Do I have to use the head of terms/memorandum of understanding/terms sheet when purchasing another business? Is it legally binding?

Heads of terms are different from a formal contract. This document sets out the preliminary terms of a commercial transaction agreed upon by the parties in the course of negotiations. It ensures both parties are on the same page as regards the major aspects of the transaction and prevents misunderstandings.

While you do not need to have a heads of terms document, it is advisable to have one when purchasing another business. This is because it may be more complex when dealing with an existing business operation, financials, culture and more.

It will also help to detail all the main issues of the deal in the beginning, which lessens the chances of miscommunication and disagreements when drafting the formal contract for the purchase.

Lastly, it will indicate your intention of buying another business. This will show that you are a serious buyer, which would be more attractive to potential sellers.

Is it legally binding?

No, heads of terms are not legally binding. While they show a strong intent to follow through with the agreement, it does not have any legally binding force.

When would I use a Heads of Terms Document when purchasing another business?

Heads of terms will be used during the negotiations to purchase another party’s business. It is usually used in the earlier stages before the two parties decide to be legally bound by a formal contract, and when they are serious about continuing the transaction. Thus, it will mainly be used to outline the proposed acquisition (purchase) terms agreed between the parties.

Here are some things to consider clarifying when drafting a Heads of Terms:

• The proposed acquisition and what you are planning to purchase
• The price of the purchase
• Conditions involved (e.g. the purchase price to be conditional upon employees retaining their positions)
• Timing of negotiations and timeline for the future
• Due diligence
• Costs
• Governing law and jurisdiction of the transaction

For more information on Heads of Terms and how it can help your business, you can read “What are Heads of Terms?”.  

Key Takeaways

• Heads of terms are not legally binding and is not a necessity if you are planning to purchase a business
• But, you should consider having one to mitigate any complexities and misunderstandings involved in the deal

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