Once you’ve found a business you want to buy and agreed the main commercial points with the seller, the next step is often to document those terms.
This is usually done through Heads of Terms, sometimes referred to as Heads of Agreement or a Letter of Intent.
Heads of Terms set out the key principles of the proposed transaction before both parties commit significant time and money to due diligence and legal documentation.
They are an important stage in any acquisition, so it is worth understanding exactly what you are agreeing to.
What are Heads of Terms?
Heads of Terms provide a written summary of the main commercial terms agreed between the buyer and seller.
They might cover:
- the proposed purchase price
- what is being acquired
- how the purchase price will be paid
- deferred consideration or earn-outs
- treatment of cash and debt
- working capital
- the seller’s role after completion
- due diligence
- exclusivity
- confidentiality
- the proposed timetable
- conditions that need to be satisfied before completion
The exact document will depend on the transaction.
Are Heads of Terms legally binding?
Heads of Terms are often largely non-binding, but certain provisions can be legally binding.
Confidentiality and exclusivity are common examples.
The document should clearly state which provisions are intended to be binding and which are not.
This is one reason to involve your legal adviser before signing, rather than treating Heads of Terms as an informal document that can be dealt with later.
Be clear about the price
A headline number alone isn’t enough.
If you agree to acquire a business for £5 million, both parties need to understand exactly what that £5 million represents.
Is it the enterprise value of the business?
How will cash and debt be treated?
What level of working capital is expected to remain in the company?
Are there any other adjustments?
A buyer and seller can both believe they have agreed a £5 million transaction while having very different expectations about the amount that will actually be paid at completion.
The earlier this is clarified, the better.
Set out how the consideration will be paid
The Heads of Terms should explain the proposed payment structure.
For example:
£3 million payable on completion
£500,000 deferred for 12 months
Up to £500,000 payable through an earn-out
This is particularly important where the transaction includes deferred consideration, vendor finance or performance-related payments.
If an earn-out is proposed, you may not agree every detailed legal provision at this stage, but the basic commercial principles should be understood.
Understand working capital
Working capital can become a major area of disagreement if it isn’t discussed early enough.
A buyer will normally expect the business to be delivered with an appropriate level of working capital to continue operating normally.
If the seller extracts too much cash or working capital before completion, the buyer may need to inject additional money immediately after taking ownership.
The Heads of Terms can establish the principles for how working capital will be calculated and treated in the final purchase price.
What is exclusivity?
A buyer about to spend money on accountants, lawyers and other advisers will usually want some comfort that the seller isn’t simultaneously negotiating with another buyer.
An exclusivity period gives the buyer a defined period in which to carry out due diligence and progress the transaction without the seller actively pursuing alternative offers.
The length will depend on the deal, but it should give both parties enough time to progress the transaction properly.
For the buyer, exclusivity provides some protection against spending significant time and money on a process only to find the business has been sold to someone else.
It doesn’t guarantee the acquisition will complete.
Think about the seller’s role after completion
If the current owner is important to the business, their future involvement should be discussed before Heads of Terms are agreed.
Will they leave immediately?
Stay for a short handover?
Remain as a consultant?
Continue running the business for a period?
Retain some equity?
The answer can have a significant impact on both the transaction and your plans for the company after completion.
What conditions does your offer depend on?
Your offer may be subject to certain conditions.
These could include satisfactory due diligence, securing acquisition finance, regulatory approval or obtaining consent from important customers, landlords or other third parties.
Make these clear.
A seller needs to understand what still needs to happen before you are in a position to complete.
Don’t agree terms you expect to renegotiate later
It can be tempting to agree favourable terms to secure exclusivity and assume you can renegotiate them during due diligence.
That is rarely a good way to start a transaction.
If due diligence genuinely identifies new information, there may be a legitimate reason to revisit the price or structure.
But your initial offer should be one you are prepared to stand behind based on the information available at the time.
Trust between buyer and seller matters, particularly in owner-managed business transactions.
Take advice before signing
Heads of Terms are often only a few pages long, but they can shape the rest of the transaction.
Getting the main commercial principles right at this stage can save considerable time, cost and disagreement later.
Your legal, financial and tax advisers can help you understand whether the proposed structure works and identify issues that should be addressed before you proceed.
A framework for the deal ahead
Good Heads of Terms should leave both buyer and seller with a clear understanding of the transaction they are trying to complete.
They don’t need to anticipate every issue that might arise during due diligence or replace the final legal agreements.
Their purpose is to make sure both sides are broadly aligned before moving into the more detailed and expensive stages of the acquisition.
Find businesses and transaction advisers on The Brokerage
The Brokerage connects buyers with business owners and brokers bringing acquisition opportunities to market. You can also use The Brokerage’s Professional Network Directory to find legal, financial, tax and other advisers who can support you through the acquisition process.