Understanding contracts when buying or selling a business

When buyer and seller are satisfied with their initial checks, and an initial offer has been made and accepted, the next step is to negotiate the firm purchase offer, which is called a Heads of Terms Agreement, or Heads of Agreement. This document sets out the main points of the sale and is not usually legally binding - except for issues of exclusivity and confidentiality.

What should the purchase offer include?

The Heads of Agreement should cover:

• what is included in the sale
• the price and payment structure
• the terms of the period of exclusivity to complete the sale, including that period's termination (usually the buyer offers a small deposit in return for the seller taking the company off the market)
• preconditions for the sale (eg minimum level of profits or orders within a certain time)

Parts of the agreement are legally binding and set out in separate documents:

• exclusivity
• confidentiality
• warranties
• indemnities

Other legally-binding agreements include the seller's disclosure letter limiting his liabilities under the warranties, and any agreements from the seller and buyer to pay each other's costs in certain circumstances if the sale falls through.

All these documents need to be carefully prepared and thoroughly checked. If the seller does not meet the preconditions, the sale will probably not go ahead. If warranties are breached, the buyer can sue for damages. It is a criminal offence for the seller to give false or misleading information about shares.

Due diligence

Once the Heads of Agreement is signed, the buyer's advisers carry out thorough searches into the business records, called detailed due diligence. There are three types of due diligence:

• legal - for example, checking that the business has legal title to the assets which it is selling/transferring
• financial - checking that everything is in order financially
• commercial - assessing the business' position in the market place

See make sure a business is worth buying: due diligence.

During this period, negotiations continue with the seller on drafting the final sale agreement, or sale purchase contract.