Summary. A term sheet looks like a page of numbers and is actually the loan agreement in outline, negotiated at the only moment the borrower has leverage. Once signed, the definitive documents are drafted from it, and every provision the borrower did not address becomes the lender's form. This guide covers what to negotiate and in what order: the facility structure and size, the borrowing base, pricing and the fees that appear only at prepayment, the financial covenants and the EBITDA definition that determines whether they are ever breached, the covenants that constrain ordinary business decisions, the events of default and their cure periods, collateral and guaranties, and the conditions precedent that determine whether the loan funds at all.

A manufacturer signs a term sheet for a $12 million facility: a $5 million revolver and a $7 million term loan. The sheet is three pages. The rate is competitive. The founder signs it the day it arrives, because the company needs the money in six weeks.

The credit agreement, drafted from that term sheet, contains the following, none of which the term sheet excluded:

A total leverage covenant of 3.0x tested quarterly, with EBITDA defined without any add-backs for the non-recurring items in the company's projections. The company projected 2.6x; it is actually at 3.3x on the lender's definition, and it is in default at the first test date.

A fixed charge coverage covenant of 1.20x that includes unfinanced capital expenditures and distributions in fixed charges. The company's planned equipment purchase, which was in the model shown to the lender, breaches it.

Cash dominion at all times — a lockbox sweeping all receipts to the lender daily, with advances made against the borrowing base. The company's cash management changes fundamentally, and its treasury function was not built for it.

A $2.4 million prepayment premium structure — 3 percent in year one, 2 percent in year two, 1 percent in year three — which makes refinancing on better terms uneconomic until year four.

A negative covenant limiting capital expenditures to $600,000 annually with no carryforward, against a business that spends $1.1 million in a normal year.

A guaranty from the founder personally, secured by a second mortgage on his residence, which the term sheet described as "customary support."

Every one of those was negotiable on the day the term sheet was signed and essentially non-negotiable afterward. The term sheet is where the loan is priced, and where everything other than price is decided by default.

What a term sheet is, and is not

A term sheet or proposal letter is generally non-binding as to the loan itself, with certain provisions expressly binding — confidentiality, expense reimbursement, exclusivity, and sometimes indemnification. A commitment letter is a binding obligation to lend, subject to conditions, and the conditions are where the substance lives.

Read the binding provisions carefully, because they bind:

  • Expense reimbursement, which obligates the borrower to pay the lender's legal, appraisal, field examination, environmental, and search costs whether or not the loan closes. Negotiate a cap and a requirement of estimates in advance.
  • Exclusivity or "no-shop", which prevents the borrower from negotiating with other lenders for a period. Keep it short — 30 to 45 days — and tie it to the lender meeting a closing timeline.
  • A deposit or good faith payment, and whether it is refundable and against what.
  • Indemnification of the lender.
  • Confidentiality, ideally mutual.

And understand what "subject to" means. A term sheet subject to "satisfactory completion of due diligence," "credit approval," "satisfactory documentation," and "no material adverse change" is subject to essentially everything. Push for the term sheet to state that credit approval has been obtained, or to identify precisely what remains, and to narrow the diligence conditions to specified items.

Negotiate more than one. The single most effective thing a borrower can do is run a process with two or three lenders in parallel. Terms improve materially in competition and barely at all in a bilateral negotiation, and the second term sheet is worth more as leverage than as an alternative.

Structure: what kind of facility

Revolving credit facility. Draw, repay, redraw up to a commitment. Priced on the drawn amount with an unused line fee on the undrawn portion. Used for working capital. Negotiate: the commitment amount, the term, whether availability is subject to a borrowing base, the existence of any clean-down requirement (a period each year during which the revolver must be at zero), sublimits for letters of credit and swingline, and whether it is committed or discretionary — a demand line can be pulled without a default and is worth far less than its headline amount.

Term loan. Funded once, amortized over a schedule, with a maturity. Negotiate: the amortization (straight-line, back-weighted, or interest-only with a balloon), the maturity, and the mandatory prepayment triggers — excess cash flow sweeps, asset sale proceeds, insurance and condemnation proceeds, and debt or equity issuance proceeds. Excess cash flow sweeps in particular should have a step-down as leverage declines and should exclude amounts needed for working capital.

Asset-based lending. Availability is a function of a borrowing base rather than of cash flow, with lighter financial covenants in exchange for tighter collateral control. Suited to businesses with substantial receivables and inventory.

Equipment financing and commercial real estate loans, each with their own structures.

SBA 7(a) and 504 loans, which offer longer terms and lower down payments in exchange for a personal guaranty requirement that is generally non-negotiable for any owner of 20 percent or more, plus guaranty fees and program restrictions.

Mezzanine and subordinated debt, typically with higher rates, PIK interest, warrants, and an intercreditor agreement with the senior lender.

The borrowing base

For an asset-based or borrowing-base revolver, this determines how much money is actually available, and it is where the borrower's negotiation should concentrate.

Structure: advance rates applied to eligible collateral, minus reserves.

Typical advance rates: 80 to 90 percent of eligible accounts receivable; 50 to 65 percent of eligible inventory, frequently subject to a cap and to a net orderly liquidation value appraisal; lower rates for work in process and for slow-moving stock; and, where included, advance rates against equipment and real estate on appraised values with amortizing sublimits.

Eligibility criteria are where availability disappears. Standard exclusions from eligible receivables include: invoices more than 60 or 90 days past due; cross-aging, which excludes an entire customer's balance if a defined percentage is past due; concentration limits excluding a customer's balance above a percentage of the total; foreign account debtors without credit support; government receivables absent an assignment of claims; contra accounts, where the customer is also a supplier; affiliate receivables; bill-and-hold and consignment; disputed invoices; and progress billings.

Negotiate the criteria specifically against the actual receivable book. A concentration limit of 15 percent is fatal to a company whose largest customer is 30 percent of sales, and it is negotiable to a higher limit for a named investment-grade customer.

Reserves are the lender's discretionary reduction of availability — for dilution, rent in landlord-lien states, taxes, accrued payroll, letters of credit, and anything the lender considers appropriate. Negotiate limits on discretionary reserves: a requirement of notice before imposition, a requirement that reserves be based on the lender's commercially reasonable credit judgment, and a prohibition on double-counting a reserve for a matter already addressed by an eligibility exclusion.

Reporting. Borrowing base certificates monthly, or weekly when availability falls below a threshold, plus receivable and payable agings, inventory reporting, and periodic field examinations and appraisals at the borrower's expense. Negotiate the frequency, the cost caps, and a limit on the number of examinations per year absent a default.

Pricing

The interest rate. A benchmark plus a spread, or a fixed rate. The benchmark for most floating-rate loans is now term SOFR plus a credit spread adjustment; some facilities use a prime-based rate. Negotiate:

  • The spread, ideally on a pricing grid that steps down as leverage improves — which is worth real money over a multi-year facility and is frequently available for the asking.
  • A floor on the benchmark, which matters when rates fall.
  • Interest periods and the ability to elect them.
  • Default interest — typically 2 percent above the applicable rate — and, importantly, whether it applies automatically on any default or only on an event of default after notice, and whether it applies to the whole facility or only to the overdue amount.

Fees:

  • Commitment or origination fee, payable at closing, typically 0.25 to 1.5 percent.
  • Unused line fee on the undrawn revolver.
  • Letter of credit fees — a fronting fee plus a fee approximating the spread.
  • Administrative agency fee on syndicated facilities.
  • Amendment and waiver fees, which are not in the term sheet and should be anticipated.
  • Field exam and appraisal fees, with per-exam caps and an annual limit.
  • Prepayment premium — the fee that surprises borrowers most. Structures include a declining percentage over the first several years, a make-whole for fixed-rate loans computed as the present value of foregone interest, and yield maintenance. Negotiate: the duration and the amounts; exclusions for prepayment from asset sale proceeds, insurance proceeds, or a change of control; and — the most valuable point — an exception permitting refinancing with the same lender or prepayment in connection with a sale of the company, which is the scenario in which the premium hurts most.

Compare offers on total cost, not on rate. A facility with a lower spread, a large origination fee, an unused line fee, mandatory field exams, and a three-year prepayment premium may be more expensive than one priced 50 basis points higher.

Financial covenants

These determine whether the borrower is in default, and the definitions matter more than the ratios.

The common covenants:

Total leverage ratio — funded debt to EBITDA, tested quarterly on a trailing twelve-month basis, with step-downs over time. Negotiate the level against a realistic downside case, not the base case.

Fixed charge coverage ratio — a measure of cash available to service fixed obligations. The definition of fixed charges is the negotiation: it typically includes interest, scheduled principal, and taxes, and lenders frequently add unfinanced capital expenditures, distributions, and operating lease payments. Each addition makes the covenant materially harder, and each is negotiable.

Minimum EBITDA or minimum liquidity — used where the business is early-stage or where leverage is not meaningful.

Maximum capital expenditures — a hard annual cap. Negotiate a level above the actual plan, a carryforward of unused amounts to the following year, an exclusion for capital expenditures funded by permitted equipment financing or by equity contributions, and an exclusion for maintenance capital expenditures.

Minimum tangible net worth, in older-style facilities.

The EBITDA definition is the single most valuable provision in the agreement. Every financial covenant runs through it. Negotiate the add-backs explicitly:

  • Non-cash charges — depreciation, amortization, stock compensation, impairment.
  • Non-recurring or extraordinary items, defined with enough specificity that the borrower can rely on them.
  • Transaction expenses for the financing itself and for permitted acquisitions.
  • Restructuring charges and severance.
  • Pro forma effect of acquisitions and divestitures, on a trailing basis.
  • Run-rate cost savings and synergies, subject to a cap (frequently 10 to 20 percent of EBITDA) and a realization period.
  • Business interruption insurance proceeds.
  • Rent expense where the covenant treats leases in a particular way.

A borrower that negotiates the ratio and ignores the definition has negotiated nothing.

Other essential terms around the covenants:

  • Testing frequency and periods. Quarterly on a trailing twelve-month basis is standard; monthly testing is materially harder.
  • The first test date. Push it out to allow the business to season.
  • Step-downs should be modest and should follow the business plan with margin.
  • The equity cure right — the ability to cure a financial covenant breach by contributing equity, with the contribution added to EBITDA or applied to reduce debt. Ask for it. Negotiate: the number of cures permitted (typically four over the life, no more than two consecutive), the cure period (10 to 15 business days after delivery of financials), whether the cure amount is capped at the amount needed to cure, and whether the cured amount counts toward subsequent test periods.
  • Holidays and springing covenants. In an asset-based facility, financial covenants frequently spring only when availability falls below a threshold — which is far better for the borrower than a covenant tested at all times.

Affirmative and negative covenants

Affirmative covenants — what the borrower must do. Most are unobjectionable; the negotiation is about frequency and burden:

  • Financial reporting — annual audited financials within 90 to 120 days, quarterly within 45, monthly within 30, plus a compliance certificate with covenant calculations, an annual budget, and borrowing base reporting. Negotiate the deadlines against the company's actual close cycle, and whether the annual statements must be audited (expensive) or may be reviewed for a smaller borrower.
  • Notices of default, litigation above a threshold, ERISA events, environmental matters, and material contract terminations.
  • Insurance, with the lender as loss payee and additional insured.
  • Inspection rights and field examinations, with frequency limits and cost caps absent a default.
  • Maintenance of existence, properties, licenses, and compliance with laws.
  • Further assurances — the obligation to execute additional documents, which lenders use to require security in later-acquired assets.
  • Deposit account control agreements, and whether cash dominion is full-time or springing on a default or a liquidity threshold. Full-time dominion changes treasury operations fundamentally, and springing dominion should be the borrower's ask.

Negative covenants — what the borrower may not do without consent. Each should have a basket or exception sized for actual business needs:

  • Indebtedness — with baskets for capital leases and purchase money debt, intercompany debt, and a general basket.
  • Liens — permitted liens including purchase money, statutory, and landlord liens.
  • Investments and acquisitions — with a permitted acquisition basket subject to conditions (pro forma covenant compliance, a maximum size, the target being in a related line of business, and no default).
  • Restricted payments — dividends and distributions. Negotiate a permitted tax distribution for a pass-through entity, because without it the owners owe tax on income they cannot receive. Also negotiate a general basket, and a builder basket tied to cumulative retained earnings or excess cash flow.
  • Asset sales, with a de minimis basket and permission for ordinary course dispositions of obsolete equipment.
  • Mergers and fundamental changes.
  • Affiliate transactions, with an exception for arm's-length transactions and for identified existing arrangements.
  • Changes in business, fiscal year, or organizational documents.
  • Prepayment of subordinated debt.
  • Sale-leaseback transactions.

The recurring negotiation is not whether these covenants exist — they will — but whether the baskets accommodate the business as it is actually run. Go through the company's last two years of activity and confirm that nothing it did would have required consent.

Defaults and remedies

Events of default:

  • Payment default — negotiate a grace period of 3 to 5 business days for non-principal amounts, and at least an administrative grace for principal.
  • Covenant breach — negotiate a cure period of 15 to 30 days for affirmative covenants; negative and financial covenants typically have none.
  • Representation breach.
  • Cross-default to other debt above a threshold. Negotiate a meaningful threshold and, importantly, that it is triggered by an acceleration or a payment default rather than by any technical breach of any other agreement.
  • Judgment default above a threshold, with a period to stay or discharge, and an exclusion for judgments covered by insurance where the insurer has accepted coverage.
  • Bankruptcy and insolvency, with a period for involuntary proceedings to be dismissed.
  • Change of control, defined to accommodate estate planning transfers, transfers among existing owners, and an equity financing.
  • Material adverse change — the most dangerous default in the agreement, because it is subjective. Negotiate the definition narrowly (a material adverse effect on the business, operations, or financial condition taken as a whole, with carve-outs for general economic and industry conditions, and for matters disclosed at closing), and resist any MAC clause that is a condition to each borrowing rather than only to the initial funding.
  • Key person provisions, where present, which should be negotiated to permit a replacement period.
  • ERISA events, environmental matters, and loss of collateral.

Remedies — acceleration, termination of commitments, default interest, foreclosure, setoff, and appointment of a receiver. Confirm that acceleration requires notice except in a bankruptcy, and that the lender's remedies are subject to any intercreditor agreement.

Collateral, guaranties, and conditions

Collateral for a secured facility is typically all assets: accounts, inventory, equipment, general intangibles, intellectual property, deposit accounts, and equity in subsidiaries. Negotiate exclusions: leasehold interests where the landlord's consent is required, contracts whose anti-assignment provisions would be breached, commercial tort claims until identified, and — where relevant — motor vehicles and other assets whose perfection is disproportionately burdensome. Real property should require a mortgage only if the lender is genuinely relying on it, because mortgages bring title work, surveys, environmental assessments, and flood determinations that add weeks and cost.

Guaranties. Corporate guaranties from subsidiaries are standard. Personal guaranties are the negotiation:

  • Resist entirely where the credit supports it.
  • Where required, negotiate a limited guaranty — capped at a dollar amount or a percentage, or limited to specific "bad boy" carve-outs (fraud, misappropriation, environmental, voluntary bankruptcy).
  • Negotiate a release on achieving defined financial metrics, which lenders grant more often than borrowers ask.
  • Resist collateral securing the personal guaranty, particularly a residence.
  • Where there are multiple owners, address several rather than joint liability, or a contribution agreement among guarantors.
  • Note that a spousal guaranty may not be required solely because of marital status under the Equal Credit Opportunity Act and Regulation B, though a lender may require a guaranty from a person whose separate creditworthiness is being relied on or, in community property states, to reach community assets.

Conditions precedent determine whether the loan funds:

  • Executed documents, resolutions, incumbency and officer certificates, good standing certificates.
  • Lien searches and payoff letters for existing debt, with UCC-3 terminations.
  • Landlord waivers and bailee letters for collateral at third-party locations — which take weeks and are frequently the item that delays a closing.
  • Deposit account control agreements, which require the depository bank's cooperation.
  • Insurance certificates with the required endorsements.
  • Appraisals, field exams, environmental reports, and surveys.
  • Legal opinions from borrower's counsel.
  • A solvency certificate.
  • Minimum availability or liquidity at closing.
  • No material adverse change, and no default.
  • Payment of fees and expenses.

Start the long-lead items immediately — landlord waivers, control agreements, environmental reports, and surveys — because they, not the negotiation, determine the closing date.

A short case study

A specialty distributor with $46 million of revenue seeks a $15 million facility to refinance existing debt and fund growth. It receives three term sheets.

Comparison. On rate, the offers span 75 basis points. On total cost over a projected four-year hold, the spread is much wider once origination fees, unused line fees, field exam costs, and prepayment premiums are modeled. The mid-rate offer is the cheapest.

Structure. A $10 million borrowing-base revolver plus a $5 million term loan. The company negotiates: the receivable concentration limit raised from 15 to 25 percent for its two largest customers, both investment grade; the inventory advance rate raised on finished goods after an appraisal; a requirement that discretionary reserves be imposed only on five business days' notice and on commercially reasonable credit judgment; and field examinations limited to two per year absent a default, with a cost cap.

Pricing. A four-level pricing grid stepping down 25 basis points at each of three leverage thresholds. The prepayment premium is reduced from three years to two, with exclusions for prepayment from asset sale proceeds and in connection with a sale of the company.

Covenants. Fixed charge coverage at 1.15x with unfinanced capital expenditures excluded from fixed charges and permitted tax distributions excluded as well. Total leverage at 3.5x stepping to 3.0x in year two. EBITDA defined with add-backs for the two identified non-recurring items, transaction expenses, stock compensation, and pro forma acquisition effect with a synergy cap. A capital expenditure cap set at $2.2 million against a $1.4 million plan, with a 50 percent carryforward. An equity cure right, four times over the life, no more than two consecutive.

Cash management. Springing dominion, triggered at availability below 15 percent for five consecutive days, rather than full-time dominion.

Guaranties. The two owners provide limited guaranties capped at $1.5 million each, several rather than joint, with a release on achieving 2.5x leverage for two consecutive quarters. No residence collateral.

Closing. Landlord waivers for three warehouses and control agreements for four accounts are started the week the term sheet is signed. The loan closes in seven weeks.

The negotiation cost roughly two weeks and a legal fee measured in tens of thousands of dollars. The value — in the concentration limits alone, several million dollars of additional availability, and in the covenant definitions, the difference between compliance and a default in the company's second year, when a customer delayed payment for a quarter.

Conclusion

Three points carry the weight.

Negotiate at the term sheet stage, and negotiate more than one. Once the term sheet is signed and exclusivity has attached, the borrower's leverage is gone and the definitive documents are drafted from the lender's forms. A parallel process with two or three lenders is worth more than any argument made later.

The definitions decide the covenants. EBITDA, fixed charges, eligible receivables, and permitted liens determine whether a covenant is comfortable or breached. A borrower that negotiates ratios and accepts definitions has negotiated the wrong half.

Model the downside before agreeing to anything. Run the covenants against a case in which revenue falls 20 percent, a large customer pays late for a quarter, and a planned capital expenditure happens anyway. Covenants that hold in the base case and fail in that scenario are covenants that will be breached, and the time to fix them is now — because a waiver later costs a fee, a rate increase, and a good deal of leverage the borrower would rather keep.

Frequently asked questions

How long does a term sheet negotiation take? Three days to three weeks, depending on how much the borrower pushes and how many lenders are competing. Closing after signature typically takes four to eight weeks, and the delay is almost always a long-lead condition — a landlord waiver, a control agreement, an environmental report, or a survey — rather than the documents.

Can we negotiate after signing the term sheet? A little, and it costs credibility. Anything raised for the first time in the credit agreement is characterized as re-trading, and the lender's answer is usually that the term sheet is silent so the form controls. Raise it in the term sheet or accept the form.

Is the term sheet binding? Generally not as to the loan, but the expense reimbursement, exclusivity, confidentiality, and indemnity provisions are — and the expense provision means the borrower may owe the lender's costs even if the loan never closes. Cap it.

What is the most important number in the term sheet? Not the rate. In a borrowing-base facility, the eligibility criteria and advance rates, because they determine how much money is actually available. In a cash-flow facility, the EBITDA definition, because it determines whether the covenants are ever breached.

Should we resist a personal guaranty? Always ask, and expect it for a small or middle-market credit. Where it cannot be avoided, negotiate a cap, several rather than joint liability, no collateral over a residence, and a release on defined metrics. The release is granted far more often than borrowers assume, because the lender's real concern is the first two years.

What is cash dominion and why does it matter? A lockbox arrangement under which all receipts sweep to the lender and are applied to the loan, with advances made against availability. It works, but it changes treasury operations fundamentally and leaves the borrower dependent on the lender's daily funding. Springing dominion — triggered only by a default or a liquidity threshold — is the better ask and is commonly available.

What if we breach a covenant? Notify the lender before it discovers the breach, with an explanation and a plan. A waiver typically costs a fee and sometimes a pricing increase or a tightened covenant, and it is far cheaper than a default the lender finds in a compliance certificate. If an equity cure right exists, this is what it is for.

Do we need our own counsel? Yes. The borrower pays the lender's counsel under the expense provision, and that lawyer represents the lender. A borrower without its own counsel is negotiating a fifty-page document against a specialist, and the fee is a small fraction of what a single unnegotiated covenant costs.

Preparing to borrow

Lenders price uncertainty, and much of what a borrower can do to improve terms happens before any lender is approached.

Clean up the financial reporting. Reviewed or audited statements, a monthly close on a predictable cycle, and a chart of accounts that supports the covenant calculations. A borrower whose numbers change after the lender's diligence loses credibility it does not recover.

Prepare a real model. A base case and a downside, with the covenant calculations built into it so both sides can see where the covenants bind. Bringing that model to the negotiation is far more persuasive than arguing about the level of a ratio in the abstract.

Clean up the collateral picture. Existing UCC filings from paid-off loans that were never terminated, equipment leases that will need to be subordinated or excluded, and inventory sitting at third-party locations without a bailee letter — each of these becomes a closing condition, and each is easier to fix before there is a deadline.

Know the receivable book. Concentration, aging, dilution history, and the identity and credit quality of the largest customers. Every one of those drives an eligibility criterion, and a borrower who can present the data proactively negotiates better limits.

Understand the existing debt. Payoff amounts, prepayment penalties, and the release process for existing liens. A prepayment premium on the loan being refinanced is a real cost of the new facility.

Assemble the diligence package in advance: organizational documents, financials, tax returns, the customer and supplier lists, leases, insurance certificates, material contracts, litigation summary, and the capitalization table. A borrower that delivers this in the first week signals competence, and the perception affects terms.

And decide who is running the process. A CFO or an advisor managing three lender relationships in parallel, with a consistent information package and a stated timeline, produces materially better outcomes than a founder taking calls as they come.

A note on syndicated and club facilities. Above roughly $50 million, a facility is frequently arranged by an agent bank and syndicated to a group. That changes several things a borrower should anticipate: amendments and waivers require the consent of a majority of lenders (and unanimity for the sacred rights — principal, interest, maturity, and collateral releases), so a workout involves negotiating with a committee rather than a relationship; the agent has limited discretion and will not act without instructions; assignment provisions determine who can end up holding the paper, and a borrower should negotiate consent rights over assignments to competitors and to distressed funds; and the flex language in the commitment letter may permit the arranger to change pricing and structure to complete the syndication. Read the flex provision, and cap it.

Finally, calendar the obligations the day the loan closes. Reporting deadlines, compliance certificates, insurance renewals, borrowing base certificates, and the covenant test dates all become defaults if missed, and the most common event of default in a healthy company is not a financial covenant breach — it is a late financial statement nobody had on a calendar.

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This guide is provided for general informational purposes and does not constitute legal or financial advice. Loan terms, market conventions, and the availability of particular provisions vary by lender, facility type, credit quality, and market conditions. Consult qualified finance counsel before signing a term sheet or a commitment letter.