VLP Legal Press #11
Choosing the Right Agreements/Contracts
Deals Don’t Start with Contracts - They Start with Conversations
When businesses or individuals come together to explore a deal, partnership, or investment, the process usually doesn’t jump straight into a final, binding contract. Instead, it moves through stages, with different types of documents marking the progress of negotiations (or conversations!).
Parties often ask: should we sign an MOU? Is a Letter of Intent sufficient? What exactly is HOT? The truth is, there’s no universal rule. So long as the signed document fulfill the legal elements of forming a contract (intention, capacity and subject matter), the choice on what documents to prepare depends on the nature of the deal, the jurisdiction, and how far along the parties are in their negotiations.
Let’s explore what these documents are and the purpose each one serves.
🤝 1. Memorandum of Understanding (MOU)
MOU records a broad understanding or intentions between parties to jointly participate in a deal/transaction or collaborate.
Purpose: Sets the stage by clarifying intentions and showing good faith.
When it’s used: At the very beginning of discussions, before formal negotiations start.
Binding? Usually non-binding, but may include binding clauses (such as confidentiality, exclusivity in negotiation).
Example: Two start-ups signing an MOU to explore the possibilities of developing a program together - no binding obligations yet, just an understanding that they want to collaborate.
✉️ 2. Letter of Intent (LOI)
A LOI is a short document that states the parties’ intention to move forward with a specific deal.
Purpose: Expresses serious intent to negotiate and pursue a deal, often with some commercial terms of the deal. Also provides a period for the relevant parties to conduct the relevant due diligence.
When it’s used: After initial discussions, once both sides are serious.
Binding? Usually non-binding, but may include binding clauses (such as confidentiality, exclusivity in negotiation and payment of deposit (for purchase deal)).
Example: A company issuing an LOI of its intention to acquire a startup. The LOI shows seriousness but isn’t yet the final purchase contract.
📑 3. Term Sheet / Heads of Terms (HOT)
A Term Sheet / HOT is where the numbers and key commercial details come in. It lays out the essential terms of the deal agreed by the parties in principle.
Purpose: Ensures both sides agree on the main points - like price, payment, and responsibilities - before diving into legal drafting. Usually includes a time period where parties are to negotiate exclusively and sign the definitive agreements (see point 4 below) within such period.
When it’s used: Midway through negotiations, once the framework of the deal is clear.
Binding? Usually non-binding, but may include binding clauses (such as confidentiality, exclusivity in negotiation and payment of deposit (for purchase deal)).
Example: Investors often present startups with a term sheet outlining how much money they’ll invest, the equity percentage, and the rights they’ll have.
🖊️ 4. Definitive Agreement / Transaction Document / Binding Contract
A definitive agreement is the finish line - the final, legally binding contract that governs the transaction.
Purpose: Creates enforceable rights and obligations.
When it’s used: At the end of negotiations, after all terms are settled and reviewed.
Binding? Fully binding and enforceable. This is the document you can take to court/arbitration if needed.
Example: When an investor decided to invest in a startup, the Share Purchase/Subscription Agreement, Shareholders’ Agreement and/or Investment Agreement are the definitive agreements that seals the deal.
Bringing It All Together
These documents aren’t rivals - they’re steps in a journey. While it’s not always necessary to go through every stage (parties can jump straight into a definitive agreement if they wish), understanding the purpose of each step helps guide the process.
This is for general reference only and does not constitute legal advice. For further guidance, contact us at: