Corporate Spotlight: What are Heads of Terms and Why Do You Need Them

If you’re lucky enough to get an attractive offer for the sale of your business, you might think that once you’ve agreed on the price then you can sit back, relax and let the solicitors get on with it.

In fact, the price is only a small part of the story. If you and the buyer plough on and try to negotiate a detailed legal agreement without first getting all the other key points agreed in principle, you might soon find that negotiations stall or, even worse, halt completely – leaving both sides with nothing to show but wasted professional fees.

Heads of Terms are a set of (usually non-binding) principles that both parties sign up to confirm their agreement to the key points of the proposed deal. Neither side is strictly held to them but it can be awkward (from a tactical negotiation perspective) to try to move the other side too far away from them once they’ve been signed.

Because Heads of Terms focus on the key commercial (rather than legal) points, it’s generally quicker, easier and cheaper to negotiate them than it is to agree on the binding legal agreement. If you can’t reach a consensus on the Heads of Terms, then you certainly won’t be able to negotiate a binding agreement and there’s little point in continuing.

Heads of Terms, therefore, serve two main purposes. First of all, they make sure you really have got a deal agreed, and secondly, they should be the foundation on which the binding agreement is based.

So, what are some of the terms other than price that you should include in your Heads of Terms?

Deal Structure

Is the buyer buying your shares in the company (a “share sale”), or is your company selling its business and assets (an “asset deal”)? These are very different in respect of both tax treatment for the seller and risk for the buyer. It’s important to make sure you’re all agreed on the structure right from the start.

Price Calculation

You think you’ve agreed on the price, but have you really? Does the buyer expect the price to be reduced to take account of debt? Do you expect it to be increased to take account of cash or debtors? Is the buyer expecting you to leave behind a level of working capital in the bank when you sell? These points should all be clearly set out in the Heads of Terms.

Payment Structure

It’s no good agreeing on a price of £1 million if you subsequently discover that the buyer wants to pay only £100,000 up front with the rest delayed for 12 months or even longer. You need to both agree on what is being paid when.

Also, your buyer might want part of the price to be dependent on the performance of the business after the sale (often known as an “earn-out”). If you’re prepared to agree to an earn-out, then you need to ensure that both parties agree on how this is going to work commercially. Are you basing it on profits or turnover? What formula will be used? How will you be sure the buyer doesn’t do anything to skew the figures?

Security

If you’re accepting a significant amount of the payment in 12 months’ time (or even later) then you need to think about security. What happens if the buyer becomes insolvent? Who will you sue? Will you get a personal guarantee from a principal shareholder or a corporate guarantee from another company in the buyer’s group? Or can you get a legal charge (i.e. mortgage) over property or some other form of security for the deferred payments?

Property Matters

Who owns your premises? If they are leased by you (or your pension scheme) back to the company, then the buyer might want to renegotiate the terms of the lease. Lease duration, rent, break notices and repairing obligations are all points that may need to be discussed.

Transition

Does the buyer want you or other sellers to stay on for a period after the sale, to help with the transition? If you’ve agreed to an earn-out, then you’re very likely to insist that you stay on, to ensure that turnover/profits are maximised. In either case, will you be an employee or a consultant? How long will you stay and how much will you be paid?

If you would like to discuss any aspect of buying or selling a business then please contact Matt Worsnop by email at matt.worsnop@bhwsolicitors.com or by phone on 0116 281 6235.