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52 Contract Management | January 2012
53Contract Management | January 2012
service agreements in merger and acquisition services
Services agreements are becoming more
important in mergers and acquisitions
(M&A) as companies increasingly rely
on external providers for critical
functions. Early attention to services agreements
in M&A planning, due diligence, and negotiations
can increase deal value for, and mitigate risk to,
both buyers and sellers. This article describes
best practices for buyers and sellers in
addressing services agreements in connection
with M&A transactions.
54 Contract Management | January 2012
Changing Business Structures Are Creating New OpportunitiesIntense cost pressures have forced com-
panies to reduce the costs of performing
services1 that support their core businesses,
such as information technology, human
resources, finance and accounting, procure-
ment, and facilities management. One
effective way to reduce those costs is to
outsource traditionally internal functions to
service providers that can offer both econo-
mies of scale and service delivery centers
with world-class tools and processes. Thus,
a company being bought and sold in an
M&A transaction (hereinafter referred to as
a “target company”) is increasingly likely
to depend on services being provided by
multiple unaffiliated outsiders.
The M&A practice evolved in an era when
“third-party services agreements” could
generally be ignored until the transaction
was nearly final. Even today, deal teams
often focus on the M&A transaction first,
leaving the services agreements and other
post-closing operational details until the
frantic rush to signing, or sometimes even
as a post-signing or post-closing item.2 In
many cases, the people who know what
services are needed and who can provide
them are excluded from the deal team until
very shortly before, and sometimes even
after, the M&A agreement is signed. As a
result, deal teams can sometimes miss op-
portunities to preserve the value of existing
agreements and mitigate the risk of leakage
of all or some of the transaction’s economic
benefits to a third-party service provider.
In this regard, there are a number of oppor-
tunities to increase deal value and mitigate
risk. These include:
� Existing third-party services agree-
ments used only by the target,
� Existing third-party services
agreements shared by the target
and the seller,
� Steps that potential sellers can
take to prepare for future M&A
transactions, and
� Steps that potential buyers can take to
prepare for future M&A transactions.
Existing Third-Party Services Agreements Used Only by the TargetIf the target of the M&A transaction is the
only business in the seller’s corporate group
using a services agreement, the easiest ap-
proach is generally to have the target contin-
ue using the existing agreement (and being
bound by the existing agreement) after the
acquisition. However, services agreements
often prohibit assignment or change of
control. Savvy third-party providers can, and
often do, use those prohibitions as leverage
to exact a price for the ease of continuing the
services agreement—particularly if the exist-
ing pricing is not favorable to the provider, or
if it is costly to replace the agreement.
Replacing an existing services agreement
creates operational risk and might be sur-
prisingly costly due to early termination fees
or minimum volume commitments. Simi-
larly, adding the target as a service recipient
under the buyer’s existing arrangements
may require lengthy negotiations with the
buyer’s third-party providers.
Replacing third-party providers on complex
or large-scale services agreements often
takes far longer than the M&A deal cycle
and may require the involvement of people
beyond the M&A team’s “circle of knowl-
edge.” Rushed negotiations may result in
substantial opportunity costs. In many
cases, better pricing is available to custom-
ers that have the time to identify their true
needs, conduct a robust sourcing process,
and make long-term commitments. For a
large-scale agreement for a critical service,
this process can take three to 12 months
from start to finish.
The current service provider’s leverage will
grow as the closing date of the M&A trans-
action approaches and the buyer’s options
narrow. As a result, there is a risk that the
current provider’s demands will grow with
its leverage.
Existing Third-Party Services Agreements Shared by the Target and the SellerIf the seller and the target both depend on
one of the seller’s third-party services agree-
ments, the target may be able to continue
receiving services from the provider as
a “service recipient” under the existing
agreement, even after the buyer acquires
the target. The seller would then invoice the
target or the buyer for the target’s allocable
share of the charges under the existing
agreement.3 This method has the benefit
of preserving the value of the existing
agreement, if it works. In considering this
option, the parties should address certain
questions, such as:
� Does the seller have the right to
designate the target or the buyer (as
applicable) as a service recipient? If so,
what are the associated costs (e.g., for
set-up or third-party consents)?
� Will the terms of the existing services
agreement meet the buyer’s needs?
� Does the pricing permit the seller to al-
locate charges to the target or the buyer?
� Will the buyer have the right to require
the seller to dispute charges or make
claims for damages under the existing
agreement?
� Will the buyer have the right to audit
the provider? (Audit rights may be re-
quired to comply with legal obligations
or the buyer’s policies.)
� Who prevails if the buyer and the seller
disagree on directions to be given to
the provider (e.g., with respect to in-
flight projects)?
� Which party will own the intellectual
property developed by the provider in the
performance of the services agreement?
� Will the seller be liable if the buyer fails
to comply with the existing agree-
ment? (The risks of adverse conse-
quences to the seller due to buyer
noncompliance will be particularly
service agreements in merger and acquisition services
Contract Management | January 2012 55
troublesome if the existing agreement is critical to the s
eller’s retained organization.)
� Will the seller be liable to the buyer if the service provider
fails to perform, or if the services are otherwise deficient?
In other words, is the seller responsible for its third-party
provider’s services, or is the seller merely managing and passing
through those services to the target or the buyer on an
“as-is” basis?
Another approach is to negotiate a new contract with the provider to
continue the service. This approach provides a much easier separation
between the buyer and the seller and allows the buyer to assess the existing
third-party provider against its competitors to obtain the most favorable pricing
and other terms. However, this may result in the buyer losing value because
the new service contract covers only its own volume. A new contract may
also cause the seller to lose value because it may pay higher unit prices under
the existing agreement (or even face termination or termination charges) because
of the reduced volume. Time constraints often make this approach impractical.
In some cases, there is an easy path to obtaining a new contract with the service
provider because the seller has a right to split the existing agreement in a way that
preserves its value (i.e., “cloning”). Or, the seller may be able to create two new agree-
ments that divide the service scope, revenue commitments, termination charges, and
other similar terms of the existing agreement (i.e., “cleaving”).
Cloning can have unintended consequences, however. For example, it might have the
effect of doubling minimum revenue commitments or of requiring the provider to
dedicate a specific person or asset to multiple customers. Thus, cloning is generally
used only for simpler services agreements.
Cleaving means reducing service volume baselines and minimum charges under both
the existing agreement and the new agreement. But it can also mean allocating
personnel, intellectual property rights, rights to dedicated assets upon a termina-
tion, and other key resources and assets between the existing and new agreements.
New projects may also be required to separate service delivery facilities, teams, and
reporting capabilities for the buyer and the seller; to decouple the seller’s confidential
information from the buyer’s confidential information; and to adapt to the buyer’s
unique needs or integrate with the buyer’s systems. Cleaving typically involves more
negotiation that cloning. The provider has likely scaled its service delivery organization
for the combined volume under the existing agreement. As a result, the provider sees
more economic benefit in providing services under two similar agreements, without
the costs of negotiating a new agreement, than in any increase in per-unit charges
that may result from the cleaving. At the same time, the service provider may see an
opportunity to obtain provider-favorable terms and pricing in return for continuing
to provide an essential service, particularly if the buyer has run out of time to find a
different provider.
Steps that Potential Sellers Can Take to Prepare for Future M&A TransactionsSellers can take steps to position themselves to maximize value and mitigate risk.
These steps include:
service agreements in merger and acquisition services
Contract Management | January 2012 57
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Contract Management | January 2012 59
� Developing an organization to support
divestiture activities, with an “M&A
playbook” and a staff for supporting
divested businesses;
� Maintaining a database of services
agreements and the businesses that
they serve;
� Ensuring that outside service providers
are committed to:
m Taking on work, shedding work,
supporting divested businesses,
and providing M&A support upon
request; and
m Permitting the seller to clone or
cleave existing agreements;
� Ensuring that outside licensors, lessors,
and similar third parties have agreed
to allow their software or assets to
support divestitures, at least for a
minimum time period;
� Including in the divestiture team, at
an early stage, the people who will be
responsible for arranging services to be
provided by or for the seller;
� Analyzing the target’s internal servic-
ing capabilities, the services the target
needs from shared contracts or from the
seller’s organization, any services the
target provides to the seller’s organiza-
tion, the costs required to provide those
services, the effect the divestiture will
have on the seller’s retained organiza-
tion (including pricing impacts under
existing services contracts), and how
best to provide the needed services; and
� Identifying projects under third-party
services agreements that the buyer
may not need and that should be put
on hold pending a transaction.
Steps that Potential Buyers Can Take to Prepare for Future M&A TransactionsBuyers can also take steps to maximize
value and mitigate risk. These include:
� Incorporating rights to expand services
and obtain acquisition support into
third-party services agreements;
� Developing an organization to support
acquisition activities, with an “M&A
playbook” and a staff with responsibil-
ity for supporting acquired businesses;
� Identifying in advance any services that
will need to be replicated or replaced,
as well as the means to mitigate the
impact of service failures;
� Documenting services and associated ser-
vice levels that the buyer’s own internal
services organizations can perform for
acquired businesses, and determining the
expected timing needed to bring those
services online for a target;
� Assigning to the acquisition team, at
an early stage, the people the buyer
will use to procure the needed services
from a third party;
� Commencing negotiations with third-
party service providers as promptly as
possible; and
� Leveraging best practices developed in
outsourcing and large-scale agree-
ments for critical services.
ConclusionDramatic changes in the ways that compa-
nies source core business functions require
timely, substantial attention to services
agreements in M&A transactions. Leaving
these issues to the end of a deal can cause
delays, squander value, increase risk, and
lead to disputes. The best time to begin
developing services agreements is well
before the target is identified. Integrating
the approaches described in this article into
contracting policies and overall M&A strate-
gies and approaches can help both buyers
and sellers to maximize value and mitigate
risks in M&A transactions. CM
About the Authors
MICHAEL MURRAY is a partner in the Cor-
porate and Securities practice of Mayer Brown,
LLP, and focuses his practice on mergers and
acquisitions, corporate governance, and gen-
eral corporate counseling. He represents buyers,
sellers, and financial advisors in connection
with public and private M&A transactions, joint
ventures, and similar transactions. He can be
reached at [email protected].
BRAD PETERSON is a partner in the Busi-
ness & Technology Sourcing practice of Mayer
Brown, LLP. His practice is focused on help-
ing large customers in business process and
information technology outsourcing transac-
tions. He is a graduate of the University of
Chicago Graduate School of Business and
Harvard Law School. He can be reached at
PAUL CHANDLER is counsel in the Corporate
& Securities practice of Mayer Brown, LLP, and
represents clients in connection with the out-
sourcing of information technology functions
and business processes. He also assists clients
that are working to develop, license, market,
distribute, and acquire rights in a wide variety
of technology related products, services, and
intellectual properties, including computer soft-
ware and hardware, databases, online services,
and telecommunications systems. He can be
reached at [email protected].
Send comments about this article to [email protected].
endnotes
1. In keeping with current terminology for strat-egy consultants and technology architects, this article uses the word “services” broadly to include back-office processes, functions, and capabilities, including all of the underlying people, systems, technology, facilities, and other resources, along with the set-up, opera-tion, and disengagement of those services.
2. In some cases, leaving service agreements to a later stage in the M&A process is a conscious decision driven by the seller, the buyer, or both. Factors such as confidentiality, the buyer’s famil-iarity with the target, limitations on internal resources, and cost can drive such a decision.
3. For simplicity, we are assuming that the existing agreement is between the third-party provider and the seller. Typically, the principles stated here would also apply if the agreement were between the third-party provider and the target.
service agreements in merger and acquisition services
