Transition Service Agreement: Definition, How it Works (+ Template)

The period during which a business unit or company is divested is fraught with risk for both parties to the transaction.

One means of managing this risk is the Transition Service Agreement (TSA), a legal document that provides buyers and sellers with a framework for the period between closing the deal and separating the businesses.

DealRoom helps thousands of firms streamline processes for divestiture transactions, and in this article, we look at TSAs and their role in divestitures.

Understanding Transition Service Agreements

Divestitures are rarely a matter of identifying an underperforming asset, division, or subsidiary and deciding to sell it.

More often than not, each of these is far more integrated in the seller’s business than they’re aware. Several divisions are likely to share the same information technology, head office functions, and distribution. Customer contracts are also likely to be affected. Effectively carving out what needs to be sold can be complex and time-consuming.

Negotiating this complexity begins during the due diligence phase, when companies determine the milestones that need to be negotiated to ensure a smooth transition of ownership. Once these have been drawn up, they can be articulated in the Transition Service Agreement (TSA).

The TSA is a contract, usually involving consideration, that outlines support services the seller agrees to provide to the buyer for a defined period after the transaction closes.

Once the broad terms of the TSA have been agreed upon between the seller and buyer, estimates are made of the deadlines, costs, and cost drivers for fulfilling each task outlined therein.

Both sides need to be realistic here. Overly ambitious TSAs can create more problems than they solve. Both sides then need to engage fully with the process: a successfully managed transition period can generate value for both parties.

Forward vs. Reverse TSA

A distinction is sometimes made between a forward and a reverse TSA; a forward TSA covers the provision of services from seller to buyer.

A reverse TSA, on the contrary, covers the provision of services from the buyer to the seller.

Although forward TSAs are far more common, anecdotal evidence suggests that reverse TSAs are also on the increase.

When a TSA is Needed

TSAs are most commonly used when it’s not possible to fully separate the parties' businesses at closing. They’re used to maintain the status quo during the transition period until the buyer is ready to run the business independently.

The most common scenario is a carve-out situation. A carve-out is when a business unit is being sold from a larger parent company.

Often in these situations, the seller will continue to provide certain services to the business being carved out for a limited period after closing, until the new, standalone company can operate on its own. Those services are usually operational support functions, such as HR, IT, accounting, and payroll. The carved-out company often doesn’t have its own infrastructure or standalone systems in place yet, so the TSA is used to maintain business continuity until it does.

TSAs are also frequently used in regulatory spin-offs, where licenses or regulatory approvals can’t be transferred to the buyer until after closing. In those situations, the TSA can be used to require the seller to continue hosting any necessary processes or systems until the buyer secures the required licenses and approvals.

TSAs are also used in private equity exits, where a fund sells a portfolio company that may need to rely on the seller’s shared services for a few months after closing, most commonly for support functions such as ERP systems, data migration, or cybersecurity.

Typical TSA Services and Duration

Transition service agreements usually cover core business functions that support day-to-day operations. Common examples include: 

• IT services, such as network access, email, security monitoring, software licenses, and data hosting/migration.
• Finance and accounting activities like accounts payable/receivable, payroll, general ledger, and reporting.
• Human resources operations, including benefits administration, recruiting systems, and employee records.
• Procurement functions like supplier management, purchasing systems, and contract administration.
• Facilities and logistics, including building access, shared office space, security, and mailroom services.
• Legal and compliance support for ongoing litigation, intellectual property, and regulatory reporting.

The duration of a TSA depends on the complexity of the separation. Standalone IT or HR support may only be required for three to six months.

More complex or integrated business operations may require a TSA period of nine to twelve months or more, such as shared ERP systems, supply chains, or cross-border legal and compliance functions.

Effective TSAs are as short as is reasonably possible. The longer the buyer is dependent on the seller’s infrastructure and operations, the higher the risk of delays, additional costs, and blurred responsibility. For this reason, both parties typically agree to an exit roadmap with defined milestones and handover deadlines upfront.

The table below breaks down the typical service areas included in TSAs and their typical durations.

Benefits of Transition Service Agreements

The benefits of transition service agreements are as follows:

• Smoother transition: TSAs ensure that the small details of transactions, which may once have been overlooked, receive the attention they deserve. This, in turn, leads to smoother transactions.
• Define what is being sold: Business units cannot be sold with ‘one leg in and one leg out.’ It has to be all or nothing. TSAs help managers focus on this concept by highlighting issues that could later destroy value if left unaddressed.
• Value generation: The clarity provided by TSAs generates value for both parties to the transaction. Ultimately, both sides want to return to operations as quickly as possible after the transaction, and a TSA facilitates this.
• Reduced risk: As outlined at the beginning of this article, reducing risk is one of the principal aims of TSAs. Ensuring that small details don’t become big ones reduces risk on both sides of the transaction.

Key Considerations for Drafting an Effective TSA

Among the issues that need to be considered when drafting a TSA include:

• Envision an end state: The seller (or buyer) should consider what the company's end state should be after the transition period wraps up. This will help when setting goals within the TSA.
• Budget accordingly: Remember that almost everything is a cost to the business to some extent—office space, executive time, and even casual Zoom calls between buyer and seller. Ensure that these are accounted for at the outset.
• Ensure contract clarity: ‘Project creep’—the risk of projects moving outside their original scope—dogs many TSAs. By ensuring clarity in the TSA, this can be avoided, and deadlines are more likely to be met.

Collaborate: Whether you’re on the buy or sell side, work with the other side. Everyone stands to create value from the TSA. Collaborating also enables the process to wrap up more efficiently.

TSA M&A Playbook/Template

When drafting a TSA playbook, our M&A Academy at M&A Science has already provided resources for companies going through a divestiture process and in need of TSA.

In summary:

1. Define what services would be required to manage business continuity from day one.
2. Check if the scope of services is appropriate.
3. Define measurables and auditable service levels.
4. Define the duration of services.
5. Check for regulatory and compliance issues.
6. Confirm for potential contractual issues with IT vendors.
7. Prepare indicative costing of TSA services.
8. Outline how governance would work post-close.

Get Your TSA Template Here.

Structure and Key Elements of TSAs

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