Key Elements to Writing a Transition Service Agreement

A Transition Service Agreement (TSA) is an important piece of the merger and acquisition process. Setting up an effective TSA is a complex, time-consuming task that requires experience and structure. Below are some practical key elements to consider when writing a TSA, the intentions of a TSA, and what actions both sides need to take when setting one up.

Key elements of a TSA to consider

  1. TSAs are not intended to optimize operations nor drive separation activities for either party, they exist to provide operational and organizational continuity, which is typically achieved by contractually agreeing to current state processes and operations for a fixed monthly fee.
  2. Improperly constructed TSAs risk substantial negative customer, operational, vendor, and legal implications, any of which can equate to material financial impact for both sides.
  3. TSA development requires dedicated resources so they can build a deep understanding of the technical and operational dependencies across business functions, allowing them to assess implications and react to proposed changes in real-time.

For example, you do not want a fractional resource agreeing to something in an HR meeting when another fractional resource not in that meeting would be able to predict issues down the road with IT or Finance, and then have the wrong language appear in your contractually obligated TSA.

  1. Accurate expense structures are required to understand the cost basis and layered risk premium for the seller and to proactively educate the buyer, avoiding unnecessary financial disputes.
  2. Clear governance needs to be defined prior to closing to ensure all parties understand how to operate within the bounds of the agreed-upon terms, follow formal processes for transparency and consistency, and the rules of engagement for when disputes arise.

For example, it is likely that personnel from the seller are moving to the buyer as part of the carve-out, people who are accustomed to working together with a certain amount of flexibility and informality. Overnight they will be expected to formally document their interactions (change requests, timesheets, steering committee approvals, etc.) and this will be unnatural to many of them. Those existing relationships increase the risk that they may want to “help each other out” on an individual basis, opening either party to legal penalties if informal actions result in a breach of contract. It is critical to clearly outline and communicate relative roles and responsibilities during the transition period to protect both parties and have the governance in place to verify individuals are adhering to the rules set forth in the TSA.

  1. Lastly, it is in the buyer and seller’s best interests to accelerate the TSA exit and disentangle as soon as possible so each party can focus on their businesses independently.

Intentions of a TSA

It is common to lose sight of the intent of the TSA when writing the TSA. Remember that TSAs exist so there are clear guidelines for the eventual transfer of ownership of:

  • Employees – does the TSA account for and clearly define employee access and needs?
  • Assets – does the TSA clearly define the asset, the price to serve the asset, the data needed for the asset, etc.?
  • Services – similar to Asset
  • Contracts – similar to Asset

The buyer typically has more of a burden here than the seller, mostly because they need to understand how the carve-out entity will operate and stand up the systems to support operations after the transition period ends. The seller only needs to ensure that they can separate the carve-out entity without impacting the remaining operations. Thus, the seller’s preparation for the negotiation is going to be more focused on holding their ground on scope and fees.

Actions both parties should take when writing a TSA

Develop their respective future state operating models post-TSA

  • What people and processes will be in place for each of the business functions?
  • Is the buyer going to integrate the carve-out into its own existing systems, or use the same systems and processes that were in use during the TSA? If the latter, is the buyer standing up new separate environments, cloning them, or wholly inheriting them as-is?
  • Or, is the buyer intending to stand up new systems and processes that are different from their existing solutions and from the ones used during the TSA? If so, how will historical data be conveyed from seller to buyer?

Build out the functional work plans required to separate the carve-out from the seller

  • Buyers create project plans for implementing the technical aspects of the operating model.
  • Sellers need to understand exactly what people, applications, data, servers, processes, etc. will be used by the carve-out and how to facilitate the separation of those services.

Only after you carefully document and develop your future operating model as much as possible will you be in a place to write TSAs that support a clean separation into the new model. Waiting to do these critical activities until after the deal closes will only create more risk and delay as functional teams will be limited in their ability to make decisions by the now-in-place TSAs.

Create TSA language with the above in mind

This will ensure that exit criteria, dependencies, and co-terminus language can be properly included, reducing the risk of contention as the buyer requests to exit each individual TSA service:

  • Include clear definitions of software, infrastructure, functions, and personnel involved in the provision of TSA services.
  • Clarify, to the greatest extent possible, the “Pitcher” (seller) and “Catcher” (buyer) roles and responsibilities as part of governance and issue escalation.

How Liberty Advisor Group can help you with negotiating and writing your TSAs

Companies that are regularly involved in M&A transactions may have internal resources with the requisite skillsets and availability (see Guiding Principle #3 above) to write TSAs, but that is not the case for most, and that is where Liberty can help.

Why is it beneficial for an outsider to negotiate TSAs on your behalf?

  • Internal operational resources will often struggle to remain unbiased relative to other functional areas and the carve-out entity, whereas independent arbiters can operate cross-functionally without the influence of existing political complications.
  • Deal management is time-consuming and a distraction from operational responsibilities, further complicating the challenge of assigning TSA negotiation to internal resources.
  • Lastly, an outside resource will help keep buyers and sellers abstracted from negotiations, which can be contentious at times, allowing both parties to maintain more positive relationships going into the TSA period.
    • Buyer – wants to maintain good relations with the organization that is supporting their critical business operations for the foreseeable future
    • Seller – wants to have someone else to deliver difficult news to the buyer such as explaining why a specific service fee is more expensive than anticipated, or that no special cases will be accommodated that aren’t enumerated in the TSA

If you are considering a transaction that requires TSAs and want an objective, independent opinion, don’t hesitate to reach out to us. We pride ourselves on providing candid advice to our clients, and if we’re not a fit for you we’ll help you find someone who is.

Check out our blog post that outlines the tension and potential conflict inherent to any scenario involving Transition Service Agreements (TSAs), as well as a framework to understand the motivations of the parties on both sides of the negotiating table.

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