Transition Service Agreement – Definition, Checklist, and Challenges

Economic uncertainties significantly influence the M&A market, with deal trends shifting to divestitures. Based on Deloitte’s recent M&A poll, 47.9% of respondents will look after divestitures in the upcoming year.

To smooth such deals, M&A professionals use transition services agreements (TSAs).

A transition service agreement (TSA) is an agreement between two entities when one entity supports another for a defined period in the post-deal phase.

This legal document outlines the conditions and timeframes of the support services after the deal closes. Businesses may use TSAs in several transactions, including but not limited to:

Divestitures. TSAs are most commonly used in divestitures when the buyer pays the seller for specific services to support the divested company in the post-deal period.
Spin-offs. The parent company signs the TSA to support the spinoff entity financially for a specific period.
Joint ventures. For joint ventures, TSAs outline the terms and conditions of the collaborative projects, including shared services and resources.

The business community distinguishes two types of TSA:

Forward TSA — The seller supports the buyer.
Reverse TSA — The buyer supports the seller.

Reasons to use TSA

Here are the common reasons for implementing a TSA:

Business continuity. The seller’s (or buyer’s) support allows to minimize operational disruptions during the post-deal period and manage business continuity.
Cost savings. TSA allows buyers to integrate the divested party’s systems, functions, and operations one at a time after the acquisition. The buyer minimizes the post-merger integration financial impact while spreading costs over an extended period and ensures a stronger position post-deal.
Ownership transition. TSA helps buyers to move the acquired services, assets, intellectual property, and responsibilities to its ownership. It ensures a smooth ownership acquisition, minimizing related disputes and management issues.

Do you really need transition service agreements?

Whether a buyer or seller needs a TSA depends on their capabilities and interdependencies within the deal.

If the complete sale of the subsidiary doesn’t hinder the seller’s business, they may not need a TSA. But if the divested business heavily relies on joint IT assets, financial systems, and service agreements, the seller agrees to sign the TSA.

The TSA process from start to finish

While transition service agreements are unique in detail for each business case, they share a similar structure and components:

The scope of services. Business functions, systems, operations, and assets under consideration, including accounting, technology, and human resources services.
Roles and responsibilities. The responsibility of the TSA service providers and receivers and other requirements related to service roles.
Service performance metrics. Expectations about the delivered services and performance evaluation criteria, including quality, quantity, and delivery time.
Transition period duration. Time frames for the set period based on the deal’s complexity.
Transition period extension. TSA extension rules and policies for additional services.
Service payment. Transition service billing plans based on the scope, quantity, quality, responsibilities, duration, and compliance. The US buyer and the UK seller may use different frameworks so laws should be properly addressed.
TSA exit strategy. Procedures, conditions, and timelines for TSA termination.
Dispute resolution. Protocols and procedures under applicable law in case either party fails their responsibilities.

Note: Deal parties should draft detailed TSAs based on due diligence findings to consider the scope of such services and associated risks. The two parties should start this time-consuming process early to effectively manage the separation.

The transition services agreements timeline

Check the TSA implementation stages and key considerations in the transaction timeline.

TSA stage	Key points	Deal timeline	Service provider activities	Service receiver activities
Planning and drafting	Deal parties develop TSA provisions, including the scope of services, costs, and schedule deadlines.	Deal announcement and due diligence	Reviews service requirements.Identifies available support services. Calculates service costs. Develops and reviews dispute resolution practices and exit strategies.	Identifies critical areas where external support is required. Develops service requirements and outlines expectations. Estimates transition duration. Estimates service transition costs. Develops dispute resolution practices and exit strategies.
Signing	Deal parties agree with the TSA terms and sign the contract.	Final due diligence phase	Reviews the entire agreement and negotiates TSA’s legal aspects.	Reviews each agreement provision and negotiates TSA’s legal aspects.
Implementation	Deal parties prepare and set up their systems and implement necessary services.	Deal closing	Assigns service coordinators. Tracks service implementation. Collects service fees. Reviews the TSA status, service changes, and issue resolutions.	Assigns service reviewers. Tracks service delivery and quality. Pays service fees. Reports on the TSA status and collaborates on service implementation, changes, and issues.
TSA termination	Deal parties finalize exit protocols and prepare to terminate the service agreement.	Completion of post-deal activities.	Clarifies TSA termination fees.Completes all data transfers.Completes all accounts.Deactivates service systems and cleans all data archives.	Develops an operating model in the post-transition period. Pays TSA termination fees. Notifies the service provider about the exit date in advance. Complete all knowledge transfers.

Transitional service agreement checklist

PWC has found that over 40% of carve-out transactions involve TSA disagreements due to poorly communicated terms. TSAs are typically the last agreements in the deal timeline and often receive little attention from both parties involved due to mutual exhaustion.

However, deal parties could mitigate many confrontations if they carefully worked on TSA terms before the deal closing. We have collected the following key points to consider when managing a TSA, based on the best M&A industry practices:

Establish a steering committee.
Set realistic time frames for the TSA period.
Identify benchmarks for TSA costs.
Designate TSA service managers as TSA authors.
Include properly defined services not included in the TSA.
Consider historic service performance.
Plan to finish data migration a few months before the TSA end date.

Value drivers for the transition services agreement checklist

Transition services agreement checklist practices	Value drivers
Steering committee	Drafts an effective TSA and defines realistic roles and responsibilities of deal parties. Centralizes TSA management and dedicates governance efforts to the process. Allocates resources, resolves issues, evaluates TSA metrics, and tracks milestones. Supports daily transition service delivery and responds to challenges timely. Deescalates TSA disagreements and avoids more complex legal disputes.
The 12-month TSA period + 6-12 months	Allows both parties to approach the process thoughtfully and ensure a smoother transition. Incentivizes the purchasing company to finish the process sooner but leaves time for quality transition and business continuity.
TSA cost benchmarks	Determines baseline cost levels if the seller lacks experience in related deals. Sets realistic expectations for such costs. Creates a foundation for an accurate cost analysis. Ensures fair costs that fall within market averages.
TSA manager co-authorship	Produces realistic TSAs. Adds a managerial perspective to the TSA structure and outlined services. Aligns planned transition services with the seller’s business capabilities. Removes misunderstanding and confusion from the TSA implementation.
Non-TSA services	Clarifies the expectations of the other party and improves their transition period performance.Clarifies cost expectations and removes misunderstandings of different business perspectives.
Historic service performance	Clarifies the seller’s service standards and the buyer’s expectations. Gives better perspectives on the seller’s capabilities, quality, and quantity of services. Ensures a commercially reasonable service level that meets the buyer’s true business needs. Ensures timely TSA execution without unnecessarily complicated service levels.
Early data migration	Reduces the risk of unexpected TSA extension costs. Addresses data migration risks and ensures enough troubleshooting time. Minimizes potential business disruptions due to timely addressed data migration issues.

4 challenges of transition services agreement management

According to Harvard Business Review’s spinoff study, 50% of companies fail to deliver value to shareholders in two years. Also, 25% of companies destroy value in the process.

Companies often fail to capture the TSA value and separate their business functions correctly during the transition period. Common TSA challenges include the following:

Vague service descriptions
Inflexible transition period terms
Inaccurate cost estimates
Unaddressed interdependencies

Let us review how these TSA challenges impact the deal process based on real-life examples.

Sears Holdings and Lands’ End

Sears Holdings, one of the largest retailers, decided to spin off Lands’ End, its clothes division, in 2013. Lands’ End officially completed its separation in 2014. However, this deal was barely successful in the short term.

Part of the problem was the ambiguity in TSA services and poor separation planning since the process took almost five years. The TSA, available at Law Insider, involved several challenges.

TSA challenges	Business outcomes
Vague service descriptions	Lands’ End failed to separate facilities as the TSA didn’t clearly outline all services required for a successful separation. This company kept its stores in 40 Sears locations four years after the official split.
Inflexible transition period terms	The deal parties didn’t extend the TSA period although they still had many interdependencies. These included contracts for software licensing, customer package delivery, and printing services. Land’s End also used Sears facilities when all contracts expired. This created uncertainty in operating models and hindered business performance for both parties.
Separation outcomes	Lands’ End reported a 6 – 10% decrease in all KPIs, including net revenues, sales, and gross margins years post-separation.Sears Holdings sued its former CEO for fraudulent operations related to Lands’ End separation which made Sears go bankrupt.

Inaccurate cost estimation: Arconic and Alcoa

Alcoa, the US aluminum company, decided to spin off Alcoa Corporation, its aluminum manufacturing division, in 2015. The separation finished in 2016. The parent company rebranded as Arconic and focused on materials for aerospace businesses. The new company, Alcoa Corporation, focused on aluminum manufacturing.

The parent company established several agreements, including the TSA, to facilitate the separation. However, the TSA planning and implementation involved several challenges, particularly for Arconic.

TSA challenges	Business outcomes
Inaccurate cost estimates	Alcoa Corporation’s separation expenses exceeded Arconic’s financial capacity due to hidden dependencies and overlooked market challenges. According to Reuters, Arconic reported significant losses at the end of Q4 2016 due to separation costs.
Unaddressed interdependencies	The pre-split company underwent considerable restructuring and reduced its smelting capacity, while both independent entities relied on joint production lines. This created extra challenges during separation.
Separation outcomes	Arconic suffered a net loss of $1.2 billion post-separation.Long-term combined liability of Arconic and Alcoa increased by 8%, while short-term debt increased by 15%.

Streamline TSA management with a VDR

According to Accenture, 80% of transactions that beat industry averages use technology to facilitate the process. These businesses leverage digital workspaces, including virtual data rooms (VDRs), for divestments and other complex M&A transactions.

Virtual data rooms are end-state solutions for M&A deals that add more clarity to the TSA process and reduce communication silos. VDRs also allow businesses to implement the best TSA practices in the following ways:

Centralize TSA governance. Let your steering committee collaborate with senior executives and TSA managers to create realistic and actionable agreements. Use a synced document repository, Q&A workflows, in-app messaging, and discussions to improve communications during the separation.
Track TSA implementation. Assign managers and collaborators, monitor TSA service execution, address issues, and manage fees in one system. Ensure process accountability and clean separation due to task workflows and full audit trail when the system records every action in the data room.
Ensure security and compliance. Avoid data breaches, manage third-party consents, and comply with data management standards during transactions. Use role-based access permissions, advanced encryption, and information rights management tools to protect sensitive information.

Key takeaways

A transition service agreement (TSA) is used in M&A when a selling company provides temporary assistance services to the purchasing company during the post-closing phase.
Businesses use TSAs in divestitures, spinoffs, and joint ventures.
TSA is an integral part of a complex deal when the sold business involves many interdependencies with the parent company.
Planning and drafting, signing, implementation, and termination are the main stages of the TSA process.
The best TSA management practices include establishing a steering committee, setting realistic timelines and expectations, and carefully outlining TSA and non-TSA services.
Common TSA implementation challenges include vague service descriptions, inaccurate cost estimates, inflexible TSA terms, and unaddressed interdependencies.
80% of transactions show better outcomes when virtual data rooms are involved.
Virtual data rooms help companies implement the best TSA management practices with centralized workflows, performance tracking, and top-notch security.