A term sheet is a proposal, not a contract. It says: on these facts, subject to these conditions, we would consider lending on roughly these terms. Almost every line in it can still move, most of it is not binding on either party, and the parts that are binding are usually the least interesting: confidentiality, expiration, sometimes a deposit. Reading one well means separating what is being offered from what is merely being described.
The dangerous habit is reading the rate line and stopping. Rate is one of eight terms that determine what a facility actually costs and what it lets you do afterward, and it is frequently not the one with the largest dollar impact. Amortization changes the payment more than pricing does over the ranges normally available. A prepayment penalty can cost more at exit than a full point of rate costs over the whole term. This article goes through the eight, in the order they matter.
Term one: amount, and what it nets to
The headline amount is gross. What matters is net proceeds: the amount that reaches your account after origination fees, documentation fees, any required payoffs of existing obligations, escrows, prepaid interest and third-party costs. Two offers with the same face amount can differ meaningfully in what you actually receive.
Ask for the net figure in writing, itemized. If the term sheet lists fees as percentages, do the arithmetic yourself and put the dollar amounts next to them. This is a five-minute exercise that regularly changes which offer is better.
Term two: amortization, term, and the balloon
These three are frequently confused and they are not the same thing. Amortization is the schedule the payment is calculated on. Term is how long the facility exists. If the term is shorter than the amortization, there is a balloon: a remaining balance due in full at maturity, which you will need to refinance or repay from another source.
A facility described as a ten-year loan may be a five-year term on a twenty-year amortization. That is a common and often reasonable structure, and it carries refinancing risk that belongs on your calendar the day you sign. Know the balloon amount and the date before you sign, not in year four.
Term three: how the rate is built
A rate line has more structure than a single number. Is it fixed for the full term, fixed for a period and then adjusting, or floating? If it floats, what index is it tied to, what is the spread over that index, how often does it reset, and is there a floor or a cap? A floating facility with a floor and no cap has asymmetric risk and you should price that consciously.
Also ask what the rate is contingent on. Term sheets frequently quote pricing subject to final underwriting, appraisal outcome, or a covenant being met. That is normal, and it means the quoted number is an expectation rather than a commitment. Nothing on a term sheet is a guaranteed rate until it is in an executed note.
Term four: fees, all of them
Fees fall into three groups: lender fees, third-party costs, and ongoing charges. Lender fees include origination, underwriting, documentation and sometimes a commitment fee on an unused line. Third-party costs include appraisal, title, environmental, valuation, filing and legal. Ongoing charges include annual line renewal fees, servicing fees and late charges.
The question to ask is not what the fees are but which of them you owe if the deal does not close. Third-party costs are generally incurred and payable regardless of outcome, because someone did the work. Knowing which costs are at risk before you authorize an appraisal is basic and frequently skipped.
Term five: prepayment
Prepayment terms decide what your exit costs, and they are the most commonly overlooked line on a term sheet. The main structures are a step-down penalty that declines by year, yield maintenance or a defeasance requirement that can be substantial in a falling-rate environment, a lockout period during which prepayment is not permitted at all, and open prepayment with no penalty.
Match the structure to your plan. If you expect to sell the asset, refinance after a repositioning, or replace the facility once your numbers improve, a penalty schedule is a direct cost of that plan. If you intend to hold for the full term, it may be irrelevant and worth trading away for better pricing.
Term six: collateral, lien position and cross-collateral
Read what is being pledged with unusual care, because it constrains everything you do afterward. A blanket lien on all business assets is common and it means the next lender is looking at a second position or nothing. If specific equipment or property is pledged, check whether release provisions exist for selling an individual asset.
Watch for cross-collateralization and cross-default language, which link this facility to others you hold with the same party. Cross-default in particular means a technical breach on a small obligation can put a large one in default. It is not automatically unacceptable; it is something you should know you agreed to.
Term seven: guarantees
Who signs, for how much, and for how long. A full unlimited personal guarantee from every owner above a threshold percentage is standard in small commercial credit. Variations worth asking about include limited guarantees capped at a dollar amount, several rather than joint liability among multiple guarantors, validity or bad-boy guarantees limited to specific misconduct, and burn-off provisions that release the guarantee once performance conditions are met for a defined period.
Ask whether a spouse is required to sign, and if so in what capacity. Ask whether the guarantee survives a sale of the business. These answers are rarely volunteered and they are always available.
Term eight: covenants and reporting
Financial covenants are ongoing tests: a minimum coverage ratio, a maximum leverage ratio, a minimum liquidity balance, sometimes a limit on distributions or additional debt. Reporting covenants specify what you send and when: annual returns, quarterly or monthly statements, compliance certificates, updated personal financials.
Both matter, and reporting covenants cause more defaults than financial ones. Missing a required statement for two quarters is a technical default even while every payment has been made on time. Before signing, confirm you can actually produce what is required on the cadence required, and put every deadline on a calendar.
Comparing two offers properly
| Line | Offer A | Offer B | What it means |
|---|---|---|---|
| Stated rate | Lower | Higher by roughly one point | A looks cheaper on the headline |
| Amortization | 36 months | 84 months | B's payment is far smaller |
| Approximate monthly payment | About $15,700 | About $7,500 | B frees roughly $98,000 of annual cash |
| Origination and doc fees | 1.5% plus $2,500 | 1.0% plus $1,000 | B nets more proceeds |
| Prepayment | Open after 6 months | 3-2-1 step-down | A is cheaper to exit early |
| Collateral | Blanket lien | Specific equipment | B leaves room for a future facility |
| Covenants | None stated | Coverage test, quarterly reporting | B carries ongoing obligations |
| Guarantee | Full personal | Full personal, burn-off after 24 months | B has a defined path off the guarantee |
On rate alone, A wins. On almost everything that determines whether the business can operate comfortably while carrying the debt, B does: unless you plan to repay within a year, in which case A's open prepayment and lower stated rate become decisive. The correct answer depends on your plan, which is the entire point of reading past line one.
The review pass before you sign
Work through this with the term sheet in front of you
- Write the net proceeds figure yourself, after every fee and required payoff.
- Write the monthly payment, the term, the amortization and the balloon amount and date.
- Convert every percentage fee to a dollar amount.
- Identify which costs you owe if the deal does not close.
- Determine whether the rate is fixed, adjusting or floating, and note index, spread, reset frequency, floor and cap.
- Calculate the prepayment cost at the point you realistically expect to exit.
- List everything pledged, and check for cross-collateral and cross-default language.
- List every guarantor, the scope of each guarantee, and any burn-off or release condition.
- List every covenant and every reporting deadline, then confirm you can produce each one on time.
- Note the term sheet expiration date and what conditions remain before a commitment exists.
- Recompute your pro-forma coverage using this exact payment, including obligations that survive closing.
Is a term sheet binding?
Mostly not. Typically only specific provisions bind: confidentiality, expiration, an agreement to pay third-party costs, and sometimes an exclusivity period or a deposit. The economic terms remain subject to final underwriting and stated conditions. Read the section that says which parts are binding, because it exists and it is short.
Can I negotiate a term sheet?
Usually some of it, and the negotiable parts are rarely the ones borrowers push on. Rate is often set by policy and pricing grids. Amortization, prepayment structure, covenant thresholds, guarantee scope and collateral release provisions are more frequently adjustable. Ask about those and you are more likely to move something.
Should I sign more than one term sheet?
Be careful. Some contain exclusivity provisions, and signing two that both bind you creates a real problem. Beyond the legal issue, third-party costs are typically incurred once you proceed, so running two processes to closing means paying twice. Compare offers before signing, then commit to one.
What does subject to final underwriting actually mean?
That the terms were quoted on preliminary information and can change if verification produces different facts: a lower appraisal, a debt the schedule omitted, a covenant that will not be met at closing. It is standard language. It also means a term sheet is not an approval, and nobody should treat it as one when planning around funds.
How long is a term sheet good for?
There is usually a stated expiration, and it is short. Beyond the date, the underlying assumptions age too: statements go stale, rates move, and the file may need refreshing. Treat the expiration as a real deadline rather than a formality, and ask what happens if it passes while you are waiting on a third party.
The offer came back smaller than I asked for. What now?
Ask what would support the larger amount. The answer usually names one specific thing: a coverage threshold, additional collateral, a longer amortization, or retiring an existing obligation. That converts a disappointing number into a defined task, and sometimes into a second tranche available after a performance test.
Do I need a lawyer to review a term sheet?
For a straightforward facility, a careful read against the checklist above catches most of it. For anything involving cross-default, a confession of judgment, unusual collateral arrangements, or a guarantee structure you do not fully understand, counsel is worth the fee. The loan documents themselves warrant review more often than the term sheet does.
Which single line should I check first?
The monthly payment against your own pro-forma coverage, including every obligation that survives closing. It tells you immediately whether the structure is livable. Everything else on the term sheet shapes the cost and the flexibility; that one line tells you whether the business can carry it through a bad quarter.
Where to start
Take any term sheet you are holding and fill in three numbers by hand: net proceeds, monthly payment, and prepayment cost at the date you actually expect to exit. Those three are rarely printed together anywhere in the document, and writing them down usually reorders how you rank the offers in front of you.
Then recompute coverage with that payment in the denominator. If it is thin, the fix is more likely to be a structural conversation about amortization than a search for a better rate, and knowing which desk underwrites the structure you need is a two-question exercise before it is a shopping exercise.
Qualified Commercial Underwriting Desk
Credit and capital markets
The Qualified Commercial underwriting desk reviews commercial real estate, dealer and Main Street files daily. The Academy is written from that work (how files are actually read, priced and declined) rather than from a rate sheet.
Educational content only. Nothing here is a commitment to lend, an offer of credit, or tax, legal or accounting advice. Program terms, timelines and thresholds vary by lender, file and market conditions, and any figures shown are illustrative.