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Transitional Services Agreements: Definition, Challenges & Solutions

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TSAs are used when an organization, or part of an organization, is sold to another company. After the sale, the selling company provides a set of services to the purchasing company for a determined period of time, often about six months, to ensure an orderly administrative transition. These services can include HR, IT, accounting, finance, and other relevant infrastructure needs.

TSAs create a smoother transition for buyers that do not have the means to immediately absorb all aspects of the acquisition. At the end of the designated period (often when the purchasing company establishes an entity), the buyer is in a stronger position to provide the administrative services to their employees that the seller previously provided.

What Is a Transitional Services Agreement?

A Transitional Services Agreement (TSA) is integral to the merger and acquisition process. A TSA is used when an organization, or part of an organization, is sold to another company to ensure a smooth and orderly administrative transition. After the sale, the purchasing company may receive a set of services from the selling company for a set period of time, including HR, IT, accounting, and financial services.

How Long Do Transitional Services Agreements Last?

TSA timelines can vary but are often six months in duration.

Common Challenges With Transitional Services Agreements

While TSAs are common, they are not always well-received by both parties. TSAs bring with them complexities and complications that affect both the buyer and seller; therefore, it is crucial to assess and negotiate the scope of its components as early as possible.

Challenges for Sellers

With TSAs, sellers must devote internal HR, payroll, and accounting resources to the process. This means that the transaction may close, but divestiture is not complete until all administrative ties are severed. In short, TSAs contractually link the seller to the buyer beyond the transaction close date. Other considerations include:

  • Sellers maintain liability and responsibility for employees that are no longer part of their team.
  • Sellers must divert internal resources to the buyer's employees. Hard costs vary between transactions, but "soft costs" like administrative burdens compound quickly.
  • The agreement creates accounting challenges, among other complications, which do not end in a "clean break." Accounting challenges include employees' compensation, benefits, and other essentials that are not carried on the seller's records as expenses since they are not the end employer. Undocumented expenses misalign department budgets and cause accounting reporting issues, as the seller's records are not set up to recognize these revenues and expenses.

Challenges for Buyers

Buyers must identify which services are essential and ancillary, the service standards, and the actual costs of the sellers’ services. Additionally, buyers have little flexibility during the TSA’s timeline, which can create additional tension in an already stressful process.

  • Buyers do not have 100% control over new employees and cannot hire new employees.
  • Buyers must rely on sellers to take on the liability of new employees, creating additional complexity.

Challenges for Both Buyers and Sellers

The transaction process leads to confusion for both parties' employees: Whom do they work for? When will they be integrated into the new company? The buyer is on a new path but is stuck in a legacy structure that can include HR, payroll, and other systems.

"One of the most common challenges when acquiring a company or part of a company is getting payroll up and running for transferred employees," says Saul Howerton, VP Advisory at Vistra, a corporate services firm specializing in international expansion and operations, private equity support, and more.

Establishing compliant payroll processes involves setting up a local bank account and creating a local legal entity such as a subsidiary or branch—which are far more time-consuming than many buyers assume. Because of these financial and legal restrictions, TSAs are often a last resort for buyers who do not have the administrative bandwidth to take on the employer functions required to onboard acquired employees. They are usually negotiated last minute as well. This causes:

  • A stressful situation for both buyer and seller
  • An expensive deal for the buyer, as they are forced to agree to terms in order to close the transaction
  • An ongoing relationship that neither party wants

As a result of these factors, it is, in many cases, not possible to fulfill the requirements to process local payroll in time for day one of a deal.

How an Employer of Record Assists in the Transaction Process

An employer of record (EoR) can help streamline the process, as it enables companies to complete the transaction without a TSA. This is especially true for sellers with employees in countries that are not at the core of the transaction or who need a simpler way to transfer low-headcount employee populations.

Depending on the specific transaction, local laws, and other factors, Vistra advisors recommend that a buyer use an EoR as a low-risk, preferable alternative to using the seller's existing payroll through a TSA.

"The buyer can use [EoR] while completing the steps needed to establish and run a payroll under the buyer's local company name," Howerton explains. "Once the bank account and legal entity are established, and payroll is registered, the company's transferred employees can move from [EoR] to the new payroll system."

Learn more: What Is an Employer of Record?

Streamline Your Merger or Acquisition With an Experienced Partner

Managing employee transfers, payroll, and other essential global M&A considerations is overwhelming for firms of any size—especially when drafting a TSA. Companies can bypass TSA complexities by partnering with an organization that offers proven alternatives, such as a global employer of record (EoR).

Velocity Global and Vistra have helped hundreds of companies navigate mergers or acquisitions and can support your firm in successfully completing your transaction—without a TSA.

Contact Velocity Global to learn how we can help you navigate your merger or acquisition with ease, speed, and compliance.

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