Why Have Heads Of Terms

Why Any Transaction Needs Heads Of Terms

If a business is attempting to close a deal, whether its corporate change of control transaction such as an equity investment in, or acquisition of, a company, a commercial or residential real estate sale, purchase of certain defined assets from a business, or any commercial contract such as the licensing of intellectual property, a distribution agreement or any supply of services contract, then the relevant parties ideally need to first set out the main terms that they forsee will form part of the deal.

handshake-512

In the UK, this document is commonly referred to as the ‘heads of terms’ and for a simple transaction could just constitute an email chain of points, as opposed to a more considered and formal word document for deals where there will be more at stake. The heads of terms can also be called a term sheet, letter of intent or memorandum of understanding.

The main reasons for having such heads of terms are as follows:

1) Focus

Heads of terms help ensure that negotiations are focused on the key issues to be decided and prevents the parties wasting time and money in the long run if such issues are highlighted and resolved early on.

2) Clarity

Like any written document they help avoid any miscommunication or misunderstanding that can otherwise occur through verbal and informal email or online discussions. People will often leave a conversation with quite different views as to what was agreed.

3) Confidence

They help the other side observe a commitment to the terms that have already been agreed informally. Each party can proceed with more confidence if previously agreed terms are recorded and the authorised representatives from the parties have actually signed something.

4) Binding provisions

Although the heads of terms will be marked ‘subject to contract’, the parties can still include important binding provisions in the document, such as confidentiality obligations, exclusivity provisions and the agreement to pay legal costs if one party leaves the negotiations early before a formal agreement is concluded, again giving the parties more confidence to proceed with the deal.

5) Resolutions

Producing heads of terms serves to focus the minds of the parties and helps them work out whether there is enough consensus to make it worth everyone’s while in pursuing the deal to completion. If the heads of terms identify a significant impassable issue early on then this potentially stops the parties wasting time and money on further negotiations and legal fees.

6) Commitment

By putting the basic terms into written form at an early stage, the parties have made clear their general intentions and entered into a ‘moral’, if not legal, commitment to observe the terms agreed that makes it harder for either party to back out on terms already recorded in writing.

7) Instructions to advisors

The heads of terms provide a useful tool to use when instructing external advisers, including accountants and solicitors. Such advisers can quickly familiarise themselves with the transaction and thus highlight and advise on issues that they otherwise might not be made aware of. They also act as instructions that help a lawyer set out and expand on, in legally binding words, the intentions of the parties without wasting time having to come back to a client with a whole host of otherwise irritating questions.

8) Submissions to authorities

They can also serve as the basis for submissions for tax clearance applications or guidance from competition authorities, thereby saving time in the process of finalising a deal later down the line.

9) Aide memoir

We’re all human and to various extents our memories always fade over time. Forgetting what was agreed on a call, in a meeting, or buried in a chain of emails two or three weeks ago is a genuine possibility. Therefore a set of clearly drafted heads of terms works as a useful aide memoir and point of reference.

Finally

Keep in mind that once you’ve signed the heads of terms the deal is still some way from being done. The stage between finalising the terms and ultimate completion can be one of the most difficult periods in the sale process as the parties and their respective advisers negotiate the legal agreements and resolve any outstanding issues. It is therefore imperative that both the parties appoint practically minded solicitors with relevant experience of the type of transaction to be finalised who will enable the deal to progress rather than assist in holding it up.

Should you involve lawyers?

The value of including advisers at the outset means that the key terms relating to the transaction are accurately recorded in the heads of terms so that they can then be replicated effectively in the formal sale contractual documentation. An experienced advisor can therefore help save time and money by not only producing a sufficiently detailed heads of terms, but also by ensuring that the transaction is structured in the best way at the outset and problematic issues are avoided.

As mentioned, even though heads of terms will be clearly marked ‘subject to contract’, they can still carry strong moral force and limit room for manoeuvre in subsequent negotiations so its important you get them right first time. It is also important to bear in mind that statements made in heads of terms, or in connection with the related negotiations, have the potential to give rise to liability for misrepresentation or negligent misstatement, even where the heads do not create a contract.

What happens after heads of terms are agreed?

In the context of a corporate deal, once heads of terms are signed by the parties, the buyer (or investor) will carry out a review of the target business. This process is commonly termed ‘due diligence’ and will take the form of a series of questions submitted by the buyer or investor in respect of the financial, legal and commercial aspects of the business for which the management team at the target company will need to submit detailed written responses, together with supporting documentation.

Where a competitive auction of the business is being carried out then the seller will usually take the initiative with due diligence by creating a data room containing responses to a standard due diligence questionnaire, together with all relevant contracts and other documents which all parties intending to make a bid will be given access to upon signing a non disclosure and non circumvention agreement.

The larger the deal and the greater the risk for the buyer or investor, the longer the due diligence process tends to take, particularly when a buyer or investor has no previous relationship with, or knowledge of, the target. In the case of a company sale, once the first set of due diligence responses have been completed by a seller, the buyer will usually then produce a first draft of the share purchase agreement, using the information in the responses to include any necessary contractual protection to suit the circumstances.

Tax advice

At the outset of any deal, before signing the heads of terms, it is vital that the parties receive professional tax advice so the transaction can be structured in the most beneficial way with tax liabilities minimised.

Further reading:

Free Heads Of Terms For Buying Or Selling A Company

About Jonathan Lea

Jonathan is a specialist business law solicitor who has been practising for over 18 years, starting at the top international City firms before then spending some time at a couple of smaller practices. In 2013 he started working on a self-employed basis as a consultant solicitor, while in 2019 The Jonathan Lea Network became a SRA regulated law firm itself after Jonathan got tired of spending all day referring clients and work to other law firms.

The Jonathan Lea Network is now a full service firm of solicitors that employs senior and junior solicitors, trainee solicitors, paralegals and administration staff who all work from a modern open plan office in Haywards Heath. This close-knit retained team is enhanced by a trusted network of specialist consultant solicitors who work remotely and, where relevant, combine seamlessly with the central team.

If you'd like a competitive quote for any legal work please first send an email to wewillhelp@jonathanlea.net with an introduction and an overview of the issues you’d like our help with, following which someone will liaise to fix a mutually convenient time for a no cost no obligation initial 20 minute call with one of our fee earners.

We are always keen to take on new work and ensure that clients will not only come back to us again, but also recommend us to others too.

×
Get In Touch

Contact Us

In need of legal advice? We would love to hear from you!

Name(Required)