Heads of terms (also known as a memorandum of understanding, letter of intent or heads of agreement) are used to set out the commercial terms of the acquisition, as well as the intended timetable for the transaction and any obligations on the parties during negotiations.
Whilst not always necessary, heads of terms can help focus negotiations, particularly in more complex transactions, so any major problems are identified early on in the process.
Other advantages to a purchaser of heads of terms is that it may be possible to obtain an exclusivity period, during which the seller is not permitted to negotiate with any other parties in relation to the sale of the company. Also known as a lock-out agreement, it provides some protection to the buyer, when committing resources to due diligence and negotiations, from losing the target business to a rival.
Although heads of terms are not usually legally binding, save for any confidentiality and exclusivity provisions, in our experience they are often used as a definitive guide and hard to manoeuvre out of, without good reason, once signed. This is of particular relevance to the buyer, who will have a lot less information about the state of the target company at the time the heads of terms are agreed. Therefore, as a buyer, you may wish to leave certain elements open or subject to the business' trading performance in order to allow changes to be made following the due diligence process.
A buyer may also want to consider whether to seek a contribution from the seller towards its costs if they pull out of the transaction, although a buyer is likely to be resistant to such a term.
Care does need to be taken that the negotiation of the heads of terms does not become too involved, negating the benefit of having them in the first place. To avoid this being the case, see our Tips for an Effective Set of Heads of Terms.