Heads of Terms: Where Most Business Acquisitions Go Wrong

Most problems in business acquisitions do not begin with the share purchase agreement.

They begin earlier — at heads of terms.

Heads of terms (or a letter of intent/memorandum of understanding) are often treated as “just commercial”. In practice, they set expectations, shape the negotiating dynamic, and determine how much time and cost is wasted later. A weak heads of terms document tends to produce one of two outcomes:

1. a deal that drifts, becomes argumentative and collapses; or

2. a deal that completes, but with avoidable risk left in the paperwork.

This note explains where heads of terms commonly go wrong under English law, and how to use them properly.

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1) Treating heads of terms as a formality

The biggest mistake is to treat heads of terms as a box-ticking step to “get the lawyers started”.

In reality, the heads of terms should do three things:

• Lock in the commercial bargain (price, structure, timing).

• Identify the risk allocation early (what happens if issues appear).

• Set the process (exclusivity, diligence, timetable, information flow).

If those three are not addressed, the parties end up negotiating the commercial deal inside the long-form documents, which is slower, more expensive, and more likely to create conflict.

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2) Failing to define the deal structure early

Many “price” disputes are not really price disputes. They are structural disputes.

Key questions that should be answered in the heads of terms include:

• Is this a share sale or an asset sale?

• Is the price cash on completion, or is there deferred consideration?

• Is there an earn-out, and if so, based on what metrics?

• Are there retentions/escrow, and what triggers release?

• Are there conditions precedent (consents, refinancing, key contracts)?

If these questions are left vague, the first draft SPA/APA often becomes the first time the parties confront the reality of the deal. By then, positions have hardened, and timetables are under pressure.

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3) Ambiguity around “debt-free / cash-free” and working capital

“Debt-free / cash-free” sounds simple until you have to define it.

Common failures include:

• no definition of “debt” (does it include leases, VAT, director loans, deferred revenue?);

• no mechanism for determining cash/debt at completion;

• no agreement on a working capital target; and

• no clarity on what happens if the target is missed.

These are classic flashpoints. They are also preventable if the heads of terms set out the pricing mechanics clearly enough that the lawyers can implement them without re-trading the deal.

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4) Earn-outs that are commercially agreed but legally unworkable

Earn-outs are common in SME deals where valuation is uncertain. They are also one of the most common sources of post-completion disputes.

Heads of terms often fail by stating:

“Earn-out: £X based on performance over 12 months”

without answering:

• What is “performance”? Revenue? EBITDA? Gross profit?

• Is it audited? On what accounting basis?

• What is the buyer allowed to change in the business during the earn-out period?

• What happens if the buyer integrates the business, changes pricing, or reallocates costs?

• What information rights does the seller have?

If these points are not addressed early, the buyer may later insist on protections that effectively remove the earn-out’s value — or the seller may demand controls that the buyer considers unacceptable. Either way, the deal stalls.

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5) Not addressing what happens if diligence reveals a problem

Due diligence exists to find issues. The question is what happens when it does.

Heads of terms often fail because they do not set out the parties’ expectations on:

• price adjustments (what triggers a reduction, and by what method);

• special indemnities (for known risks);

• whether certain issues are deal breakers (regulatory, key customer dependence, missing IP ownership); and

• how quickly issues must be raised and resolved.

Without this, diligence becomes adversarial: each issue is treated as a renegotiation rather than a managed process.

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6) Ignoring restrictive covenants and “who stays”

In owner-managed businesses, much of what the buyer is purchasing is the goodwill tied to individuals.

Heads of terms should deal with:

• whether key individuals will stay and on what terms (employment/consultancy);

• the broad shape of restrictive covenants (non-compete, non-solicit, non-deal);

• whether there is a handover period, and what “handover” means.

If this is left to the end, it often creates late-stage friction — particularly where the seller’s view of “reasonable restrictions” differs from the buyer’s.

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7) No exclusivity — or exclusivity with no teeth

Exclusivity is common on the buy-side. On the sell-side, it should be given only with safeguards.

Key points that are often missing:

• the length of exclusivity;

• what the buyer must do during exclusivity (diligence timetable, draft documents, progressing finance);

• whether the seller can engage in parallel discussions if the buyer stalls; and

• whether there is a break fee (rare in SME deals, but sometimes appropriate).

Exclusivity without obligations can simply give the buyer control without commitment. It is not always wrong — but it should be deliberate.

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8) Failing to identify consents, approvals and third-party dependencies

Many SME deals are constrained by third parties:

• landlord consent to assignment/underletting;

• customer or supplier change-of-control clauses;

• banking facilities that need refinance;

• FCA/regulated activities issues;

• key IP licences that are non-transferable.

If these dependencies are not identified early, completion can be delayed (or prevented) at the last moment.

A good heads of terms document flags likely consents and assigns responsibility for obtaining them.

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9) Confidentiality and announcements left vague

Confidentiality is usually included — but often poorly.

Heads of terms should cover:

• who can be told (accountants, funders, advisers);

• how information is to be shared (clean team where relevant);

• whether there is any permitted marketing/announcement; and

• what happens if a party leaks.

In practice, leaks do happen, particularly where staff become aware of a process. Clear ground rules reduce risk and dispute.

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10) “Non-binding” language used carelessly

Under English law, heads of terms are often stated to be “subject to contract” and non-binding. That is usually correct as regards the sale terms — but it is not the whole story.

Even where the sale terms are non-binding, certain provisions are commonly intended to be binding, such as:

• confidentiality;

• exclusivity;

• costs; and

• governing law and jurisdiction.

The heads of terms should state clearly which clauses are binding and which are not.

Two cautions:

1. Ambiguity creates risk. If you intend something to bind, say so.

2. Even where parties intend non-binding negotiations, behaviour can sometimes create disputes (for example, around reliance). Keeping the position clear reduces the risk of argument later.

(As ever, the safe default is: mark the document “subject to contract” and specify binding clauses explicitly.)

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What good heads of terms look like (in practice)

For most SME acquisitions, a good heads of terms is not a long document. It is a disciplined one.

In my view, it should cover, at a minimum:

• parties and structure (shares/assets);

• price and payment mechanics (including cash/debt/working capital);

• earn-out/retention mechanics if relevant;

• timetable and diligence process;

• warranties/indemnities headline positions (including known risks);

• key people and restrictive covenants;

• consents and third-party dependencies;

• exclusivity (if any) and what the buyer must do during that period;

• confidentiality and announcements;

• binding vs non-binding clauses, and subject to contract language.

If those points are set out properly, the legal documents become implementation, not renegotiation.

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Closing thought

The purpose of heads of terms is not to “save legal fees” by avoiding detail. It is to prevent wasted time and misalignment later.

Most acquisition pain is not caused by complex drafting. It is caused by an unclear commercial agreement.

If heads of terms captures the commercial deal with discipline, the rest of the transaction becomes markedly smoother.