The art of TSA negotiation

Pros of effective TSA negotiations

• Positioning as “preferred buyer”: When considering potential buyers’ bids in a sale process in order to select the final buyer, the seller reviews various dimensions of a buyer’s proposal, such as the overall price offered, key terms and conditions (T’s and C’s) in the purchase agreement and transition service agreement, and the buyer’s ability to stand up the organization with minimal support from the seller. The key T’s and C’s of the TSA help clarify the buyer’s experience doing carve-outs, the buyer’s high-level TSA exit strategy, and the buyer’s ability to stand up the organization. A buyer can position itself favorably in a competitive sale process by presenting itself as relying less on the TSA, having a clear TSA exit strategy, and more generally demonstrating sophistication in completing carve-out transactions.
• Continuity of operations: Transition service agreements ensure business operations continue seamlessly post-transaction, which affects NewCo’s interim run rate and cash flow.
• Financial impacts: Certainty of TSA pricing, including alignment with historical allocations and associated caps or guardrails, affects the interim run rate of the target and how closely that run rate aligns with the costs baked into the buyer’s financial model. One-time TSAs such as data migration needed for TSA exit also have an impact on the overall one-time costs of the transaction financial model.
• Liability exposure(s): Negotiating a balanced structure for addressing liabilities that arise under the TSA protects the buyer from taking on unnecessary risks after the transaction closes.

Why are TSAs important for financial buyers?

Financial buyers often acquire businesses that are carved out from larger corporations. These carve-out businesses may not have their own stand-alone infrastructure and resources to operate independently from the seller immediately after the closing of the transaction. And, unlike a strategic acquirer that has existing operations and therefore may be able to onboard the acquired business to its own IT systems, payroll systems, etc., a financial buyer does not have the infrastructure in place to provide these services to the acquired business. Therefore, financial buyers typically must rely on TSAs to drive a smooth transition and continuity of business operations after the deal closes.

Key considerations for financial buyers when negotiating and managing TSAs

1. Scope and duration: Financial buyers should clearly define the scope and duration of the services while balancing the realistic time frame needed to drive a smooth transition and allow stand-up of stand-alone services, on the one hand, with demonstrating an approach consistent with a “preferred buyer,” on the other hand (i.e., in a competitive process, buyer may wish to avoid asking for long service durations, as most sellers prefer to minimize the time period they must provide services and may therefore favor an alternate buyer that proposes shorter TSAs).
   
2. Pricing and payment: Buyer should aim for the TSA pricing to be fair and reasonable and to reflect the actual cost and quality of the services. It is not unusual for the seller to have a modest single-digit markup on top of the actual cost of the services. However, the existence of any markup and the percentage amount of that markup should be carefully negotiated by a buyer as a key economic point related to the overall cost of TSA services.
   
3. Service level and performance: Financial buyers may wish to include service level agreements (SLAs) and key performance indicators (KPIs) to measure and monitor the quality and timeliness of the services provided by the seller. They may also wish to agree on the reporting and escalation mechanisms, and the remedies and penalties, for any service failures or breaches. That said, it is often the case that the general service standard and liability structure govern performance and recovery for performance failures.
4. Escalation management under dispute resolution: Buyer and seller should align on the concept of a steering committee.
5. Change management and communication: Financial buyers should communicate effectively with the seller and the employees of the acquired business about the TSA arrangements and manage any changes or issues that may arise during the transition period.