You have an ideal buyer for your business and a potential deal on the table, so what’s next? How can you make sure that the principles of the deal are clear for both you as the owner, and the buyer? Answer, create a Heads of Terms. This is the fourth step in Selling your Business.
Heads of Terms (also known as a letter of intent, memorandum of understanding and heads of agreement) is a high-level document setting out the core components of your business sale deal, including the purchase price, the deal structure and some key terms. This might include points on the buyer’s due diligence process, expected warranties and indemnities, and the terms of any earn-out.
At Devant we would recommend that some form of Heads of Terms is prepared and signed before you get into the details of the deal to make sure that key terms are clearly set out. The Heads of Terms is not legally binding, but it does represent a moral commitment to the deal and is often referenced through the negotiation process, so you need to be sure that this is the deal you want to do!
“The sale of my business is straightforward and I know what I want so let’s save time (and money!) and move to the formal sale and purchase agreement.”
Even if the business sale appears straightforward (is there such a thing!), moving straight to the more formal sale and purchase agreement won’t save you time and money. In my experience creating a Heads of Terms saves time (and therefore money) in the long run as you have a high-level written document that both parties have agreed to and refer to. This helps avoid misunderstandings and will save you documentation time and negotiation time later on.
How to get the most from your Heads of Terms
Ask yourself these five questions:
- Is the deal complex? If it is then the Heads of Terms provides the perfect opportunity to focus the initial negotiations and identify misunderstandings and issues up front, so that any “show stoppers” can be identified and prevent both parties from wasting further time and money.
- If you are ready for the moral commitment to specific terms of the deal at this stage, don’t you want the reassurance of the same commitment from your buyer?
- Are the terms of the deal pretty much fixed and are you happy with them? Will committing to the terms now restrict your flexibility too much later on in the detailed negotiations?
- Will a Heads of Terms be useful to help explain the deal and sell it to any other shareholders that have not been involved in the negotiations so far?
- Do you need to engage other advisors and get clearance for the deal e.g. from HMRC? If so, a Heads of Terms can help as the basis for explaining the deal to them.
Be careful! When you create your Heads of Terms
In some situations, a seller may be able to gain a tactical advantage by getting the buyer to agree to points that it would not have accepted at a later stage after its due diligence process. However, Devant would strongly advise against this approach as it will only create bad feeling before the detailed negotiations have even begun!
Care should be taken in international transactions that a Heads of Terms doesn’t create a binding agreement, and you also need to be careful that the Heads of Terms does not get you into trouble under competition law or with tax implications – if in doubt check and get advice.
The tax considerations are very important can lead the terms of a deal, so in structuring the deal at a high level at the Heads of Terms stage, both tax and legal advice should be sought. Devant was involved in a business sale deal structured by our client’s accountants and tax advisors, only to find that the structure did not comply with company law. This meant the deal had to be completely re-worked – a situation that is best avoided!
Let’s keep it simple
The Heads of Terms can be a simple letter, or a more formal document in the form of an agreement. Who drafts it? Heads of Terms are usually drafted by the buyer, so if you are the seller, you do need to seek advice to ensure that you are not committing to any unfavourable terms, even if only on a moral commitment basis. Come and ask us!
Usually, the only legally binding terms are “exclusivity” commitments – the seller will only negotiate with this buyer and no others for a period of time, “confidentiality” obligations – each party agrees to keep all important and sensitive information of the other party confidential, and governing law. Occasionally there might be an agreement with regard to costs – one party (normally the buyer) might want the added security of its costs being covered if the deal does not proceed. This will add to the moral commitment of both parties and give the buyer some confidence that it is not wasting time and money.
Key areas in a Heads of Terms
- Parties involved, who is selling and who is buying, making sure the relevant legal entities are correctly referred to
- Share or asset sale, and what shares/which assets?
- Price (the amount on completion, plus any earn-out if appropriate)
- Key assumptions
- Conditions to the deal, such as passing due diligence, all consents and approvals being obtained, material contracts still being in place, shareholder approval, etc.
- Any special terms that are specific to this deal
- Procedure and timetable for the deal process
- Exclusivity
- Confidentiality
- Allocation of costs.
Key for the seller will be the price and we would always advise that you should not sell your business unless you’re satisfied with the amount of the purchase price you receive at completion. There are lots of ways that an earn-out can be reduced and if you are relying on the earn-out, then this probably isn’t the right deal for you.
Once the Heads of Terms has been agreed, the deal process can move on to the next step – formal due diligence and the sale and purchase agreement.
Heads of Terms will help focus both the buyer and seller and highlight any major areas of potential disagreement at an early stage of the business sale. Found your ideal buyer and ready to create Heads of Terms? Talk to us now to save time and reduce your legal fees later on.
Janine Scott
Senior Commercial Consultant
