Mastering Transition Service Agreements

Michael Klawon

06.March 2024

~ mins. reading time

Divestiture transactions present inherent risks for both buyers and sellers. One of the challenges during a divestiture is ensuring that critical and essential services such as technology, finance, accounting, payroll, and other infrastructure support continue to be provided after the sale.

TSAs play a critical role in ensuring the seamless continuation of critical business services after a sale. These arrangements are particularly common when the buyer lacks the skills or capacity to absorb the acquisition independently, but the seller can provide the necessary expertise. Such situations often arise when a larger company sells a business unit to a buyer with less infrastructure or insufficient time to build the necessary capabilities.

The Need for Transition Service Agreements

The Importance of TSAs: TSAs are essential to protecting deal value. Without them, the value of the assets and the deal itself could rapidly decline.

TSAs have become a standard legal tool, providing a structured framework for managing the ambiguous period between deal closing and business separation.

Definition: A TSA is a contractual service arrangement between buyer and seller companies where one company continues to provide services to ensure business continuity. Typically, a forward TSA (services from the seller to the buyer) and a reverse TSA (services from the buyer to the seller) are distinguished.

Based on our experience at smartmerger.com, where we have worked on hundreds of deals, this article provides essential guidance to help you master TSAs in your next deal.

If you would like to discuss or explore state-of-the art due diligence tools for your M&A process, feel free to reach out.

Success factors for drafting TSAs

According to Mercer research, 49% of buyers say that sellers do not agree to provide them with post-closing services. This means that sellers often view TSAs as a burden. Why is this the case? TSAs tend to be more beneficial to the buy-side because they can strengthen their position. This is less often the case for the sell side. As a result, challenges and issues can arise at any time during the transition process. Here are the key success factors to mitigate these issues:

Clear scope of services

Ensure a comprehensive definition of services by breaking them down into smaller packages or activities to create an accurate and complete understanding of the services included in the TSA. This is critical to scoping TSA costs.

Timing and Transition Exit

A TSA is time-bound and requires a defined plan for the organization to exit the existing services and transition to another model. The timing of the transition has a significant impact on costs and the business case. An exit strategy should be prepared in a timely manner, especially for staff training, system/tool adaptation, or handover to an outsourcing provider.

Transparent and clear pricing mechanisms

Services have a price, and those prices need to be transparent and clear to all parties involved. We recommend that as much detail as possible be reapplied to avoid conflict between parties during the transition process. Services can be priced differently according to different pricing mechanisms, each of which has advantages and disadvantages. Key Pricing Considerations:

Market prices: One way to set prices for TSAs is to consider and ultimately apply market prices. Example: You want to provide IT services to the company as part of a divestiture. To determine a reasonable price, you can research reasonable market prices for outsourcing providers of IT services and apply them to your TSA.
Cost-plus pricing: Cost-plus pricing includes the actual cost of services incurred by the seller plus a percentage markup based on your contract terms, assumptions, and future plans.
Cost escalation: Cost escalation involves increasing the price of services provided over the life of the TSA. A cost escalation may be used to limit the duration of the TSA to a specific time period, as prices increase over time and the TSA becomes less attractive to the buy-side.

Non-performance resolution mechanism in place:

Implementing a comprehensive dispute resolution system is critical. Consideration may be given to incorporating explicit liquidated damages and recovery mechanisms against an escrow, as standard indemnities may not provide adequate motivation.

Have and maintain a business case:

Since the provision of services is billed according to the agreement, the cost of TSAs will also affect the overall business case and ROI of the transaction. Ensure that the cost of providing TSAs for an extended period is within your planned business case.

The TSA Playbook and what to consider

A well-prepared TSA is a valuable tool that contributes to a faster closing, a good transaction price, efficient services, reduced costs and smoother transitions. Sellers who provide a commercially reasonable and attractive TSA make their assets more attractive to potential buyers, ease the transition, and provide access to resources.

The TSA provides a clear roadmap for the transition, minimizes misunderstandings and contributes to a clean separation, limiting liabilities for the buyer and protecting the seller's reputation. Here are the key activities to consider when negotiating and establishing a TSA.

Service baselining: Define the scope of services necessary to ensure business continuity from day one. This can be accomplished through a baseline assessment, ideally using a purpose-built baselining tool, such as the one available at smartmerger.com. For each service, it is advisable to evaluate the number of people currently assigned, their full-loaded labor costs, and any associated tools and expenses. In addition, document the list of employees associated with each service.
Tip: Use smartmerger.com's Excel-like baseline application. The Baselining application is designed to collect data in multiple scenarios. You can easily create data request spreadsheets with customizable headers and an unlimited number of input rows for the other party to complete. With almost no training, you get an Excel-like user experience plus features you missed in Excel, such as real-time collaboration, version control, workflows, permissions and markups, and dashboards to track progress.

Service Parties: Define who is the service provider and who is the service recipient, consider third parties that may be involved in the delivery of the services and any implications.
Prioritize structured data over VDRs: In the context of a TSA, prioritizing structured data over the use of virtual data rooms can significantly improve the efficiency and accuracy of the transaction. Because structured data is highly organized and easily retrievable, it streamlines the integration and transition processes and ensures that critical information is readily accessible and usable. An emphasis on structured data supports advanced analytics and reporting, enabling parties to derive actionable insights and make informed decisions. This approach facilitates smoother knowledge transfer, improves data accuracy, and enables efficient data sharing-essential for the analytics and reporting that underpin successful TSAs. By leveraging structured data, stakeholders can ensure more accurate assessment, effective monitoring, and comprehensive management of transition activities, making the entire process more transparent and accountable.
Costs and Pricing: Based on service baselining, you will want to assign certain costs to the service that will be provided during the transition period. For various cost considerations related to TSAs, see section two of this article.
Service Level: Define the level of service required for the TSA. It is important to define all quantities, response times and KPIs that are relevant to providing the services in a manner that is appropriate to the business. Consider whether these service levels should be auditable to ensure certain quality levels and performance standards.
Regulatory and Compliance: Review any potential regulatory and compliance issues that may arise from providing services to the entity in scope.
Align with IT partners: Today, every process runs on one or more systems or tools. Ensure you have full visibility into whether and how to continue to use certain systems or tools that may be required, and how to manage usage, cost and interoperability.
Establish governance: Define who is responsible for what during the transition, and set up proper communication plans to ensure that there is clear ownership and that everyone is aware of the necessary issues.
Security: As part of a TSA, establishing a robust permissions system is critical to protecting sensitive data and maintaining business continuity. This system should clearly delineate access levels for different stakeholders and ensure that only authorized personnel can access or modify specific data sets. By implementing strong permission controls, organizations can prevent unauthorized access and data leakage, which is critical to maintaining trust and integrity throughout the transition process. A well-defined permissions system not only protects the confidentiality of the data being transitioned, but also supports regulatory compliance, thereby minimizing the potential legal and financial risks associated with data breaches. Integrating this system into the TSA framework strengthens data security and facilitates a controlled and transparent transition environment.
Tracking and Monitoring: To improve the effectiveness and oversight of Transition Service Agreements (TSAs), it is critical to implement a comprehensive tracking and monitoring system. This system should meticulously record all key milestones and due dates and ensure that they are consistent with contractual obligations. Because TSAs often involve multiple service providers, it is essential to establish a centralized mechanism that can aggregate and monitor all relevant activities and timelines. Such a system, such as the one available on the smartmerger.com platform, would facilitate clear communication, timely updates, and coordinated efforts among all parties involved, minimizing the risk of misunderstandings or delays. In addition, this approach allows for proactive problem resolution and supports the dynamic adjustment of plans to accommodate unforeseen changes, ensuring that the transition process remains on track and aligned with strategic objectives.
Timing & Exit: Estimate and establish the time required for a buyer to properly complete the transition, including the time that TSAs will be required. Define how to transition from TSAs to other arrangements and it is also useful to define options for extending the duration of TSAs.

Conclusion

In summary, mastering TSAs is essential to successfully navigating divestiture transactions. TSAs play a critical role in ensuring the uninterrupted continuation of essential business services post-sale, thereby protecting the overall value of the transaction.

Successful TSAs require a clear definition of the scope of services, strategic timing and transition planning, transparent pricing mechanisms, and robust resolution mechanisms in the event of non-performance.

Implementing a comprehensive TSA playbook involves careful service baselining, consideration of service parties, addressing costs, pricing, service levels, regulatory compliance, IT alignment, governance, timing, exit planning, and data protection. By leveraging a platform like smartmerger.com that emphasizes the use of structured data, organizations can ensure a more streamlined, efficient, and accurate TSA process. This approach not only facilitates better data management and analysis, but also improves collaboration and transparency across all transition activities, making smartmerger.com an ideal partner for a successful and seamless transition.

To discuss or explore best practices with your M&A team, please contact me at mklawon@smartmerger.com