Mark Herndon, Chairman of the M&A Leadership Council shares part two of this series covering key requirements in supporting the buyer post-close and optimizing the Seller’s remaining business for maximum value when divesting a business.
Last week in our first installment titled “Separation for Success – Divesting for Maximum Value,” we covered how to master the divestiture process by upgrading your pre-sale planning approach and the importance of playing both “offense and defense” in when preparing a business to be divested. Today we dig into the all-important transition services agreement (TSA) and the vital need to optimize the seller’s remaining business post-divestiture.
- Nobody Wins a TSA War.
A transition services agreement is a contractual agreement that obligates the seller to perform various services for the buyer of the divested business until they can independently operate those corporate services. A TSA typically has two fundamentally different but equally important components. First, the legal contract is typically developed by the deal teams and lawyers as a part of the LOI or definitive agreement. Much of the contract language is standard and includes components such as governance, issue resolution, incentives / penalties, extension and exit provisions, and other essential legal terms and conditions. Second, the detailed functional scope of services is typically developed by joint teams comprised of the buyer and seller functional and cross-functional SMEs and includes the comprehensive descriptions of actual services, solutions, data, reports, advisory input, facilities, contracts, cost basis, and duration of each service.
TSAs, by definition, are complex. Conflicting motives between buyer and seller tend to further exacerbate potential TSA disputes. For example, a seller typically wants the shortest, simplest, and lightest TSA possible, often preferring limited extensions or scope increases. Conversely, a buyer may sometimes need longer, more extensive TSAs to ensure business continuity, with flexibility to extend and expand within reason. As a result, disagreement is inevitable, and the seller’s willingness and ability to effectively support a TSA often starts low at closing and tapers off quickly from there. One recent client, an experienced divestor, summed up their recent TSA experience this way. “During our largest divestiture, we were good friends with the buyer’s team when the TSA started, but by TSA exit, we were in all-out trench warfare.”
To avoid going to battle in your next divestiture, we suggest the following insights:
- Clarify what’s in or not in the deal. When preparing a business for sale, the Seller bears the initial responsibility to clearly define “the four corners of the deal,” including clear identification of all specific assets intended for sale. A foundational component of the TSA includes spelling out not just hard assets, but solutions, processes, data, people and/or special know-how needed to successfully run the business, and whether each element is to be included in the sale or not.
- Determine the Day-1 operating model. For any required process, personnel, solution, contract, etc., that is essential to run the business but NOT coming over in the transaction, the buyer must then determine how they will operate that component beginning on Day-1. This requires some creative problem solving – TSAs should be viewed as the exception for items that cannot be effectively cut over to the buyer on Day-1, as opposed to the default position for everything.
- Develop TSA requirements. For any services, processes, or personnel that the buyer cannot operate on Day-1, a TSA is required to bridge the gap between transaction closing and operational cutover of that item or component. This is where the real fun begins and for each bona fide TSA requirement, expert SME teams will need to actively collaborate to draft scope, define terms, clarify who provides each service and how that service is provided.
- Remember the “where is / as is” rule of thumb. Along this journey, remember that scope creep is the enemy. The most important success criteria, for buyers and sellers, is the fast and effective cutover of required services. Accordingly, both parties need to stay firmly fixed on the “where is / as is” rule of thumb that states: transition now with what the seller uses – optimize later.
- Optimize the Seller’s Remaining Business
Let’s face it – once a divestiture sale closes, there’s a natural tendency for executive focus and accountability to immediately shift to other urgent priorities and let the seller’s remaining post-sale business continue a “business as usual” basis. Unfortunately, that’s a huge mistake – as the real value creation phase is only just beginning.
There are three mission-critical requirements at this phase of every divestiture that, if done well, will take your results from good to great, but if done poorly, there will be hell to pay with analysts and stakeholders who fully expected more. Speaking of hell, we must first acknowledge the sheer fatigue that the seller’s divestiture team will be experiencing at this point. Executing well across the entire divestiture lifecycle can be hell. But as Winston Churchill once famously said, “When you are going through hell, keep going!” That’s exactly what the best divestors do post-closing – they keep going by relentlessly driving value in these essential ways.
- Strategic use of net proceeds. Frankly, this step is a given… nothing more than table stakes. If you reinvest divestiture proceeds to acquire faster growth and higher-margin businesses or strategic, transformative technologies; reduce debt, conduct share buy-back programs and the like, you will meet – but not exceed -- analyst expectations.
- Optimize separation and transition costs. Industry studies vary widely based on multiple factors, but most sellers should anticipate spending 1-2% of total enterprise value on transaction costs alone. Typical estimates include only the pre-close and post-close fees and direct spend (not overhead allocation or budgeted payroll!) required to shop and close the deal – and to support the seller’s baseline TSA requirements. Separation costs substantially above typical industry norms will invariably attract analyst scrutiny.
A more complex and often perplexing challenge is that of stranded costs. These costs consist of personnel, infrastructure, systems, applications, vendor contracts and overhead costs that are no longer needed as a part of the seller’s organization at the termination of the TSA, thus “stranded.” The challenge is that most sellers defer or delay thinking about or planning effectively for this enormous risk until far too late in the TSA, then they screw it up. This is further complicated by the harsh reality that due to the seller’s reduced revenues immediately post-sale, the sustained TSA and stranded costs disproportionately impact costs as a percentage of sales, once again coming to the attention of analysts and potentially impacting share price performance. This doesn’t just take expert financial engineering – it takes highly attentive leadership and superb change management to anticipate, plan effectively, set expectations, and genuinely do what’s right to take care of those seller employees that will no longer be needed after the TSA terminates.
- Seller performance improvement initiatives. Industry studies generally indicate that only about one-third of all sellers accomplish the one thing that is almost single-handedly responsible for driving the biggest and most important post-closing financial and operating performance improvements. As stated simply by one recent M&A Leadership Council training participant, “With divestitures, first you have to transition – but then you have to transform.” To take your value-creation results from status quo to “game-winner” status, once past closing stage, divesting executives must aggressively and strategically drive the right portfolio of internal transformational efforts. The kicker? Data shows you typically have no more than 6-24 months post close for executing these transformation initiatives to fully capture intended value.
The nature and scope of performance initiatives vary widely by company and industry. For one, it may be digital transformation, automation, and CX. For others, it may be further restructuring and business turn-around. Or, it may be outsourcing non-core services and doubling down on product innovation for yet others. Regardless of which performance improvement initiatives your company may need most, this strategy is endorsed time and again as “how the best divest.”
Separating for Success -- The Secret Sauce
Executives often ask us during various M&A Leadership Council events what we look for as the most reliable predictive factors of optimal divestiture outcomes. Answering that truthfully and transparently requires rising above the mechanics and lessons learned so prevalent in the literature. Those are all valid and important, but not the secret sauce.
In our view, there are three critically important and highly strategic ingredients that comprise the secret sauce of separating for success.
1.) The extent to which the seller views divesting not as a one-off transaction but as a business process for improved results and as an enterprise capability. An enterprise capability is built on components such as those described in this text, for example, a lifecycle framework, solid program governance, an effective and flexible playbook, a long-term viewpoint, training for the internal team charged with planning and executing the transition, and a commitment to make both the transaction and the post-sale businesses truly successful.
2.) Appropriate levels of internal and external resources that are dedicated to the divestiture planning, transaction, and post-sale objectives. It is important that they have been trained effectively to drive all aspects of the effort, including superb program management, functional and cross-functional expertise, and outstanding, proactive change management. Without appropriate resourcing, many divestitures have been doomed from the outset.
3.) And most importantly, insightful, experienced executives and advisor teams to effectively architect the vision and govern wisely over the multitude of complex decisions needed. This will ensure continued focus on the next right actions from end-to-end.
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Did you miss Part One of this installment?
If you missed last week's Separation for Success: Divesting for Maximum Value, read it now. Ready to take the next step in divesting for success? Register for our upcoming training, The Art of M&A Divestitures & Carve-outs. This training will be held online, September 14-16th.
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Mark Herndon, serves as Chairman and CEO of the M&A Leadership Council, and specializes in M&A strategy, due diligence, integration management, enterprise communications and leadership during periods of disruptive change. The M&A Leadership Council is an educational consortium of global professional service firms, experts, and corporate practitioners in the art and science of mergers, acquisitions, divestitures, and joint ventures. Over the past 12 years, the M&A Leadership Council and its partner organizations have trained over 4,500 executives, representing over 800 best-in-class companies from every major industry sector. The M&A Leadership Council actively supports corporate executives and M&A practitioners through a variety of proprietary research initiatives and publications, online and onsite training programs, best practices, and an industry-first certification for corporate M&A practitioners, the Certified M&A Specialist (CMAS®).