Heads of Terms: Setting the Stage for a Successful Transaction

HOTs are used in a variety of loan finance and other transactions, including M&A, joint ventures, project financing and private equity investments. This article is part of a series of articles on share and asset sales, so will be considering HOTs from a private M&A perspective, though some comments will be relevant to other scenarios.

Previous articles considered the key stages in a share sale/acquisition and an asset sale/acquisition. You can find out more about the differences between a share sale and an asset sale in our article entitled “Share Purchase v Asset Purchase: A comparison”.

Purpose of HOTs

HOTs serve as a roadmap for a deal. They create a sense of commitment and guide subsequent negotiations and are usually entered into before due diligence commences. They lay out the main commercial points and timetable early, hopefully streamlining the negotiation of transaction documents as the main bones of contention ought to have been covered in it. That being said, HOTs can limit room for manoeuvre in subsequent negotiations, so parties should carefully consider entering into them, and if your transaction is working to a short timescale time may be better spent working on and negotiating the transaction documents, rather than the HOTs.

Generally speaking, HOTs are not binding. They do not compel the parties to conclude the deal on the ‘agreed’ terms or at all.

Key elements of HOTs

• Purchase price and payment terms: Parties specify the purchase price (or price range), payment structure (e.g. cash, equity, or a combination), pricing mechanism (e.g. locked box accounts), time for payment (e.g. completion or deferred payments) and address earn-out provisions or adjustments (e.g. completion accounts).
• Transaction structure: HOTs will describe the proposed structure (e.g. asset purchase, share purchase, or merger) and simultaneous or split sign/close.
• Timelines and milestones: HOTs may set timeframes for due diligence, negotiation of definitive agreements, and signing/closing.
• Due diligence: HOTs will often outline the scope and timing of due diligence investigations and clarify access to information and data rooms.
• Warranties and indemnities: HOTs often say that the transaction document will include customary warranties/indemnities for the nature of the transaction. HOTs may identify key warranties and indemnities.
• Limitations on claims: HOTs that we see rarely specify limitations or thresholds, but we would recommend that these are discussed early on.
• Conditions precedent: In a split sign/close deal, the HOTs will highlight any conditions precedent to be satisfied before completion (e.g. third party consents, financing and regulatory approvals).
• Confidentiality: HOTs should include confidentiality provisions to ensure that sensitive information remains protected during negotiations.
• Exclusivity: HOTs often include exclusivity periods to prevent the seller from entertaining other potential buyers during a specified period.

Legal considerations

• Binding or not? As mentioned above, in the UK, HOTs are generally not legally binding (save for certain provisions, e.g. confidentiality, exclusivity and costs). When drafting it is important that the parties are clear about which provisions are binding and which are not. Although non-binding, parties should negotiate in good faith as unreasonable deviation from agreed terms may harm the deal.
• Intention to create legal relations. HOTs can evidence intent to create legal relations and do have moral force. Use phrases like “subject to contract” to rebut this presumption if the parties plan to use the HOTs as an agenda for negotiating the acquisition document (e.g. share purchase agreement).
• Pre-contractual statements. When discussing HOTs or during the negotiations, statements made can lead to liability for fraudulent statements, misrepresentation, or negligent misstatement. To mitigate this risk, include an entire agreement clause in the final contract, explicitly excluding liability for misrepresentation.

Comment

HOTs form the bedrock of successful M&A transactions and whilst they’re not legally binding, they set the tone for negotiations, define the deal’s contours, and pave the way for the formal agreements. You should consider involving legal advisors early in the process to ensure that these preliminary documents align with your intentions and protect your interests.

Contact our Corporate & Commercial team if you would like advice and assistance with navigating HOTs.