Whether you are a buyer or seller of a business, the early stages of a transaction are usually the same. There will be, sometimes seemingly endless, discussions, negotiations and bargaining before a deal is struck.
At this stage it is sensible to commit the key agreed terms to a document called the Heads of Terms (also known as a Memorandum of Understanding). Certainly when the Corporate Team at Acumen are assisting a buyer or seller at these early stages we will often advise in favour of this for various reasons, as discussed below.
Heads of Terms are used in various transactions from business sales, joint ventures, mergers and investments to name but a few. Their main purpose is to be used as definitive confirmation that the key terms of the transaction are agreed upon in principle before the transaction moves forward. This document helps give the transaction focus and clarity and generally means that any differing views can be resolved efficiently by reference to what was agreed at the outset.
Heads of Terms are typically drafted in the early stages of a business sale transaction, as mentioned above, and although they are not a legal requirement, or even legally binding, they do establish solid foundations for the transaction as a whole. A typical Heads of Terms can include confirmation of the price, payment terms, earn out provisions, timescales, any post-completion restrictions and many more key items. There is no set format and the parties can be flexible in how the Heads of Terms will look once finalised.
It is worth noting that the phrase ‘subject to contract’ can, and indeed should, be used to indicate that the parties involved in the transaction do not wish to be bound by the Heads of Terms. This avoids any ambiguity and generally the parties will not want the Heads of Terms to be binding in most respects (save for as discussed below) as the Heads of terms are typically entered into before any due diligence takes place. Buyers will want to be able to renegotiate the price or abort the transaction if the due diligence process raises any major concerns.
As mentioned, Heads of Terms are not a requirement and generally are not legally binding (unless stated otherwise), however that does not mean it is a document without utility. In our experience, properly drafted Heads of Terms can serve as a marker of intent and a tool to minimise the risk of unwanted surprises later on in the transaction.
The process of drafting Heads of Terms can help focus negotiations and unearth any potential misunderstanding early on. This helps parties to avoid wasted time and minimises road blocks later on when significant costs and time have been incurred.
Once parties commit to paper their intention and key agreed terms it is often the case that departures from those agreed terms become less likely. This is because parties are far less likely to resile from what they have agreed when it is in black and white and signed. This helps to maintain a smooth transaction and where departures from the Heads of Terms are required, often it is with good reason (for example findings from due diligence which fundamentally alter the complexion of the deal) and not simply due to a change of heart about the deal.
Another advantage is that Heads of Terms can be drafted in such a way to be partially binding on the parties to the transaction. This can mean that certain provisions, for example exclusivity or confidentiality provisions, can bind the parties while the other terms can remain non-binding.
Taking each of these examples in turn, parties may want there to be an exclusivity period during which no other negotiations with third parties can take place. Setting this out in Heads of Terms and stating that the exclusivity provisions are binding will afford the parties some security. In terms of confidentiality, the same security can be provided with suitable provisions which are noted as being legally binding. In both instances, such provisions would allow parties to have recourse if, for example, sensitive information is used for purposes beyond negotiations or a seller reaches a deal with a third party during the exclusivity period. Without Heads of Terms, in the unfortunate event that one party has committed some sort of wrongdoing, the other may not necessarily have a valid action or, if there is an action to be had, it may be more complex and more risky.
Heads of terms are also a useful basis for instructing professional advisers or summarising the deal for other interest parties.
Word of caution
As you can see, at Acumen we feel that setting out the details of a transaction in Heads of Terms is a good idea. However, caution must be exercised in some instances when discussing the terms of a deal.
From a buyer’s perspective, Heads of Terms can limit any “wiggle room” in terms of the deal. As mentioned above, this can be a big advantage in terms of promoting certainty but a buyer may wish to retain some room for manoeuvre and should bear this in mind.
There is also a risk of inadvertently creating a binding contract. This is relatively easily dealt with by marking the document subject to contract and explicitly stating which elements, if any are binding, but it is important to be aware of this.
Finally, there will be some straight forward and low value deals where the additional work in drafting Heads of Terms is disproportionate. In these situations it may be best to forego the process or possibly settle for a less formal, abbreviated document setting out the key terms.
Overall though, it makes sense to set out the key agreed terms of a transaction as part of a Heads of Terms document. As discussed here, such an exercise will focus minds and assist in minimising unwanted twists and turns during the transaction journey.
As always, taking advice early on in the process will help ensure that the necessary care and attention goes into drafting the Heads of Terms. The team at Acumen also find that this affords clients the opportunity to discuss the terms of the deal with us and can provide a valuable opportunity to refine or renegotiate points which we feel may not be in our client’s best interests at an early stage. Taking these steps, with early legal assistance, will invariably serve as a solid foundation for a smoother buying or selling process.
If you are embarking on a transaction and wish to speak further about the process and putting together Heads of Terms, please contact Alvin Ittoo, a senior solicitor and the head the Corporate Department at Acumen on 01273 447 075 or email him at [email protected].