During Clive’s extensive career as a business consultant and acquisitions specialist, he has learnt how important it is to prepare the parties of a sale for what they should expect in a Heads of Terms.
There is a lot to consider when you’re selling your business or acquiring a new one. And it is important you know exactly what things mean and what they include so that nothing surprises you.
What Is A Heads of Terms?
A Heads of Terms is a written record of the agreements between the buyer and seller of a business throughout the negotiation period. Although it is a mostly non-binding document, some parts of it can be. Therefore, it is essential that you know what it contains before you sign it.
You can learn more about Heads of Terms in my beginner’s guide here…
What To Expect In A Heads of Terms
No one likes to be caught out by the unexpected. Preparing yourself thoroughly for the unfamiliar elements of your business transaction will help things to go smoothly, with minimal disruption and reduced stress for all involved.
Here’s some of the things you should expect to see in a Heads of Terms…
An Exclusivity Period
Heads of Terms can carry a legally binding exclusivity period of a minimum of three months, even if it states the rest of the document as being non-binding, or subject to contract.
An exclusivity period is also referred to as a ‘lock-out’ clause. The period of exclusivity prevents the seller of a business from entering talks or negotiations with anyone else.
It also stops the buyer from feeling pressured into making a quick decision because they do not want to lose out to someone else.
A buyer will typically spend around £40-50k and sometimes more on due diligence checks before successfully completing a business sale.
These checks cover the financial, legal and commercial aspects of the business, as well as the construction of the sales and purchase agreement (SPA).
Because of this investment, it is common for a buyer to expect a seller to pay back these costs if they pull out of a sale for any other reason than a renegotiation of price or terms.
This is a legally binding clause, which helps to minimise financial risk.
Maintaining The Business
Imagine buying a thriving, well-organised, profitable business, only to end up with a watered-down version of what you expected at the end of the sales process.
To avoid this from happening, a Heads of Terms may stipulate that the business being sold has to be maintained to the same standard it was at prior to a sale being sought.
This includes financial records, client base, and things such as business licences.
Failure to maintain these things may lead to a buyer withdrawing from a sale before completion. It could also affect the pay-out for equity that is based on a consideration of post-sales performance or an earn-out.
Transitional Service Period
In the vast majority of share purchases, the Heads of Terms will include a transitional service period agreement. This is different to an asset-only purchase.
Typically, the transition period is up to six months but can be much longer depending on the circumstances or requirements of either party.
During this time, the seller will remain in the business or act as a consultant to ensure they complete a full and proper handover with the new business owner.
This is an opportunity for the buyer to gain valuable insider knowledge from the hands-on experience and expertise of someone who has been there and done it.
When purchasing a business, there is an expectation that there will be money available to fund the day-to-day running of it, also known as working capital.
Working capital can come in many forms, but at a base level, we’re talking cash in the bank.
You can expect a Heads of Terms to stipulate that there are enough funds to meet the operational costs of the business for at least two months.
After all, cash is the lifeblood of any business. Without it, it will no longer be a viable asset and a good investment for the buyer.
Watch Out For Hidden Costs…
Over the years, Clive has been involved in the sale or purchase of many businesses. In one of these business transactions, it became apparent that the seller was expecting the buyer to pay the corporation tax for a previous trading period.
Through negotiation, both parties agreed and documented in the Heads of Terms that the acquirer would assume liability for future costs but not for any relating to a period when the seller operated the business. Such as corporation tax or VAT.
Don’t Be Caught Off Guard By A Heads of Terms
Knowing what to expect from a Heads of Terms will help you to avoid any shock revelations during your business transaction. And being aware of what you might receive in a Heads of Terms will allow you to prepare in advance for further negotiations.
If understanding all of this leaves you feeling more bewildered, don’t worry. Asking for guidance with your business sale or acquisition can clarify things and even save you unnecessary costs further down the line.
Clive can support you and make sure you’re fully prepared for what to expect. Click here to arrange a call with Clive at time that suits you.