Heads of terms, and the funding points that belong in them

What the document is

Heads of terms, sometimes called a term sheet or a memorandum of understanding, is the written summary of what buyer and seller have agreed in principle. It comes after the offer is accepted and before the solicitors start drafting the sale agreement.

Most of it is not legally binding, and buyers sometimes conclude from that it does not matter much. The opposite is true. It sets the frame that everything afterwards is negotiated inside. Anything not settled here gets settled later, when both sides have spent money, the seller has taken the business off the market, and reopening a point looks like bad faith rather than diligence.

A few parts usually are binding, and they should be identified explicitly in the document rather than left to inference: exclusivity, confidentiality, who bears their own costs, and sometimes a break fee. Everything else is a statement of intent.

What belongs in it

• The price, and the payment profile. Not just the total. How much on completion, how much deferred, on what dates, and on what conditions. A total with "the balance over three years" underneath it describes several quite different deals.
• Shares or assets. Which structure, stated plainly, because it changes the diligence, the drafting and the funding, as set out in share purchase versus asset purchase.
• What is included and excluded. Property, vehicles, stock, work in progress, debtors, cash in the business, the trading name, the domain, and anything the owner regards as personal. The excluded list is the one that produces arguments.
• The completion accounts mechanism. If the deal is cash-free and debt-free with a normal working capital target, define what counts as debt and how the target is calculated. Left vague, it becomes a dispute about the final price after the money has moved.
• The seller's role after completion. How long, doing what, on what terms, and paid how much.
• Restrictive covenants in principle. Scope, geography and duration, agreed at this stage rather than presented as a surprise in the draft agreement.
• Conditions to completion. Funding, landlord consent, third-party consents, regulatory or accreditation transfers, and anything that has to be fixed first.
• Exclusivity, and how long. Long enough to complete diligence and get a facility documented, which is longer than most first drafts allow. Realistic durations are discussed in timelines.
• The timetable, with the dependencies visible: diligence before the lender's credit paper, credit approval before the security work.

The funding points that get left out

Three things belong in a heads of terms document specifically because of the funding, and they are almost always omitted.

The ranking of the seller's money. If part of the price is deferred, the senior lender will require it to be subordinated, unsecured and incapable of being accelerated while its facility is outstanding. Writing that into the heads of terms means the seller knows from the start that it is a condition of the funding rather than a demand invented by a bank in the final week. It is the single most common cause of a late stall, and it is covered in vendor finance.

How the deferred element is measured. Where there is an earn-out or a retention, the metric, the accounting basis, who calculates it and how disputes are resolved are commercial points, not legal ones. Agreeing them here is much easier than agreeing them once each side's solicitor has a position, and the detail is in deferred consideration and earn-outs.

That completion is conditional on funding. Obvious, and frequently left out, which leaves a buyer exposed to a seller arguing they are committed.

What to keep out of it

A heads of terms document that runs to twenty pages has become a draft sale agreement written by the wrong people at the wrong stage. The detailed warranties, the disclosure process, the indemnity drafting and the mechanics of the completion statement belong in the sale agreement, prepared by solicitors who do this for a living.

The test is whether a point changes the deal or implements it. Whether there is an earn-out changes the deal. How the earn-out certificate is served implements it.

Getting the sequence right

The order that avoids most of the trouble is straightforward, and it is not the order most deals follow.

Agree the commercial shape in principle. Establish what a lender will fund and what it will require on ranking and security. Write both into the heads of terms. Then start diligence, which is where the detail in due diligence belongs.

Doing it the other way round, signing heads of terms with a payment profile that has never been tested against a lender, produces the conversation nobody wants: going back to a seller who has already agreed a number to explain that the structure has to change. In owner-managed sectors, where the seller is frequently the person who built the business, that conversation costs goodwill that matters right through the handover. It comes up most often in succession sales, including in accountancy practices, where staged payment is close to universal.

What goes wrong

The exclusivity period was too short. A period that expires mid-diligence hands the seller the option to talk to someone else at exactly the moment the buyer has spent the most and committed the most.

The payment profile was agreed before the funding was tested. Reopening it later is expensive in both money and trust.

Nobody said which parts bind. Two sides with different understandings of whether a document commits them is a dispute waiting for a reason.

The completion mechanism was left to "market practice". There is no such thing precise enough to settle a number, and the number gets settled after completion.

The document was written by the parties alone. Heads of terms are short enough to feel like something two reasonable people can draft between them, and the cost of getting a solicitor to read them is trivial against what an ambiguous clause costs later. Terms that appear in this document and nowhere else are in the glossary.

Testing the structure before it is written down

The most useful thing a buyer can do before signing heads of terms is find out how the structure they are about to commit to will be read by the people who have to fund it.

We know this market and we know specific people who fund acquisitions in these sectors, so we can tell you whether the payment profile and the ranking you are agreeing are fundable before they go into a document the seller will hold you to.

Tell us what has been agreed in principle. We come back to you with who can fund it and what they will want to see.

We introduce buyers who are acquiring through a limited company or a NewCo. If you are buying personally, as a sole trader or as a partnership, we will point you to an authorised firm directly instead.