Understanding Term Sheets in Private Credit

Commercial lending has long been considered an opaque industry, without much clarity into the step-by-step process of how borrowers secure loans. 

One of the initial steps in that process is the issuance of the term sheet. These documents play a crucial role in structuring and negotiating direct lending deals, as they represent the first real indication of interest on the part of the lender (beyond merely a verbal expression of interest). 

In this article, we'll demystify term sheets, explain their importance in the lending process, and highlight some typical terms that borrowers may encounter when lenders submit their term sheets. 

Key Highlights

• Term sheets act as a jumping off point for negotiations between borrowers and lenders. Typically, borrowers will obtain term sheers from several lenders and negotiate for the most favorable terms before agreeing to move forward.  
• Term sheets are bespoke to each deal, yet there are several standard terms that one will find in any commercial lending agreement. 
• Heron Finance invests in pre-vetted deals, sourced and negotiated by experienced private credit lenders who issue their own term sheets. 

What is a Term Sheet?

A term sheet is a non-binding agreement that outlines the key terms and conditions of a proposed investment or loan. It serves as a blueprint for the final legal documents and provides a framework for negotiating the deal's specifics. 

In the context of private credit, a term sheet is issued by the lender to the borrower, detailing the terms under which the lender is willing to transact.

Term sheets are essential in private lending for several reasons:

Clarity and Transparency: A well-crafted term sheet ensures that both parties clearly understand the proposed terms, reducing the risk of misunderstandings or disputes down the line.

• Negotiation Tool: Term sheets facilitate negotiations by allowing the lender and borrower to discuss and agree on the key terms before committing significant resources to drafting legal documents.
• Efficiency: By establishing the deal's framework upfront, term sheets streamline the process of finalizing legal agreements, saving time and legal costs.
• Confidentiality: Term sheets often include confidentiality clauses, protecting the parties' sensitive information during negotiations.

In addition to the above, term sheets enable borrowers to easily compare and contrast lenders (borrowers typically receive term sheets from multiple different lenders when raising capital). Lenders willing to extend credit set bespoke terms based partly on borrower financials, collateral and management teams, and partly on the lender’s own exposure to the borrower’s industry or geographic region (such factors can impact the terms a lender offers). The lender/borrower relationship (provided there is one prior to the issuance of a term sheet) can also play a factor here. 

Borrowers use term sheets to determine which lender is most appropriate for their specific deal. In other words, term sheets are the jumping off point for a negotiation process, and help borrowers and lenders arrive at a formal partnership, known as the credit agreement. 

Typical Terms in Private Credit Deals

Term sheets vary depending on the specificities of each deal, as well as any prior relationship the parties involved maintain. Remember, lending is a relationship-driven business, given that the lender is putting a certain degree of trust in the borrower, that the borrower will spend the lender’s money wisely and appropriately. Of course, there are also ways for lenders to mitigate the risk of a borrower default. 

Yet despite the bespoke nature of most term sheets, there are some boilerplate terms that tend to find their way into these documents over and over again. Below are some examples: 

• Loan Amount and Purpose: This section specifies the total amount of credit being extended and the intended use of the funds (e.g., working capital, acquisitions, refinancing).
• Interest Rate and Fees: The term sheet will outline the interest rate structure, including any fixed or variable components, as well as any upfront or ongoing fees (e.g., origination fees, commitment fees, prepayment penalties).
• Repayment Terms: This section details the loan's repayment schedule, including the maturity date, amortization schedule (if applicable), and any balloon payments.
• Security and Collateral: For secured loans, the term sheet will describe the types of collateral or assets being pledged as security, as well as any priority or subordination arrangements.
• Affirmative, Negative and Financial Covenants: Affirmative covenants outline actions the borrower must take (e.g., maintaining insurance, providing financial statements), while negative covenants restrict certain activities (e.g., incurring additional debt, selling assets). Financial covenants are specific financial metrics or ratios that the borrower must maintain throughout the loan's life, such as minimum liquidity, leverage ratios, or debt service coverage ratios. Learn more here.
• Representations and Warranties: These are statements made by the borrower regarding their financial condition, legal standing, and other material aspects of their business.
• Events of Default: This section lists the circumstances under which the lender can declare the loan in default and potentially accelerate repayment or seize collateral.

Remember, term sheets are just the starting point for negotiations, and their terms are subject to change based on the parties' negotiations. 

Term sheets are not disclosable, so the borrower cannot show one lender’s term sheet to another. Hence, the process of negotiation often involves borrowers claiming they received more generous terms from a competing lender in an attempt to press a certain lender to soften their own terms.  

How Heron Finance Provides Access to Pre-Vetted Deals

At Heron Finance, we partner with experienced credit funds who have already originated, diligenced and underwritten deals. These credit funds issue term sheets, negotiate credit structures and loan terms, and solidify credit agreements with the borrowers of their capital. 

Heron Finance acquires a portion of these deals, which are used to build diversified portfolios for the investors on our platform. Investors on Heron Finance therefore gain access to a broad range of borrower types, credit funds, loan durations, etc. 

To learn more, visit our deals page where we explain our process in greater detail, and you can view sample deals on our platform. 

And to get started investing in private credit, click the button below to set up your Heron Finance account.