term sheet. Always review the final contract to ensure no terms have changed unexpectedly.
Key Components of a Business Loan Term Sheet
A term sheet breaks down the proposed financing into specific components. Here’s what to look for:
- Loan Amount (Principal): The total sum of money being offered.
- Interest Rate: The cost of borrowing. It’s crucial to note whether it is a fixed rate (remains the same) or a variable rate (can change over time, often tied to a benchmark like the Prime Rate).
- Term Length: The total time you have to repay the loan, such as 5, 10, or 20 years.
- Repayment Schedule: How frequently payments are due (e.g., monthly, weekly, or daily).
- Collateral: For a secured loan, this section lists the specific assets (like real estate, equipment, or inventory) you must pledge. If you default, the lender can seize this collateral.
- Fees: Pay close attention to costs beyond interest, including origination fees (for processing the loan), appraisal fees, legal fees, and especially prepayment penalties (a fee for paying the loan off early).
- Covenants: These are rules you must follow to avoid default.
- Positive Covenants: Actions you must take, such as providing annual financial statements, maintaining insurance, or paying taxes on time.
- Negative Covenants: Actions you cannot take without permission, like acquiring more debt, selling company assets, or changing business ownership.
Is a Term Sheet Legally Binding?
This is a common point of confusion. The majority of a business loan term sheet is non-binding. It’s a good-faith proposal, not the final contract.
However, certain clauses are often legally binding. The most common is an exclusivity clause (or “no-shop” agreement). By signing, you agree not to solicit or accept loan offers from other lenders for a specified time. Lenders use this to ensure you’re serious before they invest more time and legal resources into finalizing the deal.
Frequently Asked Questions (FAQs)
1. How is a term sheet different from a commitment letter?
A term sheet is a preliminary, mostly non-binding outline of terms. A commitment letter is a more formal, often binding promise from the lender to provide the loan, provided certain final conditions are met. The commitment letter comes after the term sheet has been accepted.
2. Does receiving a term sheet guarantee loan approval?
No. The loan offer is still conditional on final due diligence and underwriting. The lender can withdraw the offer if they discover negative information—like a sudden drop in your business credit score or a major customer loss—before the final contract is signed.
3. What are the biggest red flags to watch for?
Be wary of high prepayment penalties that lock you into the loan, vaguely defined variable interest rates, and restrictive negative covenants that could limit your ability to run your business effectively. For more details on lending practices, you can review resources from the Consumer Financial Protection Bureau (CFPB).
Ready to take the next step? Learn more about how to prepare your finances by exploring our guides on financial planning.