Transition Service Agreements: Avoiding Pitfalls Along the Path to Divesture
Even the best tools can be obstructive if handled improperly, and in the world of divestitures, a Transition Service Agreement (TSA) is no different.
As legal agreements, TSAs are critical elements of divestitures. A TSA refers to a contractual arrangement between a buyer and a seller whereby the seller consents to furnish the buyer with certain services for a fee while the changeover is in progress. Ideally, this arrangement expedites the transition and ensures continuity by bridging a potential gap in services between the time of closing and the time of separation. It also aids in the accomplishment of a complete separation free of any unnecessary complications.
Forming and implementing a TSA, however, comes with its own set of challenges. It is a process that requires expertise and strategic planning in order for the TSA to function effectively as a means to an end.
Recognizing the Benefits
Because a divestiture involves the purchase of a part of a business, a buyer typically may be unable to sustain its operations right off the bat. To ensure business continuity during the transition, TSAs provide for infrastructure support where needed. The kinds of services covered in TSAs can range from IT, accounting, and HR services to materials management.
From the seller's perspective, TSAs can prove beneficial in a number of important ways. For one, the agreements can supplement the newly created business model, which maximizes the value of the deal. They also help to advance the divestment deal. Through the use of TSAs, for example, the deal's financial close can be reached fairly quickly. Otherwise, progress would halt until the buyer could accept full responsibility for business operations.
Understanding the Drawbacks
Poorly designed and poorly managed TSAs can work against sellers, and without experience it is all too easy to overlook certain areas of the planning process or to make misjudgments. Recruiting competent corporate advisors to help guide this phase of the transaction is a good idea and can ensure that companies avoid some of the pitfalls most commonly encountered.
Below are a few missteps that are often committed when planning, forming, and implementing a TSA:
- Failing to draft a TSA before the transaction gets underway. Drawing up a TSA at the eleventh hour can result in a host of costly oversights. Preparing TSAs well in advance, on the other hand, allows the buyer and seller ample time to review and properly negotiate the terms of the agreement.
- Miscalculating costs. When the factors and conditions that translate into cost determinants are not fully accounted for, sellers can end up selling their transition services short.
- Poorly describing services. Using broad, general language to discuss transition services results in confusion. In order for both parties to understand what responsibilities will be delegated to them, the description of services should be clear and thorough. A solid TSA will even go into detail about the services that are NOT to be provided.
- Misgauging the timeline. When operating under a TSA, the goal is efficiency, not haste. Allotting an impractical amount of time for completing a transition indicates that goals, and the steps for achieving them, are not clearly outlined and therefore will be counterproductive. Likewise, failure to agree on a clear timeline for ending the services is also a common mistake. Therefore, an exit strategy should be part of the overall agreement realities.
- Neglecting to appoint a supervisor. Once a TSA is in effect, oversight is required to ensure that things not only move, but move in the right direction.
- Losing sight of the main objective. Throughout the transition period, attention should be focused on the real goal—that of reaching the point of separation. That said, it is often the case that the quality of service being provided becomes a bigger concern to sellers than it should. Service need not exceed adequate and expected levels.
Properly approached and handled, TSAs should work in favor of the parties on both sides of the transaction. Agreements should see both the buyer and the seller through to their shared goal of fully divesting or separating the business, easing potential friction in the process. Building TSAs that are effective and work fairly often requires competent corporate finance advisors. Those with strong TSA experience can help organizations navigate the process with confidence.
About the Author
Jeff Milkie has more than 13 years of experience in leading mergers and acquisitions, raising capital, and performing financial advisory engagements, having executed over $4.8 billion of transactions. For capital-raising assistance, strategic M&A assistance, and help with strengthening your clients’ sale profile, contact Jeff Milkie at 651.766.2894 or firstname.lastname@example.org.
About Wipfli Corporate Finance Advisors LLC
Wipfli Corporate Finance Advisors, LLC provides a broad range of advisory services tailored for middle-market companies and capital providers seeking investment opportunities or assistance with portfolio companies. Our clients benefit from the depth of our leadership team’s experience— over 30 years of combined experience advising middlemarket companies and management teams. We consistently provide clients broad transactional, structuring, and industry expertise and the benefit of solid relationships with hundreds of middle-market companies throughout the Midwest and across the United States. For more information, visit www.wcfadvisors.com.