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If you are considering buying or selling a business, one of the most important steps is drafting heads of terms. Heads of terms are important documents that set out the scope of a business sale transaction. While the terms are not usually legally binding, they clarify what you have agreed to so far in the transaction. Hence, heads of terms documents ensure each party is on the same page during each transaction stage. This article will explain the legal significance of heads of terms and common provisions that you may find in such agreements.
Heads of Terms
M&As are often complex and expensive because sellers and buyers have to conduct substantial investigations (called due diligence). There is also quite a lot that can go wrong during the negotiations and after the transaction has been completed.
Consequently, you can avoid potential issues arising in an M&A transaction by using heads of terms agreement. Heads of terms are important documents because they set out the scope of the transaction in broad terms. These agreements tend to be relatively short and include:
- summaries of the main terms that each party agrees to;
- the timeline of the transaction; and
- important conditions the seller and buyer must fulfil before they finalise the transaction.
What Should I Include in Heads of Terms Documents?
Heads of terms will usually describe both parties’ intentions when entering into the transaction. For instance, one provision may state that you agree to sell all your shares to the buyer. In return, the shareholders will receive £10 per share.
You might also wish to create more specific intentions, such as:
- when the payment for the shares will be made; or
- under what circumstances the price per share may change i.e. if the buyer realises the business’ assets are less than what the seller originally stated.
Other common provisions in the heads of terms include:
- the assumptions that the buyer is operating under i.e. the company has no outstanding litigation claims against it;
- conditions that must be met before the translation can be finalised;
- the timeline of the transaction, including when the due diligence process will commence;
- information about the legal and financial advisers of each party; and
- certain other terms that may have legal force.
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Are Heads of Terms Legally Binding?
If you have ever financed a house purchase in England or Wales through a mortgage, you will likely have obtained an ‘agreement in principle’ (AIP) from your mortgage lender. This AIP is not legally binding. Nonetheless, it is a document that outlines your lender’s intention to lend you money, provided there are no irregularities.
For M&A transactions, heads of terms operate similarly. When you agree to heads of terms, you do not necessarily have to follow through on the specifics of the terms. Instead, heads of terms represent an ‘agreement to agree’ to complete the transaction at a later date. In this sense, these agreements have what lawyers call ‘moral weight’. If you agree to the terms but later withdraw from the transaction, this could influence how your counterparty transacts with you in the future.
Legally Binding Provisions
It is common practice for sellers to include certain provisions that are legally binding. If a term is legally binding and you break the term, your counterparty can sue you. Consequently, the aggrieved party can either seek damages or have the court order you to perform your obligations.
The table below defines common legally binding provisions sellers might want to include in your agreement.
| Provision | Explanation |
| Lock-Outs | For some M&A transactions, either party may want to restrict the other party’s ability to negotiate with third parties. These are called lock-outs. The benefit of a lockout is that both parties have the comfort of knowing neither party is talking to third parties. This encourages open communication and negotiation. |
| Confidentiality Agreement | Typically, the due diligence process in an M&A transaction gives the seller substantial access to sensitive and confidential business information. As such, heads of terms may incorporate confidentiality agreements. For example, suppose you are in the business of buying wholesale goods and distributing them to your customers. In this case, you may not want the public to know where you get your goods or to who you sell them. At the same time, your buyer will want to know this information when determining if they should proceed with the transaction. |
| Break Fees | Finally, there may be break fees. This provision obligates one party to pay the other a specific sum of money if they terminate the agreement outside of any pre-agreed reasons. In this sense, break fees ensure that all parties are on the same page and negotiating in good faith. |
Key Takeaways
Heads of terms are agreements that a seller and buyer have reached when acquiring a company. The terms are not usually legally binding. However, the terms may contain specific provisions contained that create legal obligations. In this sense, the purpose of the terms is to ensure each party is on the same page with the other during the transaction. Importantly, you should always obtain legal advice when drafting these agreements to ensure that you do not accidentally create legally binding contracts or fail to give them legal effect.
If you need help drafting a heads of terms agreement, our experienced business sale lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Heads of terms set out the most important terms of a merger and acquisition, such as the price the buyer will pay the seller for the company.
Generally, heads of terms are not legally binding. Instead, they represent an ‘agreement to agree’ to complete the transaction at a later date.
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