Whether you are entering into a potential sale of your business, growing your company through acquisition or setting up a partnership, merger or other business-related agreement you’ll probably have heard of a Heads of Terms.
But what is a Heads of Terms, what purpose does it serve in a business sale and what should it cover?
Keep reading to find out…
What Is A Heads of Terms?
Heads of Terms, is a mostly non-binding written document which records the key terms of a transaction as agreed by both the buyer and seller during a sales negotiation. It’s a document that records the future intentions of all parties involved in a potential deal, but doesn’t enforce obligations on them like a legally binding contract would.
It is also known as a set of Heads Of Agreement, Memorandum Of Understanding, or Letter Of Intent.
As a summary document, the Heads of Terms help the parties of a commercial transaction in the following ways;
- Clarity – It unifies information to present a clear picture of what has been agreed.
- Speed – Provides a quick and efficient reference document to refer to when required.
- Process – Highlights the need for any other agreements, e.g. confidentiality or exclusivity.
- Transparency – Avoids the potential for any ‘hidden surprises’ further down the line.
What Is Included In Heads of Terms?
The main purpose of Heads of Terms is to establish an agreement in principle between the buyer and seller of a business about the main points of the sale or acquisition. Here’s some examples of the things it should include:
The Structure of The Deal
It pays to be clear, especially in business. The Heads of Terms should cover the structure of the deal that you’re working on.
Is it an asset or share sale? What assets are included, and which are excluded? What percentage of shares are being bought? Is it an outright acquisition or a purchase of certain parts of the business?
All these questions need to be answered in the Heads of Terms to ensure that both parties are in complete agreement from the get-go about the type of sale or purchase taking place.
The Price of The Business
The price is a big consideration when it comes to a business sale or purchase. Including it in your Heads of Terms can help avoid any sticky situations and misunderstandings later on.
There are several ways of valuing a business. The most common include:
- Asset Approach
The value of assets minus the value of liabilities equals the value of the company’s equity.
- Income Approach
The valuation is based upon the company’s income, based on historical or current value to predict future revenue.
- Market Approach
This approach takes the earnings and value information from ‘similar’ companies to calculate a valuation by comparison.
Many business owners and purchasers opt for EBITDA as a business valuation tool. You can read more about that in my previous blog post here. Whatever approach you’ve used to value the business, the amount you’ve potentially agreed for the sale should be recorded in your Heads of Terms.
Attention should also be paid to what deductions have been made because of any business debt or working capital. Also, is any money being held back as security (escrow), and if so, what are the conditions that need to be met in order for it to be released?
Finally, you will want to know what is the final transaction fee to be paid upon completion.
No one wants to invest their money in something that won’t bring them a glorious return.
One way to potentially safeguard your investment in a company is by having stipulations in place that have to be met in order for shareholders to receive their full payout.
For example, you could choose to pay 50% on closing the sale, then…
- The rest is released based upon a consideration of business performance over a set period.
- Or, will there be an earn-out? Whereby, certain performance markers are set, and a payout is made on completion of each one.
There are many variations that can be considered here, these are just two examples, but the important thing is that your heads of terms lays all this stuff out in simple terms for everyone to agree on.
Pre & Post Completion Conditions
Imagine if you’ve decided to buy a well-run profitable business, but by the time everything is completed you’re left with something that’s been run into the ground.
To avoid that from happening, the conditions section in the Heads of Terms allows you to agree on any pre and post-transaction conditions, which must be adhered to.
Such as, keeping the business maintained to the same standards as before the sale. I’ll be talking more about this in my next blog…
Transitional Service Period
If you’re taking over a business you are familiar with, things should be fairly straightforward, and you should be able to hit the ground running.
But if the industry is unfamiliar to you, or the company has been run a little differently from what you are used to, you may need some help.
To make sure your acquisition runs as smoothly as possible, you can request and agree that the current owner stays within the business or acts as a consultant for a set amount of time.
This time can gain you some valuable insider knowledge, experience and expertise to enable you to maintain or improve performance.
You should record any agreements regarding a transitional service period in your Heads of Terms too.
Other Things To Consider
You’ll already know that a business is a complex thing, and there are a lot of different factors to discuss and come to an agreement on when buying or selling a company.
What will happen to the employees?
Is there a tax implication?
Are there any warranties or indemnities?
If you’re unsure whether you are crossing all the t’s and dotting all the i’s, the best thing to do is seek professional advice.
What To Do Next…
Although most agreements made in a heads of terms are non-binding, and are stipulated as being subject to contract, there are certain parts of heads of terms that can be legally binding – so you need to know what you’re doing before you draw them up or sign anything.
If you’re at all unsure about heads of terms and want some advice, or have questions about your business acquisition, don’t be afraid to ask for help.
As a successful entrepreneur, business owner, acquisitions specialist and business consultant, I have the first-hand expertise, knowledge and skills to make a positive impact on your business sale, merger or acquisition.
For a call back at a time that’s convenient to you, click here.