Transitional Service Agreement

John is president and founder of Stone Oak Capital Inc., an M&A advisory firm, as well as a co-founder of Divestopedia. For more than 20 years, John has served his clients on numerous valuation, acquisition and divestiture assignments in a wide variety of industries. John holds the…

What Does Transitional Service Agreement Mean?

A transitional service agreement (TSA) is a type of agreement that is made between the buyer and seller of a company. In this arrangement, the seller agrees to provide certain services to the buyer at a predetermined price. These services can include accounting, IT and human resources and their exact nature and scope are written into the sale agreement. TSAs can therefore provide necessary operational support to the purchasing company, which may not have the systems or framework in place to accomplish these tasks at this point.

The process of one company buying out another one is often bumpy and filled with potential pitfalls. The buying company may be taking a giant step forward in its business development by purchasing the selling company, but the selling company may have entire departments that are needed to run the company that do not exist at the buying firm. A TSA outlines the conditions of the transition until the buying company is capable of implementing these departments within itself.

Transitional service agreements are common when a large company sells one of its divisions or certain non-core assets to a less sophisticated buyer or a newly incorporated company where the senior management is in place, but the back office infrastructure has not yet been assembled.

A TSA can also be used during "carve-outs" where a large company spins out a division into a separate public company, and then offers the infrastructure services to its fledgling spinoff company for a defined period of time. A properly executed transitional service agreement can be likened to a family, where the parents of a grown child pitch in financially to help their child become established on his or her own.

As the name states, the whole idea is to facilitate the transition of ownership from one company to another so that the buyer has time to establish its own departments of services that are being temporarily provided by the seller.

Divestopedia Explains Transitional Service Agreement

Transitional service agreements can be extremely difficult to manage if they are not properly defined. Usually, poorly drafted TSAs result in disputes between the buyer and the seller centered around the scope of services to be provided. And in most cases, a well-crafted TSA will be custom-tailored to encompass the specific circumstances of each situation.

TSAs should ensure the following key points are fully defined:

• The exact scope and nature of the services that the seller will be providing for the buyer. This is one of the most vital aspects of the entire agreement. The agreement may describe the seller’s services as “reasonable, substantial and/or satisfactory” or some other similar legal phrase. Will the seller merely provide a routine level of services, or will it be authorized to resuscitate one or more divisions for the buyer if necessary?
• The exact names of all parties involved. If the seller uses a third party for certain services, will the buyer do the same? Will the buyer enter into an agreement with just the seller, or will a third party also be named?
• The fee for the general scope of services and additional charges for services beyond the scope;
• The term of the agreement and any available renewal terms;
• The dispute resolution mechanism to deal with discrepancies between the buyer and seller; and
• How the TSA will be transitioned once the buyer is able to assume the administrative responsibilities.
• The level of access that the buyer and seller will have to each other’s information and methodologies. Will the seller provide absolutely everything in its accounting division to the buyer, or just the key components? These details must be hammered out in the TSA.

In essence, a TSA basically says that the seller will help the buyer for a predetermined period of time. This type of agreement is ultimately a powerful tool that potential buyers can use to strengthen their position within their industry. TSAs allow buyers to essentially piggy-back off of a portion of the selling company until they get established on their own terms.