Heads of terms when you sell a business

If a buyer has made an offer for your business and you like the sound of it, the next thing they'll usually send is heads of terms. It's often only a few pages and most of it isn't legally binding, so it's tempting to sign quickly and save your energy for the contract. But the price, how it's paid, what you'll do afterwards and how long you're tied to this buyer are normally settled here, and they're much harder to change later.

This guide covers heads of terms when you sell a business, as a share sale or an asset sale. The phrase is also used for commercial property leases, which is a separate subject.

What heads of terms are

Heads of terms are a short summary of the main points of a deal, agreed in principle before the solicitors write the full sale agreement. You may see them called a letter of intent, a memorandum of understanding, heads of agreement or a term sheet. The name matters less than what's in them and which parts bind you.

They aren't a legal requirement, and some small deals go straight to the sale agreement. They're common because they bring disagreements to the surface before either side has spent much on advisers.

Where they come in a sale

Heads of terms are usually signed once a buyer has made an offer and you've accepted it in principle. Once they're signed, the buyer starts its full checks on the business, known as due diligence, and the solicitors start on the sale agreement. Heads of terms often set out that timetable too, up to a target date for completion.

What's binding and what isn't

The price, how it's paid and any arrangements for you or your team are usually agreed "subject to contract", so neither side is committed until the sale agreement is signed. A few clauses are normally meant to bind both sides from the day you sign:

Some also stop the buyer approaching your staff. The document should say clearly which clauses bind. Don't rely on "subject to contract" alone. In a 2010 case the Supreme Court found that a binding contract had been made through the parties' conduct despite that wording.

Not binding doesn't mean it carries no weight. Points agreed here are hard to go back on without a good reason, such as something found in due diligence, and reopening them for no reason can look like bad faith. That cuts both ways, which is why it pays to get them right.

What goes in heads of terms

The parties and what's being sold

This names who's buying and, if part of the price is paid later, who will guarantee it. It says whether it's a share sale, where the buyer takes over your company as it is, or an asset sale, where your company sells the business and its assets and the company is left behind. It should list anything left out of the sale and say what happens to the premises.

The price and how it's paid

How and when you receive the money matters as much as the headline price. Many deals combine more than one of these.

Money paid later carries more risk. If the buyer can't pay and you have no security, you're an unsecured creditor, and a bank that lent to the buyer usually ranks ahead of you. The tax depends on how later payments are set up, and it can fall due before you've received them. Ask your accountant about this, and about reliefs such as Business Asset Disposal Relief, before you sign.

Adjustments for cash, debt and working capital

Prices for a company are often agreed on a cash-free, debt-free basis, with a normal level of working capital (the stock, money customers owe and bills you owe). The price then goes up for spare cash and down for borrowings. The heads of terms should say which method is used.

• Completion accounts. Accounts are drawn up as at completion, after the sale, and the price moves up or down to match. Part of the price is often held back until they're agreed, and the figures can be argued over.
• Locked box. The price is fixed from a balance sheet at an earlier date and doesn't change. From then on nothing may leave the business for your benefit except agreed items, such as normal salaries. Profit made after that date stays in the business unless you agree a payment for it.

The detail goes in the sale agreement, but settling the method now gives the solicitors a clear starting point. Our guide to how to value a business covers how buyers arrive at the price.

Conditions

These are things that must happen before completion, such as your landlord agreeing to a new lease, or consent from your bank, a major customer or a regulator. List them, and who's responsible for each.

Due diligence and the timetable

Agree what the buyer's checks will cover, how you'll share information, and target dates for each stage. A timetable gives you a reason to ask questions if dates slip.

Exclusivity

Exclusivity stops you talking to other buyers while this one spends money on checks and lawyers. Published guides vary on how long it lasts. One law firm puts it at four to eight weeks for smaller deals, and others quote three to six months. It should match the timetable, with a little slack, and end if the buyer drops out or misses agreed milestones. If you break it, you may have to pay the buyer's costs, so check whether that's capped.

Your role after completion

Buyers often want the owner to stay on for a handover. Say whether you'll stay as an employee, a director or a consultant, for how long and on what pay. If any of the price depends on you staying, write that down too.

Restrictive covenants

These are your promises not to compete with the business or poach staff or customers for a period after the sale. Courts may refuse to enforce covenants that go further than reasonably needed in length, area or type of business, and one law firm notes it would be unusual to see them run beyond three years. Agreeing the scope now stops them catching other things you do.

Warranties and indemnities

Warranties are statements you make about the business. Indemnities are promises to repay the buyer pound for pound for a specific risk. The wording comes later, but heads of terms can set the outline, such as a cap on what you could pay, a minimum size for claims and time limits for bringing them.

Your team

In a share sale your company stays the employer, so contracts carry on. In an asset sale, staff usually move to the buyer on their existing terms under the TUPE rules. If the buyer has said anything about keeping the team or the name, ask for it in writing here, even if it isn't binding yet.

Any share you keep

If you're keeping a share, its terms belong here too. That means how much you keep, which decisions you'll have a say in, whether you'll receive dividends, and how, when and at what value you can sell the rest. Ask what happens if the buyer later sells the whole company, including whether you can sell on the same terms and whether you can be made to sell. Rights like these are usually written into a shareholders' agreement or the company's articles, so agree the principles now.

What owners commonly miss

• The gap between the price and what you receive. Adjustments and later payments can leave the money on completion day well below the headline figure.
• Long exclusivity with no deadlines. It ties you to one buyer while the deal drifts.
• Vague earn-outs. If the measure isn't defined, or the buyer controls everything that affects it, disputes are common.
• The year after. It's easy to spend weeks on the price and minutes on your own role.

Why detail now protects you

Once you sign, exclusivity usually stops you talking to any other buyer. That's when you have least room to negotiate, and it's when due diligence starts, which buyers sometimes use to try to reopen the price. Points agreed loosely tend to reappear in the first draft of the sale agreement, still open to argument. Points agreed clearly are much harder to reopen.

There's a balance. Heads of terms that try to settle everything can take as long as the contract, so aim for clarity on what you'll receive and what you'll do afterwards.

How long they take

It depends on how much is in them and how far apart you are. A short set can be agreed quickly, while a detailed one usually goes back and forth a few times. Disagreements found now cost less to settle than ones found halfway through due diligence, so don't let a buyer's deadline rush you into signing before your advisers have read it.

Who drafts them and who should review them

Either side can write them, but the first draft more often comes from the buyer's side, so expect it to start from the buyer's position. Before you sign, have a solicitor who handles company sales read the whole thing, and ask your accountant to check the price, how it's paid, the adjustments and the tax. If you're selling to your own managers, read our guide to management buyouts as well.

A checklist before you sign

For where heads of terms sit in the whole process, see our guide to how to sell a business.