M&A Monday: The Delicate Balance of Transition Services
Negotiating Transition Services (Seller's post-closing involvement in the business) is a critical aspect of the business's success.
Buying a business is complex. Often, the keys to a business’s success are located inside the head of the seller. That is why a buyer must ask for seller to stay and work for a period of time after closing. This sounds simple, but is one of the most contentious aspects of a deal. If done right, it can also help get your deal closed.
As a young M&A associate, there were two stories that made me realize how sensitive and important TS is.
First, I represented a buyer on a deal where the seller was going to walk away with $80 million at Closing. $80 million. When we offered him an hourly rate of $250/hour for consulting services after closing, he flipped out. He said, “I have not worked for $250/hour in twenty years, I’m not going to start now. If you do not recognize my value, this deal is done!!” The seller wanted $350/hour and was willing to kill his deal over this perceived affront.
Second, when I check in with Buyers after closing, they consistently tell me that the sellers were way more critical than they represented during the sale process. At first, I thought sellers were hiding their involvement. But, in reality, I think sellers just do not realize how integral they are to the business.
Thus, I realized two things: (1) Sellers are very emotional about transition services, and (2) transition services are way more important than one would think.
Here is my guidance on navigating the TS discussion.
1. Use it to your advantage. Because TS is emotional, it can also be used to buyer’s advantage. Buyer can offer above-market consulting compensation to sweeten a deal. This should be expressed to the seller as a genuine desire to properly recognize seller’s value and your need for seller to partner help get you on your feet after closing. For example, offer the Seller $300k/year rather than $150K. Advantages: the cost is relatively low, the cost is borne by the company after closing, not buyer, and whether buyer keeps the seller on for the full year is in the buyer’s sole discretion after closing. Usually, overpaying for TS is the best money a buyer will spend (other than a good M&A lawyer, of course).
Including the broad strokes of TS in your LOI will help you win a deal over others who are going cheap on TS.
2. What is market? I generally see that 60-90 days of TS are included in the purchase price (i.e., free), and thereafter, consulting is at an hourly rate as needed. This will be extremely business-specific and depend on buyer’s experience and seller’s pre-closing involvement.
3. Change nothing, immediately. I often tell buyers, it is critical that the day after closing, seller comes into work as if nothing has changed. During the first days of buying a business, so many things will have to be done. You need seller to continue running the business and start transferring all the knowledge in seller’s head to buyer.
4. Buyer’s Discretion. Make sure TS is always in buyer’s discretion. Many buyers find that they prefer seller not being involved in the business for too long after closing. Seller can prevent cultural changes and interfere with changes. Thus, make sure that the TS can be terminated at any time only by buyer.
5. In the Purchase Agreement or a Separate Document? If the person doing TS is not the seller, there has to be a separate Consulting/Employment Agreement. However, if seller is doing the TS, it is best to put the terms directly in the purchase agreement. That is because if it is in the PA, it can be enforced as a breach of covenant, which usually has uncapped indemnity. Of course, a Consulting Agreement can be incorporated into the indemnifications by reference, but it is more clearly an enforceable covenant in the Purchase Agreement.
6. Give TS Some Teeth. Like everything, we have to think, how will this be enforced after closing? I have heard tons of stories of sellers who just checked out after closing and never answered the phone or came into the office. If TS is in the purchase agreement it can be enforced as a loss through the indemnification provisions. Sometimes, we can list specific consequences, for example, forgiveness in the Promissory Note if a breach of TS or earn out will not be paid.
7. SBA 7(a) Restrictions. If using an SBA 7(a) loan, the SBA requires (a) the seller to be a consultant, not an employee (i.e., no healthcare, benefits), (b) must not exceed one year, and (c) compensation commensurate with market rates. This does not apply in the new partial change of ownership structure.
Transition services are critical to your post-closing success and you should think about this early and use it to help make your deal more smooth from the outset.