Transitional services agreement
M&A / Merger ModelThe contract under which a seller keeps providing shared services to a carved out business for a defined period after completion.
Also written: transition services agreement, TSA
Most carved out businesses run on their parent's infrastructure: one payroll, one accounting system, one IT network, one insurance programme, sometimes shared procurement and facilities. None of it transfers automatically, and without a replacement the business cannot pay its staff or close a month end on day one. The transitional services agreement is the bridge.
Three terms are negotiated hardest, each for a reason. Scope and service levels, because the seller's staff have every incentive to prioritise the business the seller still owns, and a vague service level is unenforceable exactly when it matters. Duration and extension rights, because separation almost always takes longer than planned and whichever party lacks an extension right is the one exposed. Pricing, usually cost based and frequently stepping up over time, which is deliberate: rising charges give the buyer a financial reason to migrate rather than settle in.
Services sometimes run the other way as well, where the divested business operates something the seller still needs. Those reverse arrangements are easy to overlook in a first draft and awkward to add later.
The modelling trap is the one diligence looks for specifically. The charges are not all one off. The portion paying for a service the business will need permanently belongs in the run rate cost base, and only genuinely temporary duplication is a separation cost. Pushing the whole charge into one off costs flatters run rate EBITDA.
Weak agreements are a recognised source of value destruction after completion, because the failures they produce, a missed payroll run, an IT outage, a broken reporting cycle, arrive exactly when the business is least able to absorb them.
Worked example
A buyer assumes twelve months of transitional services at 4 a year, then its own systems at 6 a year. Illustrative figures.
Separation takes eighteen months and the price steps up in the final six. The overrun is a real cash cost, and the 6 of permanent replacement cost should have been in the run rate from the start.
Treating the whole 4 as a one off separation cost would have overstated run rate EBITDA and, at any sensible multiple, the price the buyer could justify.