The Buyer's Perspective
By Chittur P. Narayan, Principal Director of M&A Integration Management at CBRE, Inc.
Carve-outs are among the most complex transactions.
This is especially true when the carve-out involves the sale of a business unit that is operationally integrated with the rest of the parent company’s business. In such transactions, the seller may be required to continue providing post-closing support for mission critical services to the buyer.
This support is formalized using a “Transition Service Agreement” (TSA) and comprises one of the documents that is signed at closing (alongside stock and/or asset purchase agreements).
From a buyer’s perspective, ensuring that a TSA is structured in the most efficient manner that balances business continuity and assurance of support and reliability while ensuring a fair service cost is a critical deal success factor.
The following are some of the key considerations when structuring a TSA:
1. Scope and Duration of the TSA
Defining the scope of the TSA is the most critical decision made by the buyer. The buyer’s due-diligence should be effective to identify all the systems, services and support needed (e.g. accounting, payroll, specific applications, infrastructure, etc.) from the parent company, post-close, to ensure business continuity and minimal operational disruption. Looking at the TSA services needed through a customer-facing lens is a great way to identify the most critical priorities that will enable a seamless transfer from the seller to the buyer. In addition to systems, services and support needed, the due diligence should also focus on major planned projects that could impact the scope of the TSA and key personnel needed to support the TSA.
Defining the duration of the TSA is the next most important decision. Ideally, the duration should align with the buyer’s integration plan. However, there is often a conflict of interest between seller and buyer intentions. Sellers want to wrap up the transaction as quickly as possible and buyers want the longest TSA duration possible to mitigate integration risk. One option is to have a “base” duration (e.g. 3 months, 6 months, etc.) along with the option to terminate early and/or to seek an extension by providing adequate notice to the seller. This incentivizes the buyer to conclude integration early, thereby saving TSA costs while also providing “insurance” against integration setbacks.
2. Terms and Conditions
The pricing structure for TSA services must be clearly defined and structured based on accurately measurable metrics – e.g. $/hour for support personnel, MIPS for computing power, $/GB for storage, etc. Each TSA service should be priced independently where feasible. Avoid a situation where the pricing for one TSA service is dependent on or linked to another TSA service - this will make it difficult to exit individual services without exiting all services.
The pricing for the “base” period and extension or early exit must also be clearly defined. The seller may be reluctant to prorate early exists linearly as they may have committed certain resources for the entire TSA duration and may not be able to ramp these down linearly. Sellers may also be tempted to charge a higher price for TSA extensions to incentivize buyers to stick to their plan.
Licenses and 3rd Party Agreements
If there are 3rd party licenses or outsourcing agreements involved in supporting a TSA, these should be factored into the pricing – e.g. MS Sharepoint license cost if the buyer is opting for TSA support for seller’s Sharepoint sites. If the licensing or outsourcing agreement period crosses the TSA period, then the renewal cost must also be factored into the pricing.
This is a critical area that impacts the operational performance of the buyer and informs the penalty / liability for non-performance on part of the seller. Sellers have an incentive to establish generic / default SLAs – (e.g. “commercially reasonable”, “best efforts”) as this affords them the most legal protection against non-performance. Buyers should push for measurable performance metrics where feasible, ideally aligned to the pricing structure. This will enable easier recapture of non-performance penalties.
Structuring of performance criteria should also include the potential impact of non-performance by 3rd parties involved in the delivery of the TSA service. Determine upfront if the 3rd party agreements and licenses with the seller's vendors and service providers need to be amended.
Data Privacy and Security
Data privacy and security is a key enterprise concern nowadays. Ensure that the TSA clearly identifies and implements data privacy and security safeguards and defines the mechanism for attribution of liability in case of a breach by either party.
Definition of Separation vs. Integration
This is an often overlooked but very important consideration when the data for the divested business unit is comingled with the parent company’s data (e.g. Financial transactions, employee data, etc.). Separation is typically the responsibility of the seller and integration is the responsibility of the buyer. While it is difficult to have a full understanding of the extent of comingling prior to close, having alignment regarding the principles for identifying separation vs integration activities will go a long way in reducing disputes over responsibility and cost for separating comingled data.
3. TSA Management and Governance
TSA Office Structure
Maintaining a TSA office on the buyer’s side is an effective way to manage TSA agreements with the seller. This arrangement provides the following benefits:
- Ensures a single point of communication between the buyer and seller
- Ensures that TSAs are executed per agreed upon SLAs (by the seller and 3rd parties)
- Ensures that TSA exits, and extensions are coordinated, with relevant functional organizations on both sides, in accordance with agreed upon TSA terms
- Ensures that the TSA progress is communicated to all impacted stakeholders in a consistent and accurate manner via a regular reporting cadence. The reporting published by the TSA office should capture the financial impact (historical and projected) and key exit risks and issues to ensure cross-functional alignment.
- Ensures that TSA billing and payments are handled efficiently between seller and buyer organizations
The escalation path for issues involving TSA performance, service discontinuity and emergencies needs to be agreed upon prior to close. One option is to use a joint steering committee involving key leaders from both parties that meet on a regular cadence (bi-weekly, monthly, etc.) during the TSA period to resolve key issues. This forum can be supplemented by additional touch points for specific TSA services – e.g. Payroll, Accounting, Systems, etc. The escalation protocol for dealing with issues involving 3rd parties should also be agreed to prior to close (including any consent needed from the involved 3rd parties).
TSA exit planning is a complex exercise that should include the following:
- Alignment of exits to key integration milestones. E.g. if the integration plan involves migrating employees to the buyer’s payroll system, then the payroll TSA exit should be aligned to the payroll system readiness timeline.
- Resource constraints on both the buyer and seller’s side to prevent service discontinuity. Resource constraints can be mitigated by staggering the TSA exits over weeks or months rather than doing a “big-bang” approach. Staggering also provides a buffer for recovery/issue resolution in case the exits do not go as planned
- Proactive assessment of the potential for early exits or extensions. Early exits can provide significant financial benefits while extensions typically require providing adequate notice to the seller.
4. Special Situations
Reverse TSAs arise when the services that were originally performed internally by the seller now need to be performed by the buyer (for the seller) because these were being performed by the business unit that has been divested to the buyer. The same considerations that apply to TSAs also apply to Reverse TSAs. Buyers often overlook reverse TSA and are unprepared for the fact that the seller may also require services from the buyer due to the carve-out.
In conclusion, while the above considerations will assist in structuring and managing a TSA efficiently, the importance of maintaining good working relationships with the seller during the TSA period should not be underestimated. Keep in mind that the sellers also want the carve-out to succeed and will try to avoid negative press and market perceptions caused by service disruptions. Maintaining a collaborative (rather than confrontational) working relationship with key stakeholders on the seller’s side will go a long way in ensuring a satisfactory TSA exit!
Learn more about TSAs and carve-outs at our next two upcoming events:
The Art of M&A® for Due Diligence Leaders / In-Person - Boston, Sept 12-14, 2023
The Art of M&A® for Integration Leaders / In-Person - San Diego, Oct 11-13, 2023
See our Training Calendar for all upcoming courses in 2023.
About the Author: Mr. Chittur P. Narayan is a Principal Director of M&A Integration Management at CBRE, Inc., the world’s largest commercial real estate services company. He has a background in operations research and 25+ years of diverse experience in management consulting, pricing, revenue management, and M&A integration. He led the Transition Service Agreement (TSA) office for the largest acquisition in CBRE’s history and has served as the Integration Management Office (IMO) lead on 10+ transactions across multiple business lines and regions. He is also an alumnus of the M&A Leadership Council training programs.