How a Heads of Agreement Sets Terms for a Business Sale

Heads of Agreement for a Business Sale: What You Need to Know

A Heads of Agreement for a business sale records the key commercial terms a buyer and seller have agreed in principle before the formal sale contract is prepared.

It can provide a useful framework for negotiations, due diligence and preparing the final Business Sale Agreement. However, signing a Heads of Agreement should not be treated as a formality. Depending on its wording and the parties’ intentions, some or all of its provisions may be legally binding.

For business owners preparing to buy or sell a business, understanding exactly what the document does, and what it does not do, can help avoid misunderstandings before the transaction progresses.

Key Takeaways

• A Heads of Agreement records the main commercial terms of a proposed business sale before the detailed sale contract is prepared.
• It may be binding, non-binding or partly binding depending on its wording and the parties’ intentions.
• Confidentiality, exclusivity and other preliminary obligations may take effect immediately even where the proposed sale itself remains subject to contract.
• It can set out the proposed due diligence process and conditions that must be satisfied before the transaction proceeds.
• The document should accurately identify the parties, proposed purchase price, assets being sold and any important conditions before it is signed.

What Is a Heads of Agreement?

A Heads of Agreement is a preliminary document used to record the principal terms of a proposed transaction.

In a business sale, it can give the buyer and seller a common understanding of the proposed deal before lawyers prepare the detailed Business Sale Agreement.

Depending on the transaction, a Heads of Agreement may address matters such as:

• the proposed purchase price;
• the business or assets being acquired;
• payment arrangements;
• due diligence;
• conditions that must be satisfied before the transaction proceeds;
• confidentiality;
• exclusivity;
• proposed timing; and
• the process for preparing and negotiating the formal sale contract.

Similar preliminary documents may be called a letter of intent, memorandum of understanding or terms sheet. The name given to the document does not, by itself, determine its legal effect.

Is a Heads of Agreement Legally Binding?

This is one of the most important questions to address before signing.

A Heads of Agreement may be:

• legally binding in its entirety;
• expressly non-binding; or
• non-binding in relation to the proposed sale while making particular provisions, such as confidentiality or exclusivity, immediately binding.

The answer depends on the wording of the document, the parties’ objective intentions and the circumstances surrounding the agreement.

The High Court decision in Masters v Cameron remains an important Australian authority when considering whether parties intended to be immediately bound by agreed terms or intended that legal obligations would arise only when a formal contract was signed.

Using wording such as “subject to contract” can help indicate that the principal commercial terms remain subject to execution of a formal agreement, but the document needs to be considered as a whole.

For that reason, a Heads of Agreement should clearly state which provisions are intended to be binding and which remain subject to negotiation and execution of the formal sale contract.

Why Use a Heads of Agreement in a Business Sale?

A Heads of Agreement can give the buyer, seller and their advisers a practical starting point for the transaction.

Before significant time and cost are spent on due diligence and preparing detailed sale documents, it allows the parties to record the broad commercial deal they believe they are progressing.

This can help identify disagreements early. For example, the parties may think they have agreed on a purchase price but have different expectations about whether stock is included, how employee entitlements will be treated or which business assets will transfer.

Recording those matters at an early stage can make the later contract negotiation more efficient.

A Heads of Agreement does not, however, replace the formal Business Sale Agreement. The final agreement will normally address the transaction in considerably greater detail.

What Should a Heads of Agreement for a Business Sale Cover?

The appropriate terms depend on the transaction, but the document will commonly identify the proposed buyer and seller and describe the business or assets involved.

Purchase Price and Payment

The document may record the proposed purchase price and how it will be paid.

If part of the price is deferred, subject to adjustment or dependent on future performance, the commercial basis of that arrangement should be identified clearly enough for the parties and their advisers to understand what has been agreed in principle.

What Is Included in the Sale?

The parties should identify what they expect the transaction to include. Depending on the business, this could involve:

• goodwill;
• plant and equipment;
• stock;
• business names;
• customer or supplier contracts;
• intellectual property and trademarks;
• websites and digital assets; and
• other identified business assets.

The detailed treatment and transfer of those assets should then be addressed in the formal sale documentation.

Conditions to Proceed

A transaction may depend on particular matters being satisfied before the parties are required to proceed.

Examples may include satisfactory due diligence, finance approval, landlord consent to an assignment of lease, approval from a franchisor or another required third-party consent.

The wording matters because a condition should make clear what must occur, who is responsible for it and what happens if the condition is not satisfied.

Due Diligence and the Heads of Agreement

Due diligence allows a buyer to investigate the business before completing the acquisition.

A Heads of Agreement can establish the framework for that process, including the information the buyer may review, the timeframe for investigations and any conditions attached to proceeding with the transaction.

Depending on the business, due diligence may involve reviewing financial information, contracts, employees, leases, intellectual property, licences, regulatory matters and other aspects of the business.

Care is needed when drafting any right allowing the buyer to withdraw following due diligence. Terms such as “satisfactory due diligence” can have significant consequences and should reflect what the parties actually intend.

The NSW Court of Appeal decision in AMA Group Limited v ASSK Investments Pty Limited [2021] NSWCA 45 illustrates the importance of carefully drafted conditions precedent. In that case, the purchaser’s board approval was treated as a condition precedent to the obligation to enter the contemplated Business Sale Agreements.

If you are considering an acquisition, our business sales and purchases lawyers can assist with the transaction and due diligence process.

 

Confidentiality

Business sale negotiations often require a seller to provide commercially sensitive information to a potential buyer.

A confidentiality provision can regulate how that information may be accessed, used and disclosed during the proposed transaction.

For example, the buyer may receive access to financial information, customer information, pricing, supplier arrangements, operational processes or other confidential material solely for the purpose of assessing the proposed acquisition.

Where confidentiality obligations are intended to continue even if the transaction does not proceed, the document should make that clear.

Exclusivity

A buyer may ask the seller to agree to an exclusivity period while due diligence and negotiations take place.

During that period, the seller may be restricted from negotiating with or accepting offers from other potential buyers.

Exclusivity can give the buyer some confidence that it is not committing time and money to due diligence while the seller continues shopping the business to other parties.

For the seller, however, agreeing to exclusivity can mean giving up the opportunity to pursue another buyer for the agreed period.

The duration, scope and consequences of an exclusivity clause should therefore be considered carefully before signing.

Intellectual Property and Trademarks

If intellectual property forms part of the business, the Heads of Agreement can identify the parties’ expectations about what will ultimately transfer.

This might include registered or unregistered trademarks, business names, domain names, websites, copyright material, software or other proprietary assets.

The document can also regulate access to intellectual property during due diligence. Permission to inspect or assess intellectual property should not be confused with ownership or permission to use those rights commercially.

Where brand assets form an important part of a transaction, obtaining trademark and intellectual property advice can help identify what rights exist and how they should be addressed in the sale documentation.

Business Premises and Lease Issues

If the business operates from leased premises, the lease can be an important part of the transaction.

The proposed sale may depend on the existing lease being assigned to the buyer or a new lease being entered into with the landlord.

A Heads of Agreement can identify this as a condition of the proposed transaction, but the requirements will depend on the existing lease and the circumstances of the sale.

Landlord consent, lease documentation and timing should be addressed early because a business acquisition may not be commercially workable if the buyer cannot secure the premises required to operate it.

Restraints and Seller Obligations

The parties may also discuss whether the seller will be subject to restraints following completion.

A purchaser acquiring the goodwill of a business may want protection against the seller immediately establishing or joining a competing business and taking customers with them.

Any proposed restraint should be considered in the context of the particular transaction, including its scope, geographical area and duration.

The Heads of Agreement may record the commercial understanding, with detailed restraint provisions addressed in the Business Sale Agreement.

Similarly, if the seller is expected to provide training, introductions or other handover assistance after completion, the parties can identify that expectation at the preliminary stage and address the details in the final contract.

Signing Risks

One of the biggest risks with a Heads of Agreement is assuming that signing it has no legal consequences because a more detailed contract will follow.

That may not be the case.

Even where the sale itself remains subject to a formal Business Sale Agreement, individual provisions relating to confidentiality, exclusivity or other preliminary obligations may already be binding.

Before signing, check:

• the correct legal names of the buyer and seller;
• ABN or ACN details where relevant;
• the proposed purchase price;
• what assets are included or excluded;
• whether stock is included in the price or dealt with separately;
• any due diligence condition;
• finance, lease or third-party approval conditions;
• which clauses are binding;
• any exclusivity obligations; and
• what remains subject to the formal sale contract.

An authorised person should sign on behalf of each entity where applicable.

Can a Buyer or Seller Walk Away After Signing?

That depends on what the document says.

If the commercial terms are expressly non-binding and subject to execution of a later agreement, a party may be able to discontinue negotiations without being required to complete the sale.

That does not necessarily release them from separately binding provisions. For example, confidentiality or exclusivity obligations may continue to apply.

Similarly, a properly drafted condition may give a party a right not to proceed if the required condition is not satisfied.

Because the consequences depend heavily on the document’s wording, legal advice should be obtained before assuming that a party is free to withdraw.

Heads of Agreement vs Business Sale Agreement

A Heads of Agreement and a Business Sale Agreement perform different roles.

The Heads of Agreement generally records the proposed commercial framework at an early stage.

The formal Business Sale Agreement then deals with the detailed legal terms of the transaction, which may include warranties, indemnities, employee arrangements, adjustments, completion requirements, restraints, risk allocation and other obligations.

A Heads of Agreement should therefore be viewed as part of the transaction process rather than a substitute for the formal contract.

Buying or Selling a Business?

Rise Legal assists Australian business owners with business sales and purchases, including preliminary transaction documents, due diligence, Business Sale Agreements, negotiations and related commercial matters.

We can review or prepare a Heads of Agreement, explain which provisions may be binding and help make sure the preliminary terms are consistent with the transaction you intend to enter into.

For defined legal work, Rise Legal offers fixed-fee proposals and upfront pricing so you know the scope and professional fee before work begins.

Contact Rise Legal if you are preparing to buy or sell a business and would like advice before signing a Heads of Agreement.

Frequently Asked Questions

Is a Heads of Agreement legally binding in Australia?

It can be. A Heads of Agreement may be binding, non-binding or partly binding depending on its wording, the parties’ intentions and the circumstances. The document should clearly identify which provisions are intended to have immediate legal effect.

Can confidentiality and exclusivity clauses be binding if the sale terms are not?

Yes. A document can state that the proposed sale remains subject to a formal contract while making specified provisions, such as confidentiality or exclusivity, legally binding.

Does a Heads of Agreement replace a Business Sale Agreement?

No. A Heads of Agreement normally records the principal commercial terms of the proposed transaction. The Business Sale Agreement contains the detailed contractual terms governing the sale.

Should due diligence be completed before signing a Heads of Agreement?

Not necessarily. A Heads of Agreement is often signed before detailed due diligence begins. It can make progression of the transaction subject to an agreed due diligence process. The precise wording of that condition is important.

Should I have a lawyer review a Heads of Agreement before signing?

Yes. Because some provisions may be legally binding before the formal sale contract is prepared, obtaining legal advice before signing can help clarify the document’s effect and identify terms that require further negotiation.

Disclaimer

This article provides general information only and does not constitute legal advice. It does not take into account your specific circumstances. Laws and regulatory requirements may change, so you should obtain legal advice relevant to your situation before acting on the information contained in this article. Liability limited by a scheme approved under professional standards legislation.