The Buyer and Seller of a business will often agree the key terms of a sale of a business before involving solicitors, however there are some key questions that may not automatically occur to non-solicitors that are best addressed early so that from the start there is a focus on what the business is really worth, so that the deal can become clear quickly.
If these key terms are agreed in writing the resulting document can be given a number of names – including Term Sheet, MOU (Memorandum of Understanding), LOI (Letter of Intent) or HOT (Heads of Terms). The general concept is usually the same – the key commercial terms of a sale are set out prior to undertaking a thorough review of a business (due diligence) and negotiating formal legal sale documents. This step does in our experience ultimately save in legal and other professional costs.
Although the Heads of Terms are usually expressly said not to be legally binding, the parties in practice find it hard to back away from key provisions agreed in the Heads of Terms. This is why it is important to weigh up your negotiating position and (if you determine you have a relatively strong bargaining position) a few key points to negotiate early on are listed below:
– Deferred Consideration while a headline figure of x million might sound very tempting, the reality of payments staggered over a number of years dependant upon how well the business performs may essentially re-write the commercial deal from a seller’s point of view, especially if the seller has limited control over the future actions of the buyer. Conversely, for a buyer this may well be the key protection to ensure the buyer is purchasing a thriving business. For this reason it is well worth nailing down exactly when any payments are going to be made and any terms that might limit those payments. If any earn-out is to be tied to financial results those should be clearly and unequivocally defined, and setting out a couple of illustrative examples often helps avoid future disputes. The involvement of the seller post completion needs to be set out.
– Restrictive Covenants how long is any seller going to be restricted from working for a competitor? If the business is in a small sector, what other job opportunities will be available for that seller if they are tied in to a lengthy non-compete? This is often the area of greatest dispute in the final documents, so if it can be agreed at the Heads of Terms stage it might save much wasted effort.
– Limitation on Liability when the formal documentation is negotiated, any buyer would ideally like a seller to promise that all has always been good with a business and take the hit for any areas where this might not be the case. A protracted discussion setting out the limits of each party’s responsibilities often takes place. But to keep a lid on the maximum amount a seller has to pay out if there are future costs associated with problems that arose prior to sale, the seller will usually propose a cap on the seller’s liability. It may be that this can be more easily agreed at the Heads of Agreement phase, when the parties are trying to get a deal past the starting line.
– Anti-Embarrassment provision this is a short-hand way of describing the agreement that allows the seller of any business a percentage of the upside if a buyer goes on to sell a business within a short period of time (also known as “flipping”). For example, if a business is bought for £100,000 tomorrow and sold to a third party for £200,000 six months later, the original seller might get 30% of the additional price. If a buyer does not agree to this at the Heads of Term stage it is a fairly safe bet that a seller won’t get them to agree it at a later stage.
The non-binding nature of Heads of Terms is often something that clients call us to discuss at length. If the Heads of Terms are not binding, it could be asked what the point of them is. Although the moral force of Heads of Terms should not be underestimated, it is worth making sure that certain terms are carved out to be binding. These provisions are usually confidentiality provisions and non-poaching of employees (to protect the seller), and an exclusivity provision to protect the buyer. If these provisions are in place, both buyer and seller have additional protections while going through the due diligence process. The seller won’t risk losing vital intellectual property or staff members and on the buyer’s side and there is protection against the time and money spent on due diligence going to waste if a competing buyer steps in.
Although it is very understandable to want to agree key terms before involving solicitors make sure you do not miss out in the long run by missing any important matters in your Heads of Terms.
Helen Curtis is an associate solicitor in our London commercial law team and regularly advises businesses and partnerships on how to structure heads of terms and other commercial agreements.