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Highlights
- Transition service agreements (TSAs) are critical components in M&A and divestiture transactions. In a spin-off, the TSA strategy needs to be considered very early on even before the deal announcement.
- Managing and successfully exiting all TSAs not only ensure a smooth transition for the SpinCo, but also reduce separation costs, eliminate overlaps of service and duplication of resources, and expedite the operational independence of the SpinCo.
- Five key best practices to manage TSA activities include managing TSA exits and extensions, analyzing costs, managing interdependencies, and risks.
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The need for a TSA
Transition service agreements (TSAs) are put in place to ensure the smooth transition of a divestment, which entails complexities that the organization’s leadership team must navigate.
Divestitures are complex deals that require comprehensive planning as they bring changes to the entire organization. The spun-off business unit, being intertwined with the holding company’s business, requires support for a certain duration. TSA is a contract for the parent entity to continue to provide services and support to the divested entity for a set fee for a pre-determined duration (see Figure 1).
TSA strategy to ensure smooth divestiture
TSA strategy to ensure smooth divestiture
Governance model
The business that’s getting divested must establish a governance model to monitor TSAs and track progress for on-time exits.
In a spin off, the seller and the spun-off business are responsible for establishing and agreeing on a suite of TSAs to ensure there is coverage and support across all workstreams beginning Day 1. The coverage is especially important for the back-office functions, including finance, information technology (IT), and human resources (HR). Therefore, it is critical to establish a TSA governance body, the separation management office (SMO), to provide governance with agreed upon processes and mechanisms for all TSAs.
The SMO holds important responsibilities to ensure on-time exits of the TSAs, and to review and re-negotiate the TSA terms and conditions with the seller in case of early exits or extensions. Business intelligence (BI)-driven analytical tools and reports are used to facilitate the process. The SMO team acts as a central place for all stakeholders to raise issues and risks when an on-time TSA exit cannot be met. It will carry out a series of activities, including seeking workarounds, reviewing interdependencies, analyzing third-party contracts, and reviewing cost impact.
Collaboration
It is important for the SpinCo (an independent, publicly traded company) SMO to closely collaborate with the seller to manage transitions and reduce duplicated costs.
Post Day 1, although the SpinCo is officially an independent entity, it still largely depends on the seller for back-office functions such as IT, finance, and HR through TSAs until it stands up and operationalizes these functions. Many of the TSAs could have a duration up to 24 months to provide the necessary support. During this transition phase, close collaboration and frequent touchpoints between the SpinCo SMO and the seller can help address unforeseen issues related to resource constraints, scope changes of TSA projects, service agreements, and cost allocations.
For example, it is necessary for the SpinCo SMO to work with the seller to ensure that relevant historical data is retained or transferred to the SpinCo to meet regulatory and compliance requirements. It is also important to analyze whether service contracts can be directly transferred to the SpinCo with the most optimal terms and conditions.
Early exits
While the SpinCo SMO should continuously strive to identify early TSA exit opportunities, it is important to also understand the pros and cons of an early TSA exit.
Depending on how long it is expected to take the SpinCo to stand up each function and operationalize them independently, TSAs are established with a range of durations for the seller to provide support and services to the divested business. With dedicated teams and keen support from the executive leadership, we have seen many cases where the processes and systems of the spun-off entity establish their independence months before the TSA end-dates. This led to great opportunities to exit the TSAs early, allowing large savings on TSA costs. However, when reviewing these early TSA exit opportunities, the SpinCo SMO needs to gain clarity on all possible financial entanglement even if the TSA agreements with the seller can end earlier. For example, if the TSA is tied to a third-party vendor providing services, even though the SpinCo can stand up its own functions and exit the TSA sooner, the contract with the vendor may exist beyond the TSA end-date. . This leads to continuation of financial liabilities (ie stranded cost) of the divested entity even if that entity could exit the TSA early. Therefore, it is key for the SMO to identify the stranded cost early on so that they can plan and allocate resources accordingly.
Extensions
The SpinCo SMO must understand the imperatives for TSA extensions if on-time exits cannot be met.
It is important for the divested entity to adhere to the TSA exit timeline as the seller winds down its resources and terminates its support. When the divested entity has challenges of exiting a TSA on time, a business case is raised and evaluated by both the SpinCo SMO and the seller. A TSA extension may be possible, but it could require extra cost to the new company. Therefore, each TSA extension must be reviewed extensively by evaluating HR , IT requirements, and any third-party requirements, cost impact, and alternative solutions. The SpinCo SMO should establish a holistic review and approval process for TSA extension requests, including cost -benefit analysis before proceeding with the extension.
Interdependencies
The SpinCo SMO needs to identify and understand the interdependencies among all workstreams and functions to manage risks and resolve issues.
One single TSA could cover processes and systems that support multiple functions and workstreams. For example, a finance TSA could cover the finance processes as well as the IT systems and infrastructure that are supporting these processes. Therefore, exiting any TSA requires involvement of cross-functional teams, as well as careful evaluation of all interdependencies. Cross-functional TSAs are more commonly seen in the IT workstream, as many systems and IT infrastructure (such as network, identity, email) are the key foundation for a business function’s daily operation. Therefore, exiting these TSAs requires careful planning to identify dependencies from all functions and business users. Timely change-management communication via multiple channels and platforms will ensure minimal disruption.
The key to a successful M&A deal
Effective TSA management is critical for the success of any merger, acquisition, and divestiture (MA&D) transaction.
A TSA strategy must be carefully planned and considered early on. A well-structured TSA helps both the parent company and the spun-off company to realize the full value of divestiture while maintaining business continuity and making the overall transaction successful. Having a good TSA framework ensures that the divested entity receives the time and flexibility needed to achieve its end goals of the divestiture while the seller continues to support critical functions during the transition period. TSAs may be temporary in nature; however, their effectiveness is the basis for a successful M&A transaction.
