Investment Term Sheets: Which Clauses Are Binding Before the Definitive Agreements Are Signed?

In investment transactions, parties frequently sign a Term Sheet before moving to the preparation of more comprehensive transaction documents.

A Term Sheet may address the investment amount, company valuation, investor ownership percentage, board appointment rights, reserved matters, anti-dilution protections, exit rights, and conditions that must be satisfied before the investment is completed.

It allows investors and companies to establish the principal framework of a transaction before incurring significant time and expense on due diligence and definitive documentation.

An important question nevertheless arises: is the Term Sheet already legally binding?

The answer is not always simply yes or no.

A Term Sheet may contain non-binding provisions, binding provisions, or a combination of both. Its title alone does not determine its legal effect.

What Is a Term Sheet?

A Term Sheet generally records the principal commercial and legal terms being discussed before an investment is documented through definitive agreements.

Where the investment involves the subscription of newly issued shares, the definitive documentation may include a Share Subscription Agreement or SSA.

Where an investor purchases existing shares from a shareholder, the transaction may instead involve a Share Purchase Agreement or SPA.

The parties may also enter into a Shareholders Agreement governing their relationship after the investor becomes a shareholder.

A Term Sheet generally precedes these documents.

It is therefore usually shorter and focuses on the core transaction principles, while matters such as representations and warranties, indemnities, conditions precedent, closing procedures, defaults, and post-closing rights and obligations are developed in greater detail in the definitive agreements.

Does Indonesian Law Specifically Regulate Term Sheets?

Indonesian contract law does not create a specific category under which every document labelled a Term Sheet automatically has a particular legal status.

Using the title "Term Sheet", "Heads of Agreement", "Letter of Intent", or another similar expression therefore does not by itself determine whether the document is legally binding.

The general principles of contract law remain relevant.

Article 1320 of the Indonesian Civil Code provides the general requirements for a valid agreement: consent, legal capacity, a specific subject matter, and a lawful cause.

Article 1338 provides that agreements legally entered into bind the parties who made them.

The language used in the document, the certainty of its provisions, the parties who sign it, and whether the parties intended to create legal obligations are therefore important.

A Term Sheet Is Not Automatically Non-Binding

It is a common misconception that a Term Sheet cannot be binding because the final transaction agreements have not yet been signed.

That is not necessarily the case.

Where the parties expressly provide that particular provisions are legally binding, those provisions may create contractual obligations subject to the general requirements of applicable law.

Conversely, the parties may expressly state that commercial terms are indicative and do not create an obligation to complete the transaction until definitive agreements have been executed.

One of the most important provisions in a Term Sheet is therefore its binding effect clause.

It should clearly identify which provisions are:

• binding;

• non-binding;

• effective immediately upon signing; and

• effective only after definitive agreements are executed or the transaction closes.

Without this distinction, significant room for disagreement may arise if negotiations subsequently fail.

Commercial Terms Are Often Non-Binding

In many investment transactions, the principal economic provisions remain indicative at the Term Sheet stage.

These may include:

• investment amount;

• pre-money or post-money valuation;

• price per share;

• investor ownership percentage;

• class of shares;

• liquidation preference;

• anti-dilution protection;

• dividend preference;

• board appointment rights;

• reserved matters;

• information rights;

• tag-along rights;

• drag-along rights;

• exit mechanisms; and

• proposed use of investment proceeds.

The parties may still need to complete due diligence and negotiate further before finalising these terms.

For example, an investor may initially propose an IDR 20 billion investment based on an IDR 80 billion valuation.

During due diligence, the investor may identify an unrecorded tax exposure, material litigation, or problems concerning ownership of intellectual property.

The investor may then seek to adjust the valuation, transaction structure, or closing requirements.

Where the commercial terms are expressly non-binding and subject to definitive documentation, the parties retain room to address those findings before the transaction becomes final.

A Non-Binding Statement Should Be Clearly Drafted

Merely placing the words "non-binding" at the top of the document may not be the clearest approach.

The Term Sheet should identify precisely which provisions are intended to remain non-binding and which survive as binding obligations.

It may also state that neither the investor nor the company is obliged to complete the investment, issue shares, or purchase shares until the relevant definitive agreements have been signed and applicable conditions precedent have been satisfied.

This allows the Term Sheet to serve as a negotiation framework without being treated as the final investment contract.

At the same time, obligations that need to operate during negotiations can remain enforceable.

Confidentiality Is Commonly Intended to Be Binding

Confidentiality is one of the provisions most commonly intended to take effect immediately.

During an investment process, an investor may receive non-public information such as:

• financial statements;

• financial forecasts;

• customer information;

• material contracts;

• technology information;

• pricing structures;

• employee information;

• tax documents; and

• expansion plans.

A Term Sheet may require the parties to keep such information confidential and restrict its use to evaluating the proposed transaction.

The confidentiality provision may regulate permitted recipients, exceptions, duration, and the treatment of information if the investment does not proceed.

In other transactions, the confidentiality obligations may already have been established through a separate Non-Disclosure Agreement signed before the Term Sheet.

Exclusivity or No-Shop Obligations May Also Be Binding

An investor committing resources to due diligence may request a period of exclusivity.

During that period, the company and its shareholders may be restricted from:

• soliciting another investment proposal;

• seeking alternative transactions;

• negotiating a competing share sale;

• disclosing information for a competing transaction; or

• entering into an agreement inconsistent with the proposed investment.

This is commonly referred to as an exclusivity or no-shop provision.

Although the investment itself remains subject to definitive documentation, the exclusivity obligation can be drafted to take effect immediately.

The length of that period therefore matters.

A 30-day or 60-day exclusivity period has very different commercial consequences from a six-month restriction.

A company may also consider termination rights where the investor fails to conduct due diligence or provide draft transaction documents within an agreed period.

Due Diligence Does Not Necessarily Require the Investor to Complete the Investment

A Term Sheet commonly provides that the transaction is subject to satisfactory due diligence.

An investor may investigate areas including:

• corporate matters;

• material commercial contracts;

• taxation;

• employment;

• licensing;

• litigation;

• intellectual property;

• data protection;

• financial matters; and

• regulatory compliance.

The company's obligation to provide access may operate during the negotiation process.

That obligation does not necessarily mean that the investor must ultimately complete the investment.

The Term Sheet should therefore clarify whether due diligence findings constitute a condition to the transaction, a basis for ending negotiations, or a basis for adjusting the commercial terms.

Transaction Costs Should Be Addressed

Investment transactions may involve legal fees, notarial costs, tax advisers, financial advisers, due diligence expenses, valuation costs, and other professional fees.

The Term Sheet should clarify who bears those expenses whether or not the transaction closes.

One common approach is for each party to bear its own advisers' costs.

Another structure may permit the company to reimburse the investor's transaction costs up to a specified amount following closing.

Where any cost obligation is intended to survive even if the transaction fails, the document should say so clearly.

Otherwise, the unsuccessful transaction may give rise to a separate dispute concerning expenses already incurred.

Governing Law and Dispute Resolution May Apply before Closing

The parties should also consider the governing law of the Term Sheet.

This becomes particularly relevant in cross-border transactions.

For example, the investor may be based in Singapore while the target company is incorporated in Indonesia.

The Term Sheet can specify the governing law and whether disputes will be resolved through courts or arbitration.

Where confidentiality, exclusivity, or cost provisions are binding, the parties need an effective mechanism for addressing a breach even though the main investment has not been completed.

Governing law and dispute resolution provisions are therefore commonly included among the provisions intended to survive during the negotiation stage.

Signing a Term Sheet Does Not Automatically Make the Investor a Shareholder

An agreement in principle to invest is different from the actual issuance of shares.

Where the investment involves newly issued shares, the company must still comply with the procedures required under Indonesian company law.

An increase in the company's capital generally requires the relevant shareholder approval.

Existing shareholders may also have statutory rights relating to newly issued shares under the circumstances provided by the Company Law.

Once the transaction terms have been agreed, the parties may still need to complete corporate approvals, payment of the subscription amount, notarial documentation, corporate filings, and other administrative steps.

A Term Sheet stating that an investor is expected to own 20% of the company therefore does not by itself make the investor a 20% shareholder on the date the Term Sheet is signed.

Conditions Precedent Separate Signing from Closing

Definitive investment agreements are frequently executed before every requirement for completing the transaction has been satisfied.

This creates a distinction between signing and closing.

At signing, the definitive investment agreement has been entered into.

Closing occurs after the applicable conditions precedent have been satisfied or waived in accordance with the agreement.

A Term Sheet may identify the conditions precedent that are expected to appear in the definitive transaction documents.

Examples may include:

• satisfactory due diligence;

• shareholder approval;

• amendments to the Articles of Association;

• regulatory approvals or notifications;

• completion of a restructuring;

• transfer of intellectual property to the company;

• settlement of material disputes;

• execution of material contracts; or

• achievement of specified business conditions.

At the Term Sheet stage, these matters will ordinarily remain part of the transaction framework unless the parties clearly agree otherwise.

Valuation and Share Price

Valuation is often one of the central provisions of an investment Term Sheet.

Investors and founders should nevertheless distinguish an indicative valuation from a final transaction price.

Valuation may change following due diligence.

The structure may also evolve to involve a convertible instrument, a particular class of shares, a secondary sale, or a combination of primary and secondary investment.

Where the valuation is not intended to be final, the Term Sheet should make that clear.

Conversely, where the parties intend to lock in a valuation, the language used should be considered carefully because it may strengthen an argument that a contractual commitment has already been made.

Reserved Matters Should Be Considered at the Term Sheet Stage

Although the detailed reserved matters regime is normally documented in the Shareholders Agreement and, where appropriate, reflected in the Articles of Association, its key principles are often negotiated in the Term Sheet.

An investor may request consent rights over matters such as:

• new share issuances;

• changes in capital;

• amendments to the Articles;

• changes in the principal business;

• borrowing above agreed thresholds;

• disposal of material assets;

• related-party transactions;

• management changes;

• dividend distributions;

• mergers and acquisitions; and

• dissolution.

These rights can significantly affect the company's future governance.

Founders should therefore not treat reserved matters as technical provisions that can simply be addressed after the investment terms are agreed.

Even where the Term Sheet is non-binding, agreement on these principles can materially shape the subsequent Shareholders Agreement negotiations.

Anti-Dilution Rights Require Early Attention

An investor may request anti-dilution protection if the company later issues shares at a lower price.

Different mechanisms produce different economic outcomes.

Some use a weighted-average adjustment, while others may provide more aggressive protection.

A Term Sheet may record only the commercial principle.

The mathematical formula, exclusions, employee option arrangements, and implementation mechanics are then developed in the definitive agreements.

Founders should consider the potential dilution consequences before accepting the principle because the economic impact may only become apparent in a later financing round.

Exit Rights May Be Equally Important

Investors generally consider not only how they will invest but also how they may eventually exit.

A Term Sheet may address:

• initial public offering;

• trade sale;

• secondary sale;

• tag-along rights;

• drag-along rights;

• rights of first refusal;

• put options;

• share buybacks; or

• other exit mechanisms.

Not every mechanism can be implemented merely because it appears in the Term Sheet.

Its implementation must remain consistent with Indonesian company law, the Articles of Association, the company's capital structure, applicable share buyback rules, regulatory restrictions, and the definitive transaction documents.

Risks of Signing a Term Sheet Too Quickly

A Term Sheet appears much simpler than a Shareholders Agreement or Share Subscription Agreement.

That simplicity can create a false sense that detailed legal review can wait until later.

Potential risks include:

• an excessively long exclusivity period;

• unrealistic valuation assumptions;

• overly broad investor veto rights;

• dilution consequences that founders have not modelled;

• impractical exit mechanisms;

• unlimited transaction expenses;

• unclear binding and non-binding provisions;

• no deadline for negotiations;

• inappropriate governing law; or

• disclosure of sensitive information without adequate protection.

These matters can influence the entire definitive-documentation process even where most of the Term Sheet is technically non-binding.

Commercially, a term agreed in the Term Sheet often becomes the starting point from which a party will be expected to justify any later departure.

The Binding Effect Clause Is Critical

A well-drafted Term Sheet should not require the parties to guess whether it creates legal obligations.

The binding effect clause may expressly provide that provisions concerning:

• confidentiality;

• exclusivity;

• costs and expenses;

• governing law;

• dispute resolution; and

• specified miscellaneous matters

are binding.

The remaining investment terms can then be identified as expressions of the parties' current intentions that do not create an obligation to complete the transaction until definitive agreements have been executed.

This distinction separates obligations that must be respected during the negotiation process from commercial provisions that remain open to further negotiation.

What Happens If Negotiations Fail?

Not every Term Sheet leads to an investment.

Due diligence may identify unacceptable risks.

The parties may fail to agree on valuation.

A necessary approval may not be obtained.

One party may also decide not to proceed for commercial reasons.

Where the investment terms are expressly non-binding, the failure of negotiations does not automatically amount to a breach of an obligation to complete the investment.

Binding provisions, however, may continue to operate.

A company that granted the investor 60 days of exclusivity may still be prohibited from negotiating a competing transaction during that period even though the definitive agreements have not been signed.

Similarly, confidentiality obligations may survive termination of the Term Sheet where the parties have agreed that they continue after negotiations end.

Identify the Parties Carefully

The parties signing the Term Sheet also matter.

The document may be entered into between:

• the investor and the company;

• the investor and the founders;

• the investor, company, and all existing shareholders;

• the investor and selling shareholders; or

• a combination of these parties.

This distinction can affect enforceability.

Where the company is not a party, every obligation in the Term Sheet cannot automatically be imposed on the company.

Likewise, founders signing personally should understand whether an obligation applies to them individually or only in their capacity as shareholders.

Under the general principle in Article 1340 of the Indonesian Civil Code, an agreement principally produces effects between the parties who entered into it.

The identities and capacities of all signatories should therefore be made clear.

A Term Sheet Cannot Override Mandatory Law

Freedom of contract does not permit the parties to disregard mandatory legal requirements.

Investors and founders may agree on a proposed ownership structure.

However, if implementation requires shareholder resolutions, amendments to the Articles of Association, regulatory approvals, or compliance with ownership restrictions, those requirements must still be satisfied.

The same applies to transactions involving foreign investors or specially regulated industries.

A Term Sheet is a commercial framework for the transaction. It is not a substitute for the corporate and regulatory processes required by law.

What Should Be Checked before Signing?

Before signing a Term Sheet, the company, founders, and investor should confirm at least several matters.

First, identify expressly which provisions are binding and which are non-binding.

Second, test the valuation, investment amount, and ownership percentage through a cap table showing the resulting dilution.

Third, understand the consequences of reserved matters, board rights, anti-dilution protections, and exit rights.

Fourth, ensure that the exclusivity period is proportionate.

Fifth, determine who pays transaction expenses if the investment fails.

Sixth, make sure confidentiality covers information disclosed during due diligence.

Seventh, specify when the Term Sheet terminates and which provisions survive.

Finally, identify the parties required for the definitive agreements and the corporate approvals needed for closing.

A Term Sheet can then function as a useful roadmap for the transaction without creating unnecessary uncertainty during the next stage of negotiations.

Conclusion

A Term Sheet plays an important role in an investment transaction by allowing investors, companies, and shareholders to establish the proposed transaction framework before completing definitive documentation.

It is not automatically binding or automatically non-binding merely because it carries a particular title.

Its legal effect depends on its wording, the parties who sign it, the substance of its provisions, and whether the parties intended to create legal obligations.

In many transactions, commercial provisions concerning valuation, investment amount, share ownership, governance rights, and exit mechanisms are expressly non-binding until definitive agreements are executed.

By contrast, confidentiality, exclusivity, costs, governing law, dispute resolution, and certain transaction-process provisions may be intended to bind the parties immediately.

The critical question before signing a Term Sheet is therefore not limited to whether the proposed investment economics are acceptable.

The parties should also be able to answer clearly: which terms remain open for negotiation, and which terms already create legal obligations from the date of signing?