I’ve been asked a few times about heads of terms in the last couple of weeks and what goes in them.
When putting a formal M&A deal together, we have a comprehensive checklist we use to reach an agreement in principle. The level of detail you need at this stage will vary from deal to deal.
Here are just a few of the key points you’ll want to consider…
> Deal structure. What is the overall shape of the agreement? For example, is it a full or partial sale of company shares? What percentage of the sale price will be paid upfront and what amount will be deferred? Are there any earn-out provisions? Is it a cash or stock / shares purchase?
> Valuation method. Since the heads of terms is drafted before full due diligence is completed by the buyer, a simple formula allows the final price paid to ‘flex’ if the financials move significantly prior to the deal closing. This can protect buyer and seller and avoid last-minute, fraught renegotiations.
> Exclusivity clause. A period of 3-6 months is not unusual, to allow due diligence and funding to be finalised.
> Key personnel. Will the owner(s) remain during a transition period? What are the intentions of the senior management team or other key people in the business once the sale is complete?
> Condition precedent. Include any conditions that must be met by either party before the agreement is executed, such as board approval, third party approvals relating to contracts or the transfer of assets.
> Final price adjustments. If the sale is on a ‘cash free, debt free’ basis, then the buyer won’t assume any debt on the balance sheet, including any tax liabilities. And likewise, the buyer won’t get any excess cash on the balance sheet. Working capital requirements will need to be finalised once due diligence has been completed.
Done properly, the heads of terms stage will save you time further down the road. Either by clarifying expectations on both sides upfront or by raising warning flags early on.
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