Transition Services Agreements: overview and new developments

A key component of some M&A transactions is the Transition Services Agreement, or TSA. The TSA essentially answers the question: what services is the seller required to continue providing to the buyer, for how long, and upon what terms?

The TSA is a separate legal agreement from the acquisition agreement, covering certain services to be provided from the seller to the buyer.

The services provided pursuant to a TSA could include any manner of services, from accounting to IT, from management to HR.

When do I need a TSA?

TSAs are most appropriate for two types of situations:

  1. Divestiture Transactions – in other words, the purchase and sale of part (but less than all) of one business to another. Most typically, a TSA will be appropriate when a larger company spins off or sells a division to a smaller company that does not have the infrastructure or in-house support to immediately absorb and support the division (in the converse situation – a larger company purchasing part of a smaller company – the larger company would likely already have the in-house capability to support the division).
  2. Key Person Transactions – in other words, a complete purchase of one business by another, where the selling business is run by, or intricately involved with, a key person who will eventually be leaving. The most common example of this is the Founder-CEO who started the business from nothing and has a very large degree of oversight and involvement with many different divisions. If the Founder-CEO is being bought out with an eye towards retirement or his/her next startup, then he/she will do significant damage to the purchased business by leaving immediately. A well thought-out and carefully-drafted TSA that methodically transitions and disentangles the Founder-CEO from the business over an appropriate time period will tend to preserve the most value.

There is, of course, no point in having a TSA in a complete sale or acquisition without a key person, since all of the seller’s assets, divisions, and services are owned by the buyer indefinitely, and integration can proceed on the buyer’s timeline.

What’s the pro and con of using or not using a TSA?

When deployed poorly, a TSA can distract the seller’s post-transaction focus for longer than necessary and basically become a nuisance (after all, in the case of a divestiture, the seller is spinning the division off so that it can focus on other things).

Another dangerous characteristic of a TSA is that it is a very effective tool of procrastination – it can give buyer and seller who still have some disagreements a way to “kick the can down the road” on some very important decisions (decisions which should not be procrastinated).

When used properly, however, a TSA can lead to a faster close, as well as a smoother and less costly transition. This part – the “when used properly” part is when you’ll want to consult with an experienced corporate attorney, as well as your other advisors on the transaction.

Below, I will discuss a few of the concerns and questions that you’ll want to specifically think about for your Transition Services Agreement.

What’s the endgame?

Broadly speaking, buyers can: (i) outsource to a third party, (ii) expand an existing internal department to cover the new business, or (iii) develop a new internal department to cover the new business. Or, depending on the contours and circumstances of the deal, there may be a fourth option (iv) terminate the service altogether.

The terms of the TSA will be different for each of these scenarios.

So, is the plan, for example, for seller to provide HR services to buyer for a short window while buyer finds a third-party to outsource the HR to? Or, will the buyer transition the target’s payroll to buyer’s own in-house payroll department? Or, will buyer develop its own in-house repair department while being supported by seller’s repair department?

This “endgame” is one of the most important aspects of the Transition Services Agreement, and is something that your corporate lawyer, investment banker, business advisor, and any other professionals should be focused on from Day One. Define and draft a formal exit protocol. What form will the notice take? How much of a notice period is required? What final expenses will be “settled up” at that time?

What will it cost? And what is included?

The TSA is an unusual animal, in that it obligates the seller to provide a service that it isn’t in the business of providing. A TSA might require a car company, for example, to provide accounting services. Or, a financial consulting company might be providing HR functions. You get the idea.

Therefore, cost drivers will need to be clearly identified and the method of calculating costs will need to be set forth with specificity.

What’s excluded?

Relatedly to a specific cost model, what services will be “additional” chargeable services under the TSA or services calculated under a separate cost model?

Developing a list of services that are specifically not included in the TSA will help to more concretely define the relationship between the parties.

Who are the points of contact?

Since there will be a separation of business units, it’s generally a good practice to identify exactly who will provide and receive services, as well as who will provide and receive any requests for excluded services or chargebacks, and who will be the point of contact for any potential dispute.

What level of service do you need (can you provide), really?

As noted above, one of the sticking points of a TSA is that the seller isn’t really in the business of providing the type of service that the TSA provides, and the buyer’s endgame is to establish a means other than the seller to provide those services, anyway. So, as a buyer, it is important to be realistic about your demands for service levels; likewise, as a seller, it’s important to be realistic about what you can promise. A higher-than-necessary demand or promise will just create ill feelings (or worse yet, a breach!) down the road.

Rather, keep in mind that the goal here is for the buyer and seller to collaborate on disentangling the sold division as quickly as is reasonably possible – not to pick fights over service levels.

Wait a second. I read all this on some other lawyer’s site. I thought you said there were new developments…?

Indeed there are. I’m going to talk primarily about privacy regulations here, but there are more.

As the “typical” user of a TSA – small buyer, purchasing a spun-off division of a larger seller – you have a couple of potential regulatory hazards to be aware of. Some are new, some are not.

One that isn’t new is HIPAA – personal health information that may be handled by the acquired division could have wide-ranging consequences.

One that’s relatively new that you may not have heard of is GDPR. The GDPR is the General Data Protection Regulation, and is a privacy law that applies to consumers in the European Union. I won’t go into detail on the requirements of the GDPR in this post, but let’s focus on the “gating issue” of whether the law even applies. Pre-acquisition, your company may not have been subject to GDPR because you didn’t collect data on EU persons. But, suppose your new division either modifies your company’s data-collection practices, or serves EU persons. You suddenly have significant compliance and disclosure issues.

Another (similar) trap to watch out for is the CCPA – the California Consumer Privacy Act.

Companies become subject to the CCPA when they trigger one of these three conditions:

  • annual gross revenues of at least $25 million;
  • annually buy, sell, receive, or share for commercial purposes the personal information of 50,000 or more consumers, households, or devices; or
  • derive 50% or more of annual revenues from selling consumers’ personal information.

So, suppose that pre-acquisition, your company has $19 million annual revenue, and the acquired division bumps you up to $26 million. You may now have a CCPA compliance issue.

Or, suppose that the division you’re purchasing focuses on buying and selling personal information. Percentage-wise or numbers-wise, the move could conceivably create compliance obligations where perhaps NEITHER party had them before.

Who can I get to help me with a Transition Service Agreement?

I can do that. Contact me here to discuss further.

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