IT Transitional Service Agreements (IT TSAs) – how much are they needed?
Consider leveraging new technologies to accelerate separations
TSAs, especially IT TSAs, have been a ‘necessary evil’ for both buyers and sellers when closing deals for carve-outs before full separation could be achieved.
As IT systems are increasingly an essential part of a business, M&A teams often consider that the entire IT function has to be covered by a TSA lasting from 8-12 months, or even longer, depending on the complexity of the separation of systems. We argue that there are circumstances under which IT TSAs could be avoided.
Based on our experience, it is ultimately more beneficial to all parties of a transaction to complete the separation of the IT services, applications and infrastructure by the Closing date. This is because the typical complexities of IT TSAs create four major constraints for sellers and buyers:
1. The large amount of effort required, in terms of IT TSA governance and management, when neither of the parties are professional providers of IT services;
2. The legally-binding commitments of an IT TSA that lock in both the seller and the buyer;
3. The disproportionate operating costs of an IT TSA that neither the seller nor the buyer would incur in the normal course of their businesses; and
4. Limited control over systems and data under an IT TSA and reduced scope for change to the systems for the duration of the transitional arrangements.
A fundamental question that arises is how can IT TSAs be avoided? Is there a suitable alternative?
An increasing number of IT solutions are becoming available in the market that could be used to accelerate a separation of IT systems and a transition to a standalone IT estate.
The above solutions help accelerate separations, as there is no necessity to stand up physical infrastructure, which typically has long lead times and relies on external, specialised supply chain. Standard Cloud-based technologies are also instantly, or near instantly, available for adoption, configuration and training, however they typically require changes to business processes.
In addition, it is also possible to avoid a significant up-front investment to implement those solutions.
Outsourcing an entire IT environment or a significant part of it prior to Day 1, should allow the buyer to avoid the need to set up the hardware, which could take several months to acquire and configure.
The long lead time required to set up a network infrastructure and the core platform could be avoided and this should shorten the duration of any IT TSA that is considered necessary.
Each carve-out is unique and no two risk registers are the same. It is therefore recommended that M&A teams undertake comprehensive risk assessments when considering the route of no TSA. While the issue of deal confidentiality limits access to experts that can provide important input into such risk assessments, they often provide valuable insights and contribute to an appropriate selection of essential deal evaluation criteria. Moreover, they also provide an input into the feasibility, timing and potential duration of subsequent stages of a transaction.
To conclude, when considering a ‘no IT TSA’ option, business leaders should consider carefully the following issues:
- Date of Closing – “Will I have enough time to engage and to complete all IT separation activities in due time before the Closing date?”
- Level of entanglement of applications and infrastructure – “How complex would it be to separate applications that I’m using or to identify the servers that my critical applications are running on”
- Ability to provide early access to production data – “Will the seller/local regulation allow us to segregate and transfer data before the Closing date?”
- Ability to migrate into cloud-based or standard solutions – “Is there any technical limitation that would prevent a move to the cloud or to leverage commercial off-the-shelf (COTS) applications”
- Scope of the transaction – “Is whole or part of the current IT organization being transferred? What would be the effort to rebuild/outsource some IT activities”
- Target operating model – “Will the carved-out business operate as a separate organization and so justify investment in an independent standalone IT environment, or does the buyer intend to integrate large parts of the IT environment?”
In our experience, smaller carve-outs from very large entities realise greater benefits by avoiding TSAs, as it is typically easier to establish smaller standalone platforms. These benefits, combined with a total independence from the Closing date, outweigh the cost of having to re-engineer the separated entity’s business processes from ground up. Avoiding TSAs for larger entities continues to be a challenge. This is where we would always recommend that sellers do a thorough options analysis and a risk assessment before contemplating a deal, while buyer assess such options considering their existing environment.