The next step after signing the confidentiality agreement is to obtain some information about the business, so you can decide if you would like to negotiate a sale price and the terms of the transaction.
The information provided at this stage would not be everything about the business but may be enough to consider whether you would like to proceed to the next stage.
If, after receiving some information about the business, you’ve negotiated and agreed to proceed, the next step is to enter into a memorandum of understanding (MOU], which is also known as a ‘Heads of Agreement’, ‘Letter of Intent’ or a ‘Term Sheet’.
What is the purpose of the MOU?
The purpose of the MOU is to record what has been agreed and assists in furthering the transaction. It’s a way that the parties show that they are committed to continuing the negotiations, before undertaking due diligence and prior to entering into a binding agreement.
From a physiological perspective, once the parties spend money on the transaction (such as legal fees to draft the MOU], they might consider that the deal is partly completed and be more committed to seeing the transaction through to the end.
The MOU sets out a summary of the main terms that the parties have agreed to, along with the indicative timetable. The items that would usually be included in a MOU are:
Parties: The parties to the agreement.
Background: A brief background to the transaction.
Purchase price: The proposed purchase price and the way the business is valued. The amount should be able to be changed if there are circumstances that would mitigate the price after undertaking due diligence. If this is stated upfront, the seller might not be surprised if there is further negotiation of the purchase price at the end of the due diligence period.
Deposit: The details of the deposit, including whether it will be refunded if the transaction does not proceed.
Conditions: If any items need resolving before the transaction completes (such as the release of encumbrances over the business) or matters that should be in place to proceed (like finance or approval by the landlord to enter into the lease). These items should be included as conditions.
Assets: The treatment of any assets that will be acquired.
Exclusivity periods: An exclusivity clause prevents the seller from negotiating with any other party in respect of the business for an agreed term which might be while the buyer is completing the due diligence. This will prevent any third parties being brought into the transaction to compete with the buyer, which would otherwise put pressure on the buyer during the negotiations.
Confidentiality provisions: A clause indicating that the MOU and all information disclosed under it, is confidential will assist in keeping the disclosed information confidential.
Governing law: The jurisdiction where the contract has been made or which governs the interpretation of the MOU, and where the court will be located should a dispute arise.
Expiry date: The MOU should include a proposed expiry date or details of any triggers which will result in the termination of the MOU.
The indicative timetable: An indicative timetable should provide for when the parties intend to enter into more formal agreements and complete the transaction. The timeline will help inform and prompt the parties to take action. It should include all the elements of the transaction along with the applicable indicative deadline for when the activity should be completed.
While timescales will vary, a sale and purchase of a business can take anywhere from one week to one year. If a party has never purchased or sold a business before, the timeline might be underestimated and could impact upon completion.
If the business is in distress or if either party has a reason to complete quickly (such as going on vacation or if it’s nearing the end of the financial year) there may be pressure to enter into and complete the transaction urgently. In this case, one party might be more willing to provide concessions to the purchase price or the terms. You will need to balance these concessions with how much time you’ll have to complete the transaction and if you are the buyer, whether this will impact on the due diligence.
Key items for the transaction documents: The MOU is only an outline of what the parties have agreed. Any key items for the transaction documents should also be included in the MOU.
Costs: There usually is a clause which provides which party will be obligated to pay the fee of drafting and settling the MOU. Generally, each party will pay their own costs, but sometimes, during negotiations, one party may indicate that they will pay the price of putting together the MOU.
Terms: Any other terms between the parties that are particular to the transaction should be included.
Is the MOU binding?
Other than the provisions relating to the deposit, exclusivity, confidentiality, governing law, the expiry date and costs, the terms are not set out in detail and may be subject to agreement and change as a result of what is discovered during due diligence investigations. As there isn’t enough certainty in the MOU the main terms are not binding. This means, although you might enter into a MOU, there is no obligation under the MOU to complete the transaction.
The terms of a MOU are only a summary of the agreement. The terms will be expanded into much more detail once the business has been investigated further and the draft of the sale agreement commences.
Key takeaways: MOU
- The purpose of the MOU is to record what has been agreed and assists in furthering the transaction. It shows commitment on both parties to proceed and helps provide the basis for the draft of formal documentation.
- The MOU should include the main terms of what has been agreed, but except for a few provisions, the MOU is not binding.
About the Author:
This extract has been taken from the book, ‘Entrepreneur Know How – Mindset and Winning Steps for Buying a Business,’ written by Sharon Robson (Available through Amazon). Sharon is also the principal lawyer, director and founder of the boutique law firm, Antler Legal – a corporate commercial legal practice in Sydney, Australia. She has played a key role in facilitating, advising and negotiating many business transactions on behalf of her clients. Sharon is also a speaker, marketer and business owner. She is passionate about mindset and empowering people through education.