Last Updated on February 20, 2023 by lukesguide
Even if you have been in the online business space for a while, buying a new business requires a lot of time to ‘learn the ropes’ and get up to speed on how the business operates. This is where a Transition Services Agreement (TSA) comes in handy!
Depending on the complexity of the business and any prior knowledge or experience you have, the transition process can take many months (even years!). New business owners don’t have a lot of time to get up to speed as any business disruption during the transition phase can result in lost customers and lower profits so it makes sense to get some help.
If only there was a way to pick the brain of the previous owner while you are finding your feet with the new business… well the great news is there is!
Savvy business buyers will, as part of the deal, enter into a TSA with the outgoing seller so that they remain with the business for a short period after closing the sale. The buyer can then learn the ins and outs of the business from the person that knows it best!
A Transition Services Agreement (TSA) can be a tricky legal document to get right but after reading this article, you will have a good understanding of:
- what Transition Services Agreements are;
- when you would use a Transition Services Agreement; and
- what terms should be included in a Transition Services Agreement.
A Transition Services Agreement is a legally binding contract between the seller of a business and a buyer, that sets out the key terms and conditions under which the seller will continue to provide support and expertise to the new owner to facilitate a smooth transition.
Think of a TSA as similar to a typical consultancy or services agreement. The vendor, as the previous owner of the business, has knowledge and expertise relating to the business that the new owner does not have.
Without a TSA, the new owner would ordinarily be on their own to figure out how everything in the business works (unless there are employees that come with the business to assist with this).
Under a TSA, the previous owner acts as a service provider and provides transitional services to the new owner to help them succeed in their new business.
Now, it is important to realize that the seller does not do this out of the goodness of their heart.
In most cases, the seller will earn a fee for their time to provide their services.
If the buyer and seller have agreed to an earn-out, it is in the best interests of the seller to help ensure the business continues to thrive so that any earn-out milestones are met as soon as possible.
A Transition Service Agreement (TSA) can be used in any situation where a business, company or asset is being acquired. The terms of the TSA are usually negotiated at the same time the terms of your asset or stock sale agreement are being agreed.
The reasons for entering into a TSA are different for a buyer and seller. Here are some examples of why a buyer and seller would use a TSA.
If you are a buyer coming into a new business, you will need some practical guidance on how the business operates once you take over.
Even if you are an experienced operator, every business is different and has its quirks. This means that there will be a learning curve when getting started and there are benefits to having a TSA in place.
How steep this learning curve is will depend on how much expert knowledge of the business you can siphon from the outgoing owner.
Think about a TSA this way – if you are buying an expensive piece of machinery for your business that you have never used before you would want an instruction manual or training provided so you aren’t sitting there scratching your head trying to work out how to use it.
Under a TSA, you can stipulate exactly what you want to learn about the business, for how long, and for what cost.
Whether you agree to a TSA is just one of the many questions a seller will need to ask themselves when selling their business. If you are a seller, you may have different motivations for wanting a TSA in place.
Most sellers want to see their old business continue to grow and succeed. After all, many business owners have poured their blood, sweat, and tears into their business and often consider their business as their ‘legacy’.
As further motivation, some sellers may have agreed with the buyer that they will be paid an earn-out or other deferred consideration in the event that the business reaches certain performance milestones within a few months or years of closing the deal.
In this case, it is in the best interests of the seller to get the new owner up to speed as quickly as possible so there is little disruption to the business that could potentially result in poor financial performance.
This is important as most earn-outs are tied to certain business growth milestones or financial metrics being achieved after the new owner takes over.
Your advisors will be be able to help you determine whether a TSA is a good idea or not.
The appropriate terms to be included in a TSA will depend on what is agreed between the buyer and vendor.
The key elements included in TSAs are:
- scope of services;
- standard of services;
- fees and payments; and
- intellectual property rights.
We provide more detail on each of the key provisions below.
The scope of services clause in a TSA is crucial as it sets out details of the provision of services by the vendor.
The scope of services to be provided will need to be agreed upon by the buyer and vendor. Depending on the type of business and the experience of the buyer, the vendor’s role as a service provider may be very hands-on or it could be passive.
For example, a passive role may involve the vendor being available by email or phone to answer any ad-hoc queries as they come up. The vendor may also be required to point the buyer in the direction of other service providers used by the business with certain skills or expertise.
Alternatively, an active role may include the vendor working alongside the buyer in the business office and showing them the ropes over the course of several weeks or months.
The duration of the TSA will depend on the specific needs of the buyer and also the period of time the seller is willing to provide.
The parties will need to agree on an appropriate duration for the TSA upfront and make sure this is reflected clearly in the service agreements. The duration could be weeks or months.
The applicable standard of services to be provided by the seller should be defined in the TSA.
As a buyer, you want to ensure that the seller will act in a manner that is reasonable in the circumstances and that they take due care when providing their services. You will also want to prevent them from doing anything that could potentially harm the reputation of the business going forward.
The standards that you will hold the seller to should be explicitly set out in the TSA. The ability to terminate the TSA and claim damages should also be included should the seller fail to meet these standards.
Unless the provision of services by the seller was agreed as part of the purchase price payable under the transaction, the service provider will normally expect to be paid a fee for their time or as a minimum, be reimbursed for any reasonable expenses.
If there is a service fee payable, the exact details of this fee, including the amount, frequency, and payment method should be set out clearly in the TSA.
It is often the case that during the course of services being provided under a TSA, new intellectual property is created.
It is important that the TSA includes provisions that make it clear that ownership of any new intellectual property created during, or related to, the provision of the services vests in the buyer.
If you are buying a business, it is worthwhile learning as much as you can from the outgoing seller to flatten your learning curve and hit the ground running.
Have you used a TSA before? Was the seller helpful in helping you hit the ground running with your new business? Let us know in the comments.