Heads of Terms: issues to include
Buyer and sellers of a business often agree key terms before involving solicitors. However, ensure you address the following issues. Address these issues at the “Heads of Terms” stage, and your deal will more quickly close, saving professional fees.
Clients ask us about the non-binding nature of the Heads of Terms, i.e. If they are non binding, then what is the point. Don’t underestimate the moral force of the Heads of Terms. Nevertheless ensure certain terms are binding. Binding terms usually include:
- Confidentiality provisions,
- Non-poaching of employees, to protect the seller.
- Exclusivity provisions to protect the buyer.
Thus the seller won’t risk losing intellectual property or staff. If a competing buyer emerges, the current buyer has safeguarded their spend on due diligence,
The Heads of Terms sets out the key commercial terms. In our experience, this step reduces legal and other professional costs. The resulting document is variously called the:
- Term Sheet;
- MOU: Memorandum of Understanding;
- LOI: Letter of Intent;
- HOT: Heads of Terms.
Once the parties agree the Heads of Terms, there is due-diligence: a thorough business review. Finally the parties negotiate the formal legal sale documents.
Heads of terms: key issues
The Heads of Terms is usually not legally binding. However, both parties find it difficult to alter key provisions agreed in the Heads of Terms. Since most companies do not involve lawyers when negotiating heads of terms, ensure you agree:
A headline acquisition figure of £x million usually sounds tempting. However, from the seller’s perspective, the buyer rewrites the deal if the payments:
- Are staggered over many years;
- Depend on the business’ performance; and
- The seller does not control the buyer’s management term.
Yet, the buyer wants to ensure the business is actually thriving, and will pay extra for a thriving business. Thus the Heads of Terms should define:
- When payments will be paid;
- Terms that limit those payments, and note:
- Illustrative examples helps avoid future disputes;
- Seller’s involvement after the sale completes.
Restrictive covenants can prevent sellers joining competitors for a defined period. However, if the business operates in a niche sector, the seller may enjoy few other job opportunities.
This issue often consumes the most time when negotiating the formal legal documents. If negotiated at the Heads of Terms stage, it could save wasted effort.
Limitation on Liability
Ideally the buyers wants the seller to promise they managed the business honestly, ethically and legally. If the seller didn’t manage the business appropriately, when issues emerge the seller should compensate the buyer.
The result is lengthy negotiations to limit each party’s responsibility. Sellers should limit or cap their maximum pay-out if problems actually arise. These limitations on liability are probably more easily agreed during the Heads of Terms phase, without the lawyers involved.
An anti-embarrassment provision allows the seller a percentage of the upside if a buyer sells the business within specified period, termed “flipping”. For example, a business is bought for £100,000 today, and sold for £200,000 six months later. An anti-embarrassment clause enables the original seller to perhaps get 30% of the additional value.
Note, if a buyer does not agree to an anti-embarrassment clause at the Heads of Term stage, it is a safe bet the buyer won’t agree later.