For years, companies have been increasing profits by outsourcing and engaging third parties to provide business process and information technology services. As well, business units and subsidiaries within companies increasingly integrate systems, share databases and centralize functions to create efficiencies. All of this means that in an M&A deal, it’s important to consider how to address outsourced and shared services before and after the deal closes.
When a business is acquired, many deals will include a transition services agreement (a TSA) to ensure an acquired business can effectively operate during the period between closing and complete separation, and post-closing.
TSAs usually involve the buyer paying the seller to provide services beginning on closing and continuing for some period of time. TSAs aren’t new, but it’s worth considering a few key issues before pulling your precedent off the shelf. We surveyed some leading M&A lawyers in our Toronto office and identified some of the crucial issues for buyers to consider when negotiating TSAs. These are the results.
1. Preparation
Where the services being transitioned are provided to the seller by a third party, a seller may be restricted from providing transition services. To perform services under a TSA, a seller may be required to obtain consents or additional licenses and, in some cases, may need to negotiate new, or renegotiate existing, service agreements. This preparation can come at a significant cost – especially considering that the third party service provider may have significant negotiating leverage. A buyer will want to ensure the seller has, and pays for, the right to provide the transition services. Obtaining a third party IP indemnity in the TSA is crucial for a buyer to protect it in the event the seller is in breach of its up-stream agreements.
2. Flexibility
It’s important at the outset, and indeed at the diligence stage, to consider exactly what services will need to be transitioned. The key to this, for the buyer, is to have a clearly defined vision and operational strategy for the target business immediately post-closing and into the future. It’s easy to look at outsourced service agreements and see what terminates, what can be assigned and what consents are needed; it’s harder to identify what activities the seller has been providing in the normal course. In order to drive a fair bargain, the buyer needs to identify the services required, the necessary service standards and the actual costs of the services. Keeping the scope of services flexible or expandable (as ancillary services without the need to amend the TSA or enter into a new statement of work) can assist a buyer in dealing with essential, previously internal services, or maintaining access to systems, not identified or truly understood until after closing. It’s also important for a buyer to be sure that the performance obligations of the seller are not heavily qualified (e.g., commercial reasonableness, or even best efforts) in a way that can give the seller an out.
3. Motivation
If a seller is not in the services business, it may be reluctant to commit to, or actually provide, service to the level desired by the buyer. More likely, a seller may not be focused on providing excellent transition services after the purchase price money is already in the bank. How does a buyer motivate a seller to provide the transition service at the required level? The actual cost of the services may not reflect the value to the buyer, so having TSA indemnities, penalties, and large liability caps may be insufficient.  Where transition services are key to successful post-closing operations, the deal team may be able to negotiate provisions, in the purchase agreement of the TSA, to incentivize a seller to properly provide services. For example, the use of escrow amounts (as liquidated damages at levels higher than the actual costs of the transition services and lasting for as long as possible) is one way a buyer can keep a seller properly motivated to ensure the target business gets the services and support it needs after closing.
4. Security
Where the target’s systems were previously integrated with that of the seller, providing certain services, such as access to business data, employee information or customer lists, can be challenging for a seller trying to comply with various confidentiality obligations and privacy laws. The cost and complication of separating, protecting and delivering this information is sometimes overlooked or under-valued. Negotiating these costs as part of the TSA post-closing can be bad news for a buyer. Before the deal is done, a buyer will want to ensure that the seller has thought about these issues and will pay for the costs of addressing them.
5. Duration
A buyer will want the right to end, and stop paying for, the transition services as soon as they are no longer needed (or as soon as the service levels provided by the seller fall below what the buyer expects). A seller may want some certainty as to term especially where it is investing considerable resources into setting up people and process to provide the services. Finding the right balance is not easy, especially when neither party is in the service business. From the buyer’s perspective, it’s ideal to have an early exit option that doesn’t come with fees or strings that change the economics of the main deal.
6. Renewal
Not so long ago, TSAs commonly had terms measured in months, with six months being long by TSA standards. Today, as a result of the trend toward outsourcing and the expanded use of technology, TSAs can have terms measured in years – terms approaching 2.5 years are not uncommon.  Regardless of the term of a TSA, it’s not unusual to see TSAs extended and renewed over and over again as more time is required to deal with, for example, issues of testing, third party contract negotiations, and technology assets/license inventory corrections. So, it’s critical that a buyer have the option to renew at agreed to prices. As well, additional tools can be negotiated into the TSA to ensure the services, however long the period, are implemented in a logical, measurable, objective fashion using, for example, transition plans, acceptance protocols, phased in implementation, and milestones.
7. Human Resources
It’s important for a buyer to ensure that the seller makes sure the right technical and operations people are retained, available and assigned to the task. Not only do those on the inside with systems and operations knowledge need to be involved, they need to have the day-to-day capacity to work with the buyer and provide the services levels to which the seller commits in the TSA. As well, the buyer should consider to what extent its own employees need to be engaged at the seller’s facilities or with the seller’s systems and should consider the practicalities of such engagement.
8. Legal Team
In addition to ensuing that right people are in place to provide the services, it’s important to have the right advisors in place while the TSA is negotiated. In many cases, work on the TSA is best dealt with by in-house counsel in conjunction with technical and business teams given their closeness to the buyer’s existing business and the post-closing operational nature of the terms. In any case, deals can close quickly so it’s important that the TSA not get pushed off as a post-signing or post-closing item. Ideally, if transition services are important to success of the target business, transition terms should form part of the bidding or LOI process. However, working through transition issues and negotiating a TSA can be complicated and time consuming, can lead to additional diligence, and can require a lot of highly technical and specialized input. Because of this, a buyer should ensure that its deal team includes expertise in the areas of law directly applicable to TSAs – including IT, privacy, and commercial law – and ensure that these professionals communicate with the M&A specialists.
Stay tuned to this blog in the future when we’ll consider some key TSA issues for sellers to consider.