Mergers and Acquisitions: Heads of Terms

The third in our series on the practical aspects of running a successful mergers and acquisitions transaction, this article looks to highlight the key elements of a Heads of Terms. Please see our news section here for other publications in the series.

  1. What is a Heads of Terms?

When entered into, in the context of a share sale and purchase, a Heads of Terms (which can also be referred to as a Letter of Intent, Memoranda of Understanding or Term Sheet), is entered into relatively early in the transaction for the purpose of the parties recording:

a) The main terms of a preliminary non-binding understanding, intended to lead to a binding contract or series of contracts for an entire project or transaction.

b) An agreement to set out the key terms of a transaction, which contains some binding terms and some non-binding.

c) The terms of a preliminary binding agreement, again intended to deal with certain preliminary matters prior to the signing of a contract to cover the whole project or transaction.

2. Is it legally binding or not?

Above we mention the fact that a Heads of Terms can be non-binding, partly binding or entirely binding with additional terms. The answer to the question therefore invariably depends on what the parties have agreed to at the outset but in the majority of cases we would find that a heads of terms contains only some provisions which are agreed to be binding by both parties. That brings us to the next question.

  1. What provisions are covered in a Heads of Terms?

A standard heads of terms will generally contain provisions including but not limited to:

a) Commercial Terms

This will set out the overall agreement between the parties. For example Investaco Limited intends to acquire 50% of SellCo Limited for a price of €10m subject to completion of financial, legal and commercial due diligence.

b) Time Limits

A deadline for completion of the transaction and execution of a binding Share Sale and Purchase Agreement would generally be included, as well as confirmation of the timelines relating to completion of due diligence.

c) Pre-Conditions

It might be necessary to set out any pre-conditions to completion such as the approval of the Competition and Consumer Protection Commission, consent of existing customers or secured creditors, or even the conclusion of a commercial agreement by the target company with a new customer without which the deal may not be commercially viable for the purchasing company.

d) Confidentiality

Where a separate Non-Disclosure or Confidentiality Agreement has not been entered into then it is usual for the Heads of Terms to contain a binding confidentiality clause with mutual restrictions on both parties, as in most cases confidential information is likely to be exchanged by both parties.

e) Exclusivity

This is usually a binding provision in the Heads of Terms as the Purchaser will want to ensure that the seller is not at the same time using their bid to attract another buyer at a higher price, potentially wasting the buyers time and resources.  The exclusivity clause would generally be limited to a specified time period so as to ensure the buyer has an incentive to complete their due diligence in as an efficient manner as possible.

f) Transaction Advisor Details

Details of the advisors appointed by each party including financial and legal.

g) Costs

A provision setting out that each party will be liable for its own costs, or where the parties agree that one party would be responsible for the costs of a portion of or all of the other parties costs in particular circumstances.

h) Jurisdiction and Governing Law

This is not an exhaustive list and every heads of terms will be different in its form and content.

Conclusion

This is a just a flavour of the content of a Heads of Terms which can be as simple or as complex as the parties require. As stated above it is generally the pre-cursor to a more complex and biding agreement to follow with care required to ensure that the parties don’t commit to a binding agreement where this was not intended.

In the next article, we will look at the advantages of using heads of terms.

If you would like more information on this topic or any other of the topics in our series on Mergers and Acquisitions, contact:

Mergers and Acquisitions: Pre-Transaction Steps

This article is the second in a series of publications by J.W. O’Donovan’s Corporate Team on the practical aspects of running a successful mergers and acquisitions transaction. To read the first, click here. 

Most people would assume that the starting point for the sale or purchase of a company is the agreement by the seller and buyer of a heads of terms for the transaction. However, there are a number of matters that should be considered at an early stage, even prior to any specific transaction being identified. These include:

  1. Review of Corporate Structure

A business owner who anticipates a sale of its business in the near to medium term should review its corporate structure to identify the target entity. It may be appropriate for any aspects of the business that would not form part of the sale to be ‘hived-off’ into other structures. Many long-established businesses have complicated group structures due to previous events such as management buy-outs. It may be advisable to simplify these by striking off or winding up dormant companies or merging subsidiaries with their holding companies.

  1. Tax Planning Considerations

It is critical that a business owner considers the potential tax arising on a sale of the business long before any sale is likely to occur. There are reliefs available but the criteria can be quite technical and specific advices should be obtained to ensure that such reliefs are availed of, to the maximum extent possible. An example might be where the owner’s spouse works in the business – if he or she is appointed as a director they may qualify for entrepreneurial relief or retirement relief on a sale of shares; such shares can be transferred between a husband and wife without any tax arising.

Aside from the personal reliefs that may be available on a sale of a business, many business owners are now choosing to hold a portion of their shares through a personal holding company as that holding company would be able to avail of an exemption from capital gain tax on a sale of such shares.

In order to qualify for some of the available reliefs, it may be necessary for the relevant structure to have been in place for a number of years prior to a sale. It may also be necessary to move any non-trading assets outside of the group (a ‘hive-off’ as described above).

  1. Vendor Due Diligence

One of the first steps that a buyer will take in a transaction will be to commence a due diligence exercise to examine the financial, operational and legal aspects of the target business. Significant issues identified in due diligence can result in indemnities being sought from the seller or a renegotiation of the commercial terms of the transaction. As a result, it can be advisable for a business owner who anticipates a sale to carry out its own ‘vendor due diligence’ exercise so that any issues in the business can be identified and remedied prior to a transaction commencing.

This exercise would cover matters such as:

  • review of internal financial reporting. If adequate management accounts and other financial records are not available it can make it difficult to justify a valuation when negotiating with a buyer,
  • review of commercial agreements to identify gaps in documentation, expired contracts in need of renewal and change of control clauses allowing the other party to terminate in the event of a sale of the business,
  • review of internal processes such as health and safety and data protection compliance,
  • review of employee contracts and policies to ensure all employees have been issued with a contract or memorandum of terms of employment and that each employee has received their legal and contractual entitlements.

Even if an anticipated sale does not materialise, the business will be on a better footing as a result of carrying out this internal review.

  1. Finance & Target Identification

On the buyer side, before engaging with a seller it is advisable to ensure that the necessary finance to carry out an acquisition is available. In recent years, a number of alternative lenders have entered the Irish market and have provided the finance for acquisitions. However, their requirements can be different from those of the pillar banks and it makes sense to engage with all potential lenders at an early stage in order to establish if they will be a good fit.

A buyer may also want to spend some time identifying potential targets in the relevant market and assessing their suitability for acquisition. Gaining a detailed understanding of the benefits that would result from a proposed acquisition in terms of potential synergies and efficiencies and growth in market share can be very important in ensuring a transaction is approved internally and in obtaining sanction from external lenders, where applicable.

  1. Identifying advisors

Both the seller and buyer will need to select advisors with the appropriate expertise to ensure their interests are represented and the transaction runs as smoothly as possible. For the seller in particular, firms that previously provided legal and financial services to the business may not have experience in large transactions and it may be necessary to appoint new advisors for the purpose of carrying out the transaction. In such event, it is important to ensure that the existing advisors work closely with those taking the lead on the transaction to pass on their relevant knowledge regarding the business.

Most large accountancy firms will have in-house tax advisory services but, in some instances, a separate tax advisor may be required. Furthermore, in some instances, minority shareholders may choose to take independent legal or tax advice.

In our next article in the series, we will cover the preparation of the heads of terms for a transaction.

For more information, contact:

 

Introduction to Mergers and Acquisitions

Despite a business environment held hostage to the Brexit threat for the last three years, J.W. O’Donovan has seen continued growth and activity in the sale and purchase of Irish private companies. There has been particular activity around inward investment by foreign-based multinational companies either looking for an established business in Ireland or looking to further build on existing footholds they might have in the State.

We are often approached by clients and potential clients looking for guidance and advices on a potential sale or purchase of a company. For many, it is their first time involved in such a process. It can be a very daunting and, for some, overwhelming introduction to what has become a relatively forensic legal and financial process.

With that in mind, the Corporate team at J.W. O’Donovan will, through a series of upcoming dedicated articles, share some of the ins and outs of a typical share sale and purchase in relation to an Irish private company. In the first of the series, we look at the basic components of transactions of this type.

What is involved in a a private company sale or purchase? 

In terms of setting out what is involved in a private company sale or purchase in Ireland, a transaction can generally be broken down into its essential elements as follows:

  1. The Target company(s)

This is the company or indeed group of companies that are referenced generally as the “Target” entity, although it is actually the shares in the company that are being acquired.

2. The parties involved comprising the Seller(s) being the shareholder(s) in the Target company and the Buyer

The Seller can be an individual or holding company of the Target. Quite often, it will be a holding company for tax planning purposes, which enables an ultimate beneficiary to maximise reliefs available between grouped companies. We will touch on this again in later articles.

3. Pre-Heads of Terms discussions and negotiations

This stage includes a high level business review to evaluate price offering for the shares.

4. The Heads of Terms

The Heads of Terms is a document setting out the commercial terms reached between the parties.

5. Financial Due Diligence

At this stage, the buyer’s financial advisors will do a thorough analysis of the financial wellbeing of the Target company.

6. Legal Due Diligence

The buyer’s legal team will also do a complete review of key areas of the Target company including corporate structures, commercial agreements and HR records and policies.

7. Negotiation and transactional documentation

The primary documents including Share Purchase Agreement, Deed of Tax Covenant and Disclosure Letter are drawn up.

8. Approvals of Regulatory Authorities

Approval is sought from Regulatory Authorities such as the Competition and Consumer Protection Commission, where required.

9. Completion and transfer of funds

Once the transaction documentation is signed and funds are transferred to the sellers, the transaction is complete.

10. Post-completion integration

After the transaction completes, the two companies are then integrated on an operational level.

These are the components in their basic form but a transaction may have a number of ancillary or additional components. These may include pre-transaction corporate restructures such as the establishment of special purpose vehicles or the transfer of assets out of Target company to a special purpose vehicle or existing connected company.

No two transactions are the same. There are too many variables involved that dictate the manner in which a transaction proceeds. One fundamental difference between transactions and the parties involved is the contrast between the buyer’s objective and the seller’s objective.

A buyer is likely to be motivated by expansion plans with the target company being seen as a good bolt-on to an already established business in the same sector. A seller’s objective can sometimes be broader. For example, it may be the realisation of an investment, or a decision to move out of a particular market. Whatever the reason, from the outset of the process, both parties need to be clear on their objectives – what do they want to achieve, for how much and by when?

In our next article, we will go into more detail on the Pre-Transaction steps to be considered before engaging in the Sale/Purchase process.

If you would like more information on this topic, contact John Sheehan, Partner at jsheehan@jwod.ie or 021 7300200.