The importance of heads of terms

By Pauline Rigby, head of corporate at Forbes.

Heads of terms can never be underestimated in corporate transactions. Clients often question the advice to put together the heads of terms because they prefer the idea of moving straight into due diligence and then the agreement itself.

So why do the majority of corporate lawyers advise that a set of ‘heads’ should be put together at an early stage?

Heads of terms are important because, while the majority of the provisions will be legally unenforceable, the heads set out the main terms of the deal that define the boundaries when dealing with negotiations.

They show the serious intention of the parties to commit to a legal and financial due diligence process and also have moral force. The heads additionally provide for a timeline in which the transaction comes to life that encourages all parties to commence negotiations in good faith and commit to the timeframe.

Heads can also include confidentiality provisions and restrictions regarding the use of information, as well as helping to prevent the poaching of staff, clients and suppliers for a set period of time after the date of the heads. This, of course, is extremely important when balancing the risk of the deal not proceeding.

A lot of deals fall over either within or just after the due diligence stage, which means that a large amount of information  has already been given out, potentially to a competitor.

Restrictions and confidentiality provisions will therefore help ensure the seller’s business itself is protected, despite information changing hands.

Costs should also be addressed within a set of heads, providing financial protection against wasted costs which should enable you to proceed with more confidence.

Moreover, exclusivity is really important to a potential buyer as this will provide the seller and the buyer with a specific amount of exclusive time in which to agree a deal. Exclusivity provisions generally provide the buyer with comfort that they have a specific amount of time to investigate the business properly and get the deal over the line.

The seller, however, should be careful not to agree to an exclusivity period that is too lengthy and restrictive. Instead, it should enable the seller to continue with the potential sale process and not lose momentum should the buyer pull out of the deal.

A well drafted set of heads of terms provides a foundation for the deal, showing the intention of the parties and providing a moral force. It can help cement the deal in the minds of the parties and underpin hopes that a successful transaction will be the end result.