Definition
Heads of terms is the UK name for a short document that records the main commercial terms agreed between buyer and seller before the full legal documents are drafted. It is the equivalent of a letter of intent in the US, and similar documents elsewhere may be called a term sheet or heads of agreement. It is usually stated to be non-binding, apart from specific clauses such as exclusivity and confidentiality.
A letter of intent sets out the main terms on which a buyer proposes to acquire a business, before due diligence and the full purchase agreement. In the UK the equivalent is usually heads of terms.
An exclusivity period is an agreed time during which the seller will not negotiate with other buyers, giving you room to complete due diligence and arrange finance.
Worked example
A fictional buyer agrees to purchase the shares of Whitcombe Dental Laboratory Ltd, a fictional UK business. The heads of terms record:
- a price of £1,800,000 on a cash-free, debt-free basis, with a normal level of working capital
- £1,500,000 payable on completion and £300,000 deferred over 12 months
- warranties and indemnities to be given by the selling shareholders
- the founder to stay for a six-month transition period
- eight weeks of exclusivity
Cash-free, debt-free is a pricing basis in which the headline price assumes the business changes hands with no cash and no borrowings. The seller keeps the cash, repays the debt and leaves a normal level of working capital behind.
Working capital is the money tied up in running a business day to day, mainly stock and money owed by customers, less money owed to suppliers. A sale needs to agree how much of it comes with the business.
Why buyers care
Heads of terms turn an informal agreement into something both sides and their advisers can work from. Lawyers draft the share purchase agreement from them, so gaps or loose wording at this stage tend to become arguments later.
Because the document is mostly non-binding, either side can still walk away. A binding exclusivity clause, though, stops the seller negotiating with other buyers while you spend money on due diligence, so make sure the period is long enough for your finance and diligence to finish. Ask your solicitor to confirm which parts are binding before you sign.
Due diligence is the investigation a buyer carries out before committing to a purchase, testing the finances, contracts, legal position and operations against what the seller has described.