Key Considerations in Transitional Service Agreement in M&A

A Transitional Service Agreement is an agreement from a purchase agreement that is made between the seller & buyer of a company or entity. Transitional Service Agreement makes a crucial factor of Mergers and Acquisitions transactions. When an entity is sold, there may be some obligations on the part of the seller that has to be satisfied. It’s an agreement where the seller consents to provide definite services at a predetermined price and for a specific time period. The acquirer may require the back office to operate the company. This is when the sellers step in to help the buyer in the smooth and effortless working of the company.

In a Transitional Service Agreement, the seller is the father, and the buyer is the kid. Here, the father backs the kid till the kid is not independent. Moreover, the seller delivers its services to the buyer until the buyer is not competent enough to have the framework or systems to achieve the duties at hand.

When one entity buys out another entity, there are barriers to be crossed, and quite often, it is uneven. An entity that desires to jump of faith and buy out a strong company often faces barriers to running that entity independently. The selling company has its departments established in handling different factors of the entity or company, which is rare in the buyer’s capacity. Thus, the Transitional Service Agreement delivers a structure of these departments regarding services until the buyer is able of executing it. Scroll down to check the key considerations in Transitional Service Agreement in M&A.

What are the Key Considerations in Transitional Service Agreement?

Following are the key considerations in this agreement:

1. Suitable Solutions & Resources: The seller and the buyer should be clear of what services are to be given by the seller & used by the buyer. It must be clearly written to aid in recognising both the parties of the services that are being catered. This prevents confusion on the part of the seller, and the seller can offer inter alia valid solutions & resources.
2. Time Estimation: The timeline and the impacted cost are essential while entering into a Transitional Service Agreement. The seller & buyer should be realistic about the time duration of the agreement. An imprecise time would not permit the buyer to adapt to the system, nature, and environment of the business. This is called the Exit Strategy^[1]. This strategy has to be well-thought since there are dependencies to avoid the system from violating.
3. Geographical Region: There are certain agreements formed at the worldwide and local levels. It is essential to distinguish where the services are being given to avoid confusion while functioning with multinationals.
4. Dispute Resolution: No business activity can be 100% smooth and efficient. Discrepancies are bound to arise. To resolve these discrepancies, a dispute resolution mechanism should be put in place between the seller & the buyer.
5. Cost & Invoicing: As you already know that everything in this world comes at a price, and so does making a Transitional Service Agreement. The cost or price to be incurred must be discussed between the buyer & the seller. The costs to be estimated should recognise variable cost factors and fixed cost elements. Regularly, the buyer’s determination is dependent on the seller, and the costs will go down. Sometimes, there remains a steady dependency on resources until that wears out. By remembering, the cost structure should be clear to prevent any disagreement in the future. Most sellers are not in the selling services business and may lack the systems, experience, skills, knowledge, and tools to examine service costs correctly. In such a case, the seller outsources such services to explore the cost drives precisely.
6. Renewal: If the buyer wishes to keep the seller’s services or wishes to renew the agreement, it is essential to document this clause. After the time duration of the present agreement, the seller may decline to continue providing the services; in that case, a renewal clause will assist in avoiding a gap.

Why Does Divestiture Take Place?

When a company or an entity grows, it recognises that it has too much in its place. The company decides to arrange for their assets by exchanging, selling, shutting them down, or declaring insolvency. Rather than being involved in too many business activities, divestiture aids the entity or company to focused & remain profitable. The bond between the seller and the buyer takes a move after the deal closes. The seller aims to clear up the untidiness in the end & ultimately leaves it to the buyer to take it forward. The seller wishes to wrap it up and resume concentrating on its other priorities.

Management of the Transitional Service Agreement in Mergers and Acquisitions

The association between the buyer and the seller needs to be controlled and coordinated. To look into the issues of the agreement & monitor the services being provided is an essential factor. To keep moving ahead, each company must appoint a coordinator to regulate the services. It helps avoid any disorder or confusion. The coordinator is identical to a manager in different organisations. They don’t dwell deep into the work but require a comprehensive view and keep a check on the services being delivered and the separation of the activities.

A manager can take responsibility and aid in case of any essence of the services being given as it is not always possible to approach the seller or buyer directly. The vendors or third party concerning the service offered may approach the manager directly. The manager mostly acts as an agent to the principal.

Conclusion

Basically, the seller supports the buyer until the buyer is capable of himself. It is vital to documents all the key considerations. Simple verbal promises in a transactional service are not efficient.  The seller could reject the service to be offered after closing if it is not recorded as they have no accountability after the transaction is finished.

To provide an easy transition, the seller and the buyer should know the Transitional Service Agreement and prevent any loopholes or traps that may come in their way. The buyer & seller should independently deem inter alia all the feasibilities, documents required, time estimation, services to be delivered and to be received ultimately.

Read our article:What are the different types of Mergers and Acquisitions?