A heads of terms needs a number. But a good heads of terms will explain how the parties arrived at that number, and be clear that the number is the value for the equity. And the price is a moving target.
The price will always fluctuate between signing the heads of terms and closing the deal – sometimes by quite a lot – and explaining how the parties at the figure(s) in the heads of terms will be useful for framing discussions later on about how it may or probably will need to be adjusted.
Much has been written on how to value companies and businesses, and law firms are not qualified to do the valuing.
Where a good corporate finance broker will provide value is in advising on what metric to use for valuing the Target equity. It could be a multiple of EBITDA, net asset values, annual recurring revenues (used ubiquitously for software companies), or something else.
If, for example, the heads of terms state that the proposed value is arrived at by multiplying the average of the last two financial years’ EBITDA by 10, and it turns out – following financial due diligence – that EBITDA was in fact 25% lower than was assumed in the heads of terms, then the sellers may not be surprised when the buyer floats the idea of the purchase price being 25% lower.
Some of the same principles may also apply if the present net asset value was chosen as the metric for valuation, or annual recurring revenues, or almost anything else.
A good heads of terms will have said how value is being calculated and the parties should not be then apart on how the Target is being valued, even if the value referred to in the heads of terms needs to change in the long form documents.