Heads of terms for buying or selling a business

Heads of terms are the short document a buyer and seller sign once they’ve agreed a deal in principle, setting out the price, how it’s paid, what’s being bought and the timetable. You might see them called a term sheet, a letter of intent or an offer letter, and they usually run to three or four pages. They come before due diligence and before anyone starts drafting the share purchase agreement or asset purchase agreement.

I draft and review heads of terms for buyers and sellers of owner-managed businesses. It’s also the cheapest point in the deal to get advice, as the heads are short and nothing has been agreed in detail yet.

My own view is that heads of terms are extremely important, and that time spent on them at the earliest possible stage is time well spent, because it gets the buyer and seller aligned on the points that matter before the lawyers start drafting. It’s much easier to negotiate while everyone is fresh-faced and happy with the deal than after two, three or six months of negotiation, when deal fatigue has set in and each side has less patience for the other’s points.

Are heads of terms legally binding?

Mostly not, and they should say so, with the usual approach being for the commercial terms to be expressly not binding, and for a few clauses to be binding, normally exclusivity, confidentiality and sometimes who pays the costs if the deal falls through.

Whether a particular document binds you depends on what it actually says, though, and the label at the top doesn’t decide it. In Hoffman v Finalto a term sheet which said it was “legally binding on the parties, subject to a definitive agreement” was held to be binding straight away, and the buyer who walked away from it had to pay damages. In Pretoria v Blankney it went the other way, and signed heads of terms without a “subject to contract” label were held not to be binding because of how they were written and how the parties had dealt with each other. If you don’t intend to be bound, the safest course is to say so clearly on the front page and then to make sure that nothing in the body of the document says otherwise.

Even where they aren’t binding, heads of terms set the baseline for everything that follows. Reopening a point you’ve already agreed in writing is hard, and anything left out of the heads tends to become something you have to ask for later, when the other side knows you’ve spent money on the deal and may have agreed not to talk to anyone else.

What heads of terms should cover

The price is the obvious part, but how and when it’s paid usually matters just as much. If part of it is deferred, paid in instalments or dependent on how the business performs, the heads should say so and give the outline of how it will work, and a seller should raise security for any deferred payment at this stage rather than later. I’ve written separately about earn-outs and deferred consideration.

The heads should also say whether it’s a sale of the shares or of the assets, and on an asset sale which assets are included and which liabilities stay behind. They should cover whether the price is on a cash free, debt free basis, what conditions have to be met before completion (a landlord’s consent, bank funding, FCA approval or a franchisor’s consent, for example) and the timetable to completion.

Then there are the points about the seller. If you’re staying on after the sale, the heads should cover your role, pay and how long you’ll be there, and the restrictive covenants should be outlined, as a buyer will want them to run for a period after completion and sometimes from when you eventually leave. If you’re keeping some of the shares, the leaver terms and how you can eventually sell the rest need setting out too, which I’ve explained in my article on selling 51% of a company.

It’s also worth getting the outline of the warranty protection into the heads, meaning the cap on the seller’s liability, the time limit for claims and whether any part of the price will be held back as a retention, as these are often the points that take longest to agree later. There’s more on those on my page about warranties and indemnities.

Exclusivity

A buyer will almost always ask for a period of exclusivity, during which the seller agrees not to negotiate with anyone else. From the buyer’s side that’s reasonable, as you’ll be paying for due diligence and legal work and you don’t want your offer used to get a better one elsewhere.

From the seller’s side, exclusivity is when your bargaining position is weakest, so the period should be no longer than the deal needs, with any extension by agreement. A seller should also be able to end it if the buyer stops making progress. My own view, as I’ve said in the article on partial sales, is that a first period of more than eight to ten weeks should usually be resisted.

Acting for a buyer or a seller

If you’re the buyer, the heads of terms are where you set up the conditions you need to be met before you’re committed, such as funding and satisfactory due diligence, and the exclusivity which protects the money you’re about to spend. It also helps to flag anything you already know you’ll want an indemnity for, so that it doesn’t come as a surprise to the seller once the agreement is drafted. There’s more on the buyer’s side on my buying a business page.

If you’re the seller, the heads are your best chance to get the terms that matter to you agreed while the buyer is still keen, and in particular the security for any deferred payment, the limits on your liability and the terms of any ongoing role.

How long it takes and what it costs

If I’m acting on the deal as a whole, the heads of terms are part of my fixed fee for the transaction. Every quote is specific to the deal, but as a guide my fee will be between 0.5% and 5% of the deal value. Under £1m it’s usually 3% to 5% and over £1m it’s usually 1% to 2%, although it does depend on the business, the price and the commercial terms. The minimum fee is £3,500 plus VAT, and on lower value deals I can quote for a reduced, more standard service.

Next steps

If you’ve been sent heads of terms, or you’re about to put an offer in writing, send me the details, including the draft heads if you have them, whether you’re buying or selling and when you’ve been asked to sign. It’s much easier to change them before they’re signed than afterwards.