Heads of Terms: A Key Step In The Negotiation Process

Whether you’ve successfully scaled your business and have buyers knocking on your door or you’re looking to acquire a business yourself, you’re likely overlooking a key step in the negotiation process: Heads of Terms.

What are Heads of Terms?

Also known as Letters of Intent or Memoranda of Understanding, Heads of Terms set out the main points of a deal in writing before the real contract negotiation begins. Think of them as a non-binding (well, mostly—we’ll get to that in a minute) outline of the major issues, and how the parties intend to address them.

Do I really need them?

We know what you’re thinking—why should I add another step to an already complex negotiation? Why draft another document? And if it’s an outline of the same points that will be in the final contract, isn’t that kind of redundant?

But before you dismiss the idea of using Heads of Terms, consider the following ways they can help your negotiations go even smoother—especially in a share purchase or asset purchase.

Heads of Terms save you time and money.

Imagine you’ve found a great buyer or seller. You have an initial conversation, and it seems like you’re on the exact same page about how the transaction should go down. So you skip the Heads of Terms and go straight to due diligence and contract drafting, with lawyers and accountants in tow (and on your payroll).

Multiple months of due diligence go by, multiple invoices from said lawyers and accounts come and go, you turn down multiple other acquisition opportunities . . . and you realize the buyer assumed some key employees were staying, while the seller assumed they’d be allowed to come with him to his next venture. The deal falls through.

If you’d had Heads of Terms, both parties could’ve walked away before spending all that time and expenditure.

Heads of Terms protect you and your business.

Remember when we said Heads of Terms were mostly non-binding? It’s true that the majority of the provisions in the Heads of Terms won’t have a legally binding effect on the parties, which allows both sides to talk about big points without any pressure, and to write down their intent without any legalese. The big exception here is that the parties can—and generally do—make the confidentiality provisions binding.

Why is that important? Let’s go back to the scenario above, where you’ve found a seemingly perfect buyer or seller and forego Heads of Terms in favor of speedier negotiations. Unlike many other contract negotiations, acquisitions involve a lengthy due diligence period—meaning each party is permitted to do extensive research into the other, including looking at private internal documents. Heads of Terms allow the parties to have binding confidentiality provisions that prevent the other from sharing any proprietary information discovered during this process.

In addition to binding confidentiality terms, parties can also add binding exclusivity or “no shop” provisions, which prevent parties from negotiating with others during the due diligence period, protecting against concerns that the other will abandon ship to get a better deal elsewhere.

Heads of Terms help you “sell” the deal to third parties.

Acquisitions are big decisions and often require the agreement of all the important stakeholders. A critical stakeholder will be less likely to change their mind if your agreements on major points are lost in lunch conversations, phone calls, and chains of emails. Heads of Terms help summarize the deal and assure anyone with doubts that both parties see eye to eye and are committed to following through.

And don’t forget, you may need to “sell” your deal to third parties outside your organization too. Maybe a bank or investor requires assurances before helping you finance the deal. Maybe your office landlord wants information on the deal before agreeing to let the other party takeover, or before letting you out of a lease breakage fee. Heads of Terms are a tool you can keep in your arsenal to ease the doubts of others who don’t know or trust the deal as much as you do.

Conclusion on Negotiating an Acquisition

Heads of Terms are far from a redundant step in an acquisition negotiation. They save you time and money, protect your business and its confidential information, and help you sell your deal to any skeptics.

If you want to learn more about Heads of Terms—or any other legal agreements for your startup—Linkilaw’s here to answer your questions! Book a consultation with our legal team to learn which agreements you do (and don’t) need for your business.