What are Heads of Terms?

As part of our ‘M&A Deconstructed’ series, M&A experts Nick Davies and Justin Levine discuss Heads of Terms.

Throughout this in-depth conversation, M&A Solicitor Nick, and M&A Consultant Justin, cover what is included in Heads of Terms, what ‘Heads of Terms’ really means and what information should be included in Heads of Terms. In addition, the two discuss deal momentum and its importance whether you are buying or selling a business, types of ‘heads’ – from one-pagers to extensive Heads of Terms documents – and the movement of working capital within a business.

Take a look at this in-depth discussion in the video or read through the transcript below…

Video sub-topic timestamps:

00:00 – Introducing Heads of Terms
01:19 – Types of Heads of Terms
01:58 – Binding or non-binding?
02:11 – Exclusivity
02:51 – Deal momentum
04:44 – Price expectations
05:08 – How price can be affected
05:30 – Assumptions and deviations
06:03 – Final price fluctuations
07:27 – Legal jurisdiction
09:50 – Digitised signatures and legality for completion
11:05 – When to engage legal input
13:55 – Teamwork between Corporate Finance, M&A Solicitors and Accountancy teams

Video Transcription

What is meant by ‘Heads of Terms’?

Justin Levine:
So Nick, heads of terms.

Nick Davies:
Yes.

Justin Levine:
Some people, some clients, some companies will know what heads of terms are.

Nick Davies:
Yep.

Justin Levine:
But for you succinctly, what’s a heads of term?

Nick Davies:
Heads of terms are a summary of the proposed transaction, in which the buyer and the seller set out their view on how the deal should be structured. You’re going to talk about price, you’re going to talk about how the price is calculated. You might talk about some conditions or requirements before completion can be met. You’re going to talk about due diligence, changes in directors, other changes in the company…

Nick Davies:
So, it’s a summary, a few pages summary of how the deal is going to progress. It’s useful to look back on if there are later some changes in recollection or changes in view. People can be pulled back to the heads and say, “Well, look, this is what we anticipated at the outset. What’s changed?” So yes, a useful document if done in the right way.

Justin Levine:
Yes. Well, for me heads of terms is very simple. To me it’s the deal.

Nick Davies:
Yes.

Types of Heads of Terms

Justin Levine:
It’s the terms of the deal. And I suppose I’ve seen heads of terms from literally a single pager. “I agree to buy that for that amount of money.” And I think the worst I saw was about 26 – 27 pages of narrative of complete detail. But it is, for me, it is just simply the terms of the deal that says you’re going to be selling your business: For how much money? When is it going to happen? What are the conditions attached and so on…

Nick Davies:
Yes.

Justin Levine:
But it’s funny because when I’ve seen clients do what I call ‘do-it-yourself’ heads of terms.

Nick Davies:
Yes.

Are Heads of Terms legally binding?

Justin Levine:
… and I’ve seen pretty extensive heads of terms drawn up by buyers or buyers’ solicitors. And I wonder, I do reflect a little bit… For me it’s a really important document because, of course it is mostly non-binding, because of course there’s usually terms in there, aren’t there, that are legally binding terms. And they’re usually referred to in the document, but mostly it’s a non-binding document, isn’t it?

Nick Davies:
Yes, that’s absolutely right. You normally have a period of exclusivity in the ‘heads’ [heads of terms]. A seller will grant a buyer a fixed period; this might be two or three months for the buyer to complete their due diligence and to hopefully get the transaction completed. That gives the buyer certainty to invest the time and the money in that process, without knowing or without fearing that the seller is going to go off and sell the business from underneath them to somebody else.

Nick Davies:
So, that will be a binding provision in the heads normally. The governing law clause is normally binding, confidentiality, and there might be a few other pieces. But generally what you say is correct, they are normally a non-binding statement of the party’s intent at the time.

What should be included in Heads of Terms?

Nick Davies:
You mentioned the different types of heads of terms from the one page ‘back of a fag packet’ type heads to the 26 / 27 pages. There’s a middle ground and that’s what you need to find. We often use an expression, “Don’t do the deal in the heads.” And I think that if you’re getting up to 25, 26, 27 pages, you’ve overcooked it a bit. And actually you can lose a lot of deal momentum if you get bogged down in spending weeks negotiating heads at terms. It should be a snapshot, which is fairly easy to capture, and you should be doing that in less than 10 pages really.

Nick Davies:
The danger of the one page heads, which is often not professionally prepared, is that quite a lot of the detail: Are we talking completion accounts, are we talking locked box? A lot of that detail is often not captured. So yes, the middle ground is where you want to be.

Justin Levine:
Yes, it’s funny you say that because of course I’m thinking about a recent project, a recent engagement where I think… Acting for the sellers, typically the process of getting a deal agreed with a buyer, buyer and seller, is you agree a price…

Nick Davies;
Yes.

Justin Levine:
… or consideration, if you like, in M&A terms, but it’s a price. And actually what is less transparent in my view, and the sellers often fall into this trap, is that they think is that … Let’s say they’re offered £10 million for their business. They assume that they’re going to sell and they’re going to complete, and on the day of completion 10 million pounds will flow into their bank accounts and off they sail into the sunset. And of course it…

Nick Davies;
It doesn’t always work like that, does it? No.

Justin Levine:
It doesn’t always work like that. And inevitably, the buyer will do some due diligence, and I’m sure we’ll talk about that later. But they’ll do due diligence and they’ll inevitably find bits here, there, and it could be small bits, it could be big bits. But they’re going to want to retain or have some comfort that the warranties and indemnities that come up later downstream, that they’re going to be able to claim.

Including deal value in the Heads of Terms

Justin Levine:
And what I’m basically saying is that I think it’s quite good to address upfront in the heads just that element of, how much is going to be on the table at the end of this process? Can the buyer commit to a certain value percentage of the deal? 9 million out of the 10, or 9.5 million out of the 10 million say.

Listing assumptions in the Heads of Terms

Nick Davies:
And the price is often not binding, is it? We talked about binding, non-binding. The price is often not binding because as you say, the buyer at the outset doesn’t know what they’re going to uncover in due diligence. There may be a horrendous piece of litigation. There may be some sort of regulatory problem with a large fine looming. Well, if you’ve offered 10 million pounds for a business and then you discover in due diligence there’s a million pound claim coming, you’re probably not going to honour that 10 million pounds. Because one of the assumptions, and you might list assumptions in heads of terms, is that there is no material litigation. That all the customer contracts are in place, that all of the IP is valid.

Nick Davies:
So, listing assumptions can be a good way to set out how you see the playing field. And then if there are any deviations to those assumptions, then it’s an opportunity for the parties to revisit the price and negotiate the price. The basis for the price might by reference, as we said, to completion accounts and locked box. We’ll talk about those, I think, in a separate video, but there is a bit there to understand for the seller. Certainly, the first time seller who hasn’t been through the process before, in terms of understanding what the output is from that number once the various calculations have been completed.

Movements in working capital

Justin Levine:
Yes. I think if there’s one material aspect that I draw upon over the past 10 years, is that one thing that a seller typically doesn’t understand, to put it bluntly, and it’s that movement; especially if you’re doing completion accounts. It’s the movement in working capital in the business, from the point you agree the deal to the day the deal actually completes; which can be three to six months.

Nick Davies:
It can be, yes.

Justin Levine:
It can be in that period. And the business is moving and the working capital, the balance sheet, is moving and that can have a very material positive or negative impact.

Nick Davies:
Absolutely right.

Justin Levine:
And that’s I suppose where corporate finance, the whole notion of getting a specialist advisory team, comes into helping guide. Because of course you can forecast this stuff and work it out.

Nick Davies:
Absolutely. I mean, it’s more your zone than mine, but yes, that fluctuation in business in the intervening period, from heads of terms to completion. You might have new customers arriving, you might lose a material customer. There may be all manner of changes in the business which need to be reflected in the price. So yes, people need to have a good grasp and understanding of that.

International mergers and acquisitions: legal jurisdictions for Heads of Terms

Justin Levine:
I have a question for you, well two, that come to mind. We’ll use this just as a bit of experience for me as well. We still see overseas transactions, in other words the buyer is based in a geographic domain outside the UK, and they want to strike heads of terms with the seller. So buyer is overseas, seller is UK, for example.

Justin Levine:
The question is: Which legal jurisdiction should be used? Of course, we’d always argue that it’s UK, but what happens if somebody says, “Listen, we want it to be French.” “We want it to be German.” “We want it to be Italian.” In other words, where the buyer is based. Do you have a view on that?

Nick Davies:
Yes. I mean typically, if the seller and the target business are based in the UK, you’ve got a very strong argument for saying, “Well, this contract is going to be performed in the UK, and the sale and purchase is of a UK-based entity and it’s a UK based-seller.” So I think you’ve got a strong argument to insist upon that. If the buyer has a stronger bargaining position, for whatever reason, and the seller decides to agree to a foreign jurisdiction, you’re going to need some advice from that jurisdiction. We’re not qualified to offer advice on the application of, I don’t know, Australian law or law applicable in Dubai or the United States.

Nick Davies:
But I mean the vast majority of deals, and we do a lot of foreign international transactions, do use UK, English and Welsh law, because it’s a proven body of law. We’ve got good case law here, it’s well understood. And in fact, some foreign transactions, which may be based buyer or seller and the target overseas, may still opt to use English law because it is that well-known body of law.

Justin Levine:
Yes. My personal take on it is, always try to err towards English law because… We have dealt with international, [deals]… both you and I have dealt with…

Nick Davies:
Yes, we have.

Justin Levine:
… extensive international where it’s gone as far as Australia, South Africa, or Hong Kong.

Nick Davies:
Yes.

Justin Levine:
When I think about those, actually there’s very few legal bodies, and I’m talking about law firms now, that have a genuine pan-global presence that can actually legitimately say, “Okay, no problem at all. We can advise on Japanese law, Chinese law, or South African.”

Nick Davies:
Yeah, it’s rare to find one firm that can do all of that.

Justin Levine;
Very rare.

Nick Davies:
I mean, they do exist. I expect probably at a certain price level, which may not be appropriate for the sort of SME level deals that we’re typically doing. It’s a case by case basis, you’ve got to look at it and work out what’s best for the client really. But yes, English law.

Justin Levine:
Just one more question.

Nick Davies:
Yes.

Are digitised signatures in Heads of Terms legally binding?

Justin Levine:
Actually, I don’t know the answer to this, so I’m asking you a question I don’t know. We still exist in an era where terms, heads of terms, SPAs etc. are physical ink on paper.

Nick Davies:
Yes.

Justin Levine:
And of course we can now use, I won’t mention brands for publicity purposes, but we can use PDF documentation to get digitised signatures.

Nick Davies:
Yes.

Justin Levine:
Do they stand up in law?

Nick Davies:
Yes, we don’t see a problem with those. I mean, they are increasingly popular. Those signatures can be checked and verified by IT technology, beyond my level of knowledge. But yes, certainly with parties increasingly being remote. Years ago, we used to have physical completion meetings and we’d all track off to London or Birmingham or wherever, sit around a table and have the completion meeting.

Nick Davies:
That’s very rare now. Even in more recent pre-COVID times, completion meetings are typically remote, where the client will come here and sign or they’ll send their signed documents by email and we’ll exchange those with the other side. So ‘wet ink’ signatures will often change hands after the deal, but they’re typically not a requirement to actually getting completion done.

Justin Levine:
Thank you. To me, probably one final point, when I advise sellers, the preparation phase of getting a business ready and going to market often is a discrete piece of work. Typically, that initial piece can involve the lawyers and it can involve accountants and tax advisors. But it’s typically a discrete piece where, let’s say, corporate finance, M&A firm, will do that piece of work.

Justin Levine:
But at the heads period, specifically when you come to the heads, you say, “Listen, we now have or we’re approaching a deal.”

Nick Davies:
Yes.

When to engage a specialist M&A Lawyer?

Justin Levine:
In other words, you’ve introduced the seller to the buyer. There’s been the management meetings, they’ve reviewed the information memorandum, and so on and so on. And there’s a point at which the deal happens. From my point of view, that’s usually the point that I will say to a seller, “Now we need to engage an M&A lawyer.”

Nick Davies:
Yup.

Justin Levine:
“We need to engage potentially accounting and tax input.” Getting that heads square, right, to me it’s quite an important part of that process. And I think that notion … Sellers often try to fall back and say that they want to use their local solicitor that did their house conveyancing. And I normally say, “No.” What’s your view on that?

Nick Davies:
Yes. I agree with you as to the importance of the heads of terms. And I think in terms of your preparation comment, that’s almost, or it should be, a pre-head stage. I mean, ideally, unless you’ve had some sort of surprise offer arrive on the doormat, most sellers know that they’re thinking of selling.

Nick Davies:
And when they’re in that process of thinking of selling, there should be an internal audit process, where those sellers are checking their contracts, checking their property arrangements, checking their statutory records, checking their employment information. Trying to make sure that the company is in organised and compliant fashion, so that when you sign your heads of terms and the buyer sends you their 50-page due diligence questionnaire, you know that the information you’re going to provide is going to be what the buyer is expecting to see.

Nick Davies:
Anything which is not as the buyer is expecting to see is going to be something which is going to have to be solved. And it’ll either be solved by going away and fixing it, or by the buyer claiming that it goes to the price and causes a negotiation.

Nick Davies:
So in terms of when to involve the various parties, I think early involvement is sensible. I think that if you have some niggling doubts that perhaps there are a few things in your company or business which are not as tidy or as organised as they could be, speak to your CF advisor or your lawyer about that. And work up a list and say, “Right, we need to achieve A, B and C.” Lawyers can help you with that as well.

Nick Davies:
And then on the heads of terms, you get a mix of input. You might need some accountancy or tax input for whatever reason. Probably the CF would take the lead on the heads, but there should be some legal input as well. There are some important legal terms there. So yes, early involvement would be my message.

Why Heads of Terms are a ‘team effort’

Justin Levine:
Do you think, (probably one final point for the heads) is, it is a team effort, if you’re selling a decent sized SME, and you’ve dealt with transactions north of 300 million pounds, I think.

Nick Davies:
Yes. That’s probably our upper end. Yes.

Justin Levine:
But it’s a sizeable amount, right?

Nick Davies:
Indeed, yes.

Justin Levine:
I mean, it’s in the M close to an L.

Nick Davies:
Yes.

Justin Levine:
A ‘SMLE’, we’ll invent something new! But it’s quite a wide range.

Nick Davies:
Yes.

Justin Levine:
But if you’re dealing with big sums of money, typically the seller does have a team of advisors.

Nick Davies:
They would, yes.

Justin Levine:
CF, M&A lawyer, a solicitor or team, accountancy, tax. And my question to you is; do you think it’s important, because inevitably they are different firms…

Nick Davies:
Yes.

Justin Levine:
Do you think it’s important that that team have worked together and have some relationship between them? Or is it in your experience, it doesn’t really matter and it’s just a transaction and each party, each of those advisors will work together [well]. It’s a vanilla kind of output if that makes sense.

Nick Davies:
Yes. I mean, I think there is a benefit to working with fellow advisors who you’ve worked with before. You know and understand how that party works. Ultimately, if the professional advisor is competent and experienced, it shouldn’t be a problem who they are where they’re based. I think we gravitate towards people that we know and have worked with before. And often that can bring some efficiencies to the process, and a dovetailed approach, which is important.

Nick Davies:
It is a team effort, it’s a group effort. A lot of the issues overlap when you start talking about the share sale and purchase agreement, which have lots of tax content. You’re going to need accountancy and tax input on that. So yes, get the best team you can. If they’ve worked together before, great. If not, so long as they’re all decent and experienced advisers, you should be fine.

Justin Levine:
Okay. So I think we’ve covered off heads of terms.

_ _ _ _ _ _ _ _ _ _ _ _

More from Series 1 of M&A Deconstructed

As part of this in-depth series, other topics discussed include:

• What is EBITDA?
• Equity Share vs Asset Sale
• Completion Accounts vs Locked Box
• What is Due Diligence?

Connect with the M&A experts

Justin Levine, Managing Director, The NonExec Limited M&A Boutique 
Justin leads a boutique exit advisory firm specialising in manufacturing, technology, IT, digital, healthcare, wholesale and distribution markets. With the support of a 15-strong virtual team of analysts and researchers, he helps private business owners with growth and exit strategies. Connect with Justin >

Nick Davies, Partner and Specialist M&A Solicitor, Steele Raymond LLP
Nick acts for a wide range of business clients across various sectors, advising on complex corporate transactions including company sales, purchases and mergers. Nick also advises on on mergers, de-mergers and re-organisation. Connect with Nick >

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If you have any questions regarding your business, a business exit, a merger or any other corporate legal query, please contact Nick Davies on 01202 294566 or email [email protected]