Heads of terms for a business purchase: what to include and why lenders need them

Heads of terms for a business purchase are a short written summary of the main commercial points a buyer and seller have agreed in principle: the price, how it will be paid, the structure of the deal, the conditions and the timetable. They are mostly not legally binding, but they set the framework that the lawyers, accountants and lenders work from. In the United States, and in many international deals, the same document is called a letter of intent (LOI); in the UK you may also see "heads of agreement", "term sheet" or "memorandum of understanding". This guide is for buyers of UK businesses, and for sellers, who want to understand what to put in heads of terms and why funders care about them. Smart Funding Solutions is a broker, not a lender, and we arrange purchase funding from around £10,000 to £500,000+, with larger facilities available in suitable cases, as part of our acquisition finance work.

01What heads of terms do in a business purchase

Heads of terms turn a verbal agreement into a written one before either side spends serious money on lawyers and due diligence. They confirm that the buyer and seller really do agree on the essentials, and they give each adviser a clear brief.

Without them, it is common to discover halfway through drafting the sale agreement that the seller assumed a cash payment at completion while the buyer assumed a third of the price would be deferred, or that the seller expected to keep the company car and the property. Settling those points in a two or three page document, in plain English, is far cheaper than settling them through solicitors' letters.

Heads of terms also mark the point at which a deal becomes fundable. Most acquisition lenders will give only general guidance until they can see agreed terms, because the price, structure and seller involvement determine how much they can lend and on what basis.

02Heads of terms or letter of intent: is there a difference?

In practice there is little difference: both describe a preliminary, largely non-binding summary of agreed deal terms. "Heads of terms" is the usual UK phrase, while "letter of intent" is common in US-style and cross-border transactions, where it is sometimes written as a letter from buyer to seller that the seller countersigns. What matters is the content and which clauses are stated to be binding, not the title. If an overseas buyer or adviser sends you an LOI, read it as you would UK heads of terms, and check in particular whether it includes binding exclusivity, break fees or cost-cover provisions that are less common in smaller UK deals.

03Are heads of terms legally binding?

Heads of terms are normally expressed to be "subject to contract" and are not legally binding on the main commercial points, so either party can still walk away before contracts are signed. A few specific clauses, however, are usually made binding on purpose.

• Exclusivity (or "lock-out"). The seller agrees not to negotiate with other buyers for a set period, giving the buyer time to complete due diligence and arrange finance.
• Confidentiality. Both sides agree to keep the deal and the information shared private. A separate non-disclosure agreement may already be in place.
• Costs. Each party usually bears its own costs, though sometimes a party who withdraws without good reason agrees to cover the other's costs.
• Governing law. Usually the law of England and Wales, or Scots law for Scottish deals.

The document should state clearly which clauses are binding and which are not. Ambiguity here can lead to disputes, so it is worth having a solicitor review the draft even though it is short.

04What to include in heads of terms: a checklist

Good heads of terms cover every point that would be expensive to argue about later. The table below sets out what buyers and sellers typically include, and why each matters to a lender.

Item	What to agree	Why lenders care
Parties and target	Who is buying (often a new holding company), who is selling, and exactly what is being bought	Identifies the borrower and the business generating the cash flow
Structure	Share purchase or purchase of trade and assets	Affects what security is available and which liabilities come with the business
Price	The headline price and whether it is on a cash-free, debt-free basis	Sets the amount to be funded and the leverage
Price mechanism	Locked box or completion accounts, and any normal working capital level	Determines how much cash the business will have on day one
Payment terms	Cash at completion, deferred consideration, earn-out, vendor loan	Deferred elements reduce the funding needed and show seller confidence
Conditions	Satisfactory due diligence, finance, landlord or regulatory consents, key contracts	Shows the buyer is protected if funding or diligence fails
Seller handover	How long the seller stays, in what role and on what pay	Reduces the risk of losing relationships and know-how
Restrictive covenants	Non-compete and non-solicitation by the seller, and for how long	Protects the goodwill being paid for
Warranties and indemnities	The general approach, any specific indemnities, and limits on claims	Gives recourse if undisclosed problems appear
Employees and property	Key staff, pension arrangements, leases or the purchase of premises	Affects costs, continuity and any property security
Exclusivity and timetable	The lock-out period and target dates for diligence, contracts and completion	Lenders plan credit approval and legal work around it

The document should state clearly which clauses are binding and which are not.

05How deal structure in the heads of terms affects funding

The choices made in the heads of terms determine how much a buyer needs to borrow, which lenders are interested and what security they can take. Agreeing them with funding in mind avoids renegotiating later.

Share purchase or asset purchase

In a share purchase the buyer acquires the company with its history, contracts, staff and liabilities. In an asset purchase the buyer acquires the trade, goodwill and chosen assets, leaving the company and its liabilities with the seller. Employees in an asset purchase usually transfer under the TUPE rules. Lenders can fund either, but the security package and the working capital position differ.

How much is paid at completion

The proportion of the price paid in cash at completion is the figure lenders focus on, because it is what must be funded on day one from the buyer's contribution and borrowing. Our guide to the deposit needed to buy a business explains what buyers usually contribute themselves.

Deferred consideration and earn-outs

Payments to the seller after completion reduce the day-one funding requirement and keep the seller committed. Lenders usually require them to rank behind their debt and to be payable only if the business can afford them. Our guide to deferred consideration explains staged payments and earn-outs, and our guide to vendor finance covers seller loans.

The finance condition

A clause making the deal conditional on the buyer obtaining satisfactory finance protects the buyer if funding falls through. Sellers sometimes resist it, which is one reason to engage lenders early so the condition can be satisfied quickly.

£137,500A transaction we arranged£137.5K to fund an accountancy practice acquisition.An established firm had an acquisition agreed. We structured the funding around the transaction and got it completed.

06Heads of terms and the lender's decision

For a lender, agreed heads of terms are the starting point of a credit application: they show what is being bought, at what price and on what terms, and they set the timetable the lender must work to.

Our accountancy practice acquisition case study is a good example. An accountancy firm buying another practice obtained a £137,500 acquisition facility, presented to lenders on the basis of agreed heads of terms. That allowed the lender to assess the actual deal rather than a hypothetical one.

Lenders will usually ask for the heads of terms alongside the target's accounts, the buyer's own financial information and a forecast for the combined business. Our guide comparing business acquisition lenders explains how different funders approach the same deal.

07Common mistakes in heads of terms

Most problems with heads of terms come from leaving important points vague or agreeing terms that funding cannot support.

• Agreeing a price before testing affordability. Check that the business can service the debt and any deferred payments before committing to a figure. Our guide on how to value a business covers the usual methods.
• A vague earn-out. If the measure, the period and the accounting basis are not clear, disputes are likely, and lenders may struggle to assess the obligation.
• An exclusivity period that is too short. Diligence, finance and legal work take time. A lock-out that expires before funding is approved leaves the buyer exposed.
• Ignoring working capital. On a cash-free, debt-free deal, the business may have little cash on day one. Agree a sensible normal working capital level.
• No finance condition. Without one, a buyer may find themselves committed to a deal they cannot fund if the contract is signed before funding is confirmed.
• Overlooking consents. Landlord consent to assign a lease, change-of-control clauses in key contracts, and any regulatory approvals can all delay completion.

08What happens after heads of terms are signed

Once heads of terms are signed, the deal moves into due diligence, finance approval and legal drafting, usually running in parallel during the exclusivity period.

1. Due diligence. Financial, legal, tax and commercial checks on the target. See our guide to business acquisition due diligence.
2. Finance application. The lender assesses the deal, may commission its own checks or valuations, and issues an offer subject to conditions.
3. Legal documents. The buyer's solicitor drafts the share or asset purchase agreement; the seller's solicitor prepares a disclosure letter setting out exceptions to the warranties.
4. Negotiation. Points uncovered in diligence may lead to price adjustments, specific indemnities or more of the price being deferred.
5. Completion. Contracts are signed, funds are released, existing charges are cleared and ownership passes.

For the full process from finding a target to completion, read our step-by-step guide on how to buy a business.

09How Smart Funding Solutions can help