If you are conducting a business transaction such as a merger or acquisition, a heads of terms agreement is essential for keeping track of the terms agreed.
The main purpose of heads of terms is to provide an element of clarity from the beginning of the transaction through to the end. That way, as the weeks and months tick by and the deal moves ever closer to completion, both parties have a documented outline to remind them exactly what they agreed on.
Heads of terms are not usually legally binding, but they do show a serious intent to complete the transaction. Completing a heads of terms is an important step in determining whether you have a serious buyer or seller, or just a time waster.
In this article, we will explain in greater detail why having heads of terms is beneficial to you and the other business, what you should include and the legal aspects you need to be aware of.
Do You Need a Heads of Terms Agreement?
A heads of terms document is not a legal requirement for conducting a business transaction, but it is useful for keeping a record of what you and the other party discussed during the negotiation stage.
This is important, as when it comes to buying or selling a business, the process can be both complex and time-consuming. While you may think all the hard work is done once you’ve negotiated the transaction, this is really just the beginning.
Following negotiations, the business(s) in question will be scrutinised by the party making the purchase, in order to ensure there are no risks in acquiring the company that have not been disclosed. This is called due diligence.
This can comfortably take months and with so much new information flying around, it can be easy for a transaction to take a backwards step and return to the negotiation stage.
A heads of terms solves this issue by providing a tangible document detailing the agreed upon deal. That way, it is clear what the details of the transaction will be, assuming nothing out of the ordinary is uncovered during due diligence.
As we have already noted, agreeing to heads of terms is also a key way of both parties showing that they take the transaction seriously.That way everyone can move forward knowing the time and money they put into making the transaction is unlikely to be wasted by one party suddenly getting cold feet.
If the other side does not appear to be interested in coming up with heads of terms, you should question why, as it could indicate they are not that committed to making sure the transaction takes place.
What Should You Include in the Agreement?
The fact that it isn’t a legal requirement doesn’t stop a heads of terms being one of your most important documents. While it may only cover the transaction in broad strokes, it still includes a number of purchase or sale conditions that need to be considered carefully.
In short, it’s much more than a price on a piece of paper.
A heads of terms agreement should cover everything you and the other party need to know about each other’s businesses, along with as much information about the proposed transaction and its structure.
To start, heads of terms should include basic information, such as:
- The names of both businesses and the names of the main party members from each side who will be taking part in the negotiations
- The fundamental purpose of the transaction, for example, to merge one company with another
- The key obligations of each side to ensure the transaction is completed as smoothly, quickly and amicably as possible
- The expected price each side has agreed to settle on
- What type of transaction is to be expected, such as an asset purchase, share purchase or a negotiated merger
- A timescale in which the business agreement is expected to be completed
While these terms may seem straightforward, in fact they can be difficult to iron out. For example, whether an acquisition is completed by a share or asset sale can have significant impacts on the final price.
Likewise, it can also seriously impact how the transaction is completed, from the amount of due diligence that’s required to the obligations of each party.
For that reason, you should always involve a corporate solicitor in the drafting of your heads of terms, so you have a clear understanding of the legal ramifications you’ve agreed. That way, you won’t face any nasty surprises further down the line.
Another reason for using a solicitor is that every heads of terms includes its own unique conditions. This makes sense since every business transaction is different. Once the basic requirements have been documented, the written agreement also lists any preconditions that must be met before a contract is drafted.
At this point, it is also recommended for both sides to acknowledge that they understand what the final terms of the contract will be.
All this makes drafting a heads of terms document a lengthy and complicated procedure, and if there’s any misunderstanding, the deal can end up back at square one after months of hard work, if it’s not called off entirely.
It’s always recommended that you bring an experienced solicitor to the negotiations to make sure the terms you want are documented correctly and to make sure the other party’s terms are reasonable.
Are Heads of Terms Legally Binding?
As mentioned, heads of terms are essentially a draft of what was agreed during negotiations. For that reason, they are not usually considered legally binding in the same way a contract would be, as demonstrated by the Court of Appeal’s recent decision in the case of Generator Developments v Lidl UK.
When reading through heads of terms, you’ll notice how the language differs to reflect this. Phrases such as, “subject to contract,” “agreement in principle,” and “condition precedent” are used to stop the document becoming a contract. However, even though heads of terms are not legally binding, there are some terms that, if broken, the court would consider an unlawful breach. These terms include:
- Breaking a confidentiality agreement — both sides will usually ask that sensitive business information be kept out of public knowledge, therefore disclosing private matters to a third party would be considered illegal
- Disregarding an exclusivity agreement — providing both parties agree to this term at the start of their business transaction, neither side is allowed to negotiate with another person or business for a set period of time
- Breaking a non-solicitation clause — neither side is allowed to approach the other party’s employees in an attempt to hire them for their own company. They are also not allowed to poach each other’s customers or clients
While these terms would be considered legally binding if agreed upon, there must be a suitable timescale set in place, such as a maximum of 12 months for non-solicitation.
Aside from confidentiality, exclusivity and non-solicitation, nothing else written in a heads of terms should be considered a legal obligation. If you are asked to sign the document for any reason other than the terms listed above, you should ask your solicitor first
So, while a heads of terms agreement is not usually legally binding, that does not mean you can completely disregard it. This is another reason expert advice should be taken when drafting one.
Can You Walk Away From Negotiations?
As heads of terms are not a finalised agreement, you can terminate the negotiations at any time if the other side is becoming increasingly difficult to work with or if you discover an issue that would make the transaction not worth going through with.
However, walking away from a transaction should never be done lightly. If you’ve reached the point where you’ve agreed heads of terms, you’re likely to have already spent significant time and energy trying to move the deal forward.
Therefore, it’s always wise to consult legal advice on the potential risks and rewards of persevering with the deal, even if it’s not gone fully to plan so far.