In today's economy, companies often look to each other for ways to leverage their respective strengths to maximize shareholder value. These relationships may lead to asset acquisitions or divestitures in the typical merger and acquisition (M&A) context or to outsourcing alliances.
While these two types of transactions share similarities, they raise substantially different issues from a legal perspective. In both transactions, assets and human resources move from one entity to another; local laws and regulations related to the sale of a business may be triggered; and new acquisition vehicles may be created. Here the similarities end, as outsourcing transactions are principally service-provider relationships.
True, many asset acquisitions involve the conclusion of a "transition services agreement," where the seller provides the purchaser with key services (e.g., financial, payroll, technical, administrative) for a defined period of time post-closing. However, the main purpose of an asset acquisition in the typical M&A context is not the continued provision of services to the seller. Further, in an outsourcing transaction, the provision of services flows from the purchaser of the assets to the seller; rarely does the purchaser become a service provider (even for a limited transition period post-closing) to the seller in a typical asset acquisition.
The above raises the following interesting distinctions between asset acquisitions and outsourcing transactions.
Service Level Agreements
As a service-driven transaction, outsourcing generally involves delivery obligations that are basically the opposite of a typical asset acquisition. The party delivering the outsourcing services acquires assets (including hardware, software rights, rights to access premises and employees) from the party receiving services for the purpose of delivering the services to buyer. The outsourcing agreement will generally specify the respective delivery obligations in detail. In particular, the buyer usually demands inclusive service definitions, whereas the service provider usually demands that the services be defined with particularity and that changes be handled through scope change procedures. Service delivery is measured against performance standards, generally referred to as "service level commitments" or "service level agreements." A typical asset acquisition does not address such issues in any detail.
Term and Termination
Since the asset acquisition in the outsourcing context is derivative of the service obligation, from the perspective of the service provider, it is important to not only identify the scope of service but to also limit the buyer's ability to insource or otherwise manipulate changes to the service level commitment. The acquired assets are a necessary component of the transaction, but their value to the service provider is tied to the continued performance of services by the service provider. This raises term and termination issues that are not typically present in an asset acquisition.
In the outsourcing transaction, the service provider uses the acquired assets to provide services to the buyer. While the diligence performed by the service provider in anticipation of the transaction must focus on the value of the assets to be acquired, the outsourcing diligence must also focus on performance obligations. For example, the service provider must also perform diligence to validate the assumptions made in its proposal to the buyer. The scope of the diligence is, therefore, heavily focused on the delivery of the services that the buyer currently receives using the to-be acquired assets. This is not a principal focus of due diligence in the M&A context.
Most outsourcing engagements involve a transition period, during which delivery of the services is transferred from the buyer or its designee to the service provider. The transition period may run from three to six months, during which time the processes in place for the delivery of services may change. For example, the service provider may initially deliver services on-site and gradually transition to remote delivery.
Transition period considerations are different in the context of asset acquisitions. A "transition services agreement" is intended to make the purchaser operational as soon as possible after closing, such that the purchaser and seller will have limited contact, if any, following the conclusion of the transition period. By contrast, the transition period in an outsourcing deal is intended to facilitate the ongoing relationship between buyer and service provider.
During the transition period, affected employees may be offered positions with the service provider. While employee transfers (including key man provisions) are typically a component of asset acquisitions, the ability of the service provider to meet service performance obligations in an outsourcing relationship may be at risk unless key employees transfer along with the assets. In asset acquisitions, the purchaser may conclude limited-term employment agreements with the key employees, and such agreements are normally a condition to closing. While the continued employment of these individuals may affect the value of the purchased assets from the purchaser's perspective, it does not typically affect either party's ability to perform under the main asset purchase agreement or to fulfill any post-closing obligations.
Often, outsourcing transactions require that large volumes of data be transferred to and processed by the service provider for use by the buyer in its business. The transfer and processing of data may raise regulatory issues similar to those issues raised by an asset acquisition. However, the data use and protection issues tend to be more significant in the outsourcing context because the transferred data used by the service provider will often continue to be owned by the buyer. In a typical asset acquisition, the seller may require certain protections in the form of confidentiality provisions at the early stages of the transaction and during the term of the "transition services agreement," if any. However, these protections are in place for a limited term and are intended to facilitate the closing of the transaction and a quick post-closing transition, as opposed to being a key element of an ongoing relationship.
Outsourcing transactions typically include licensing and ownership provisions that reflect the fact that the buyer continues to retain ownership over key, value-add assets (e.g., proprietary technology, software, know-how and data), even though the service provider may have rights to use these assets during the term of the outsourcing arrangement. Allocating risk and responsibility for licenses and retained ownership provisions may not be as significant a component of an asset acquisition where the purposes of the acquisition is typically to permanently transfer rights from one entity to another.
Since the outsourcing transaction is intended to continue post-closing, the nature of warranties and indemnities are very different from an asset acquisition. In an asset acquisition, purchaser performs due diligence on the assets and relies on warranties and indemnities from the seller to protect its investment. Such warranties are typically given as of the date of closing and are not subject to later revision.
In contrast, the parties in an outsourcing transaction must structure the transaction so that each party has incentives to perform cooperatively post-closing. Not only does the buyer give warranties with respect to the assets, but the service provider makes commitments with respect to service levels, which may be subject to review and revision. This raises a different set of considerations from a typical asset acquisition, where the contract itself is less important as a roadmap for continued performance.
A key distinction between asset acquisitions and outsourcing transactions is ongoing service obligations and the potential scope for damages resulting from failed performance. In an asset acquisition, the seller's post-closing liability is basically limited to breaches of the representations and warranties made in the purchase agreement. If a "transition services agreement" is concluded, the seller normally indemnifies the purchaser for any direct losses caused by its gross negligence or willful misconduct in performing the transition services.
By contrast, the provision of services is the primary driver for the outsourcing transaction. Outsourcing raises direct damage concerns that generally do not arise in an asset acquisition. Because the outsourcing transaction contemplates service performance, outsourcing transactions generally raise insurance and risk allocation issues that are not present in a typical asset acquisition. Liability limitations differ in both scope and term in an outsourcing transaction.
There are a number of similarities between asset acquisitions and outsourcing transactions:
- Both can be of very significant scale (in terms of dollar value, geographical scope, market impact, industry change, etc.)
- Both may include asset acquisition components or "ongoing business transfer" considerations.
- Both require diligence prior to, and often during, negotiations.
On the whole, though, because of the ongoing operational aspect of the outsourcing transaction, there are fundamental differences from the asset acquisition that must be taken into account when structuring and implementing an outsourcing transaction.
Lessons From The Outsourcing Journal:
- The ongoing performance obligations of outsourcing transactions differentiate them from asset acquisitions, which are more "static" transactions that basically end at the closing.
- The parties in an outsourcing transaction address these issues through the use of service level agreements, termination indemnities and governance structures intended to protect either party from changes in these ongoing service obligations.
- Identifying and effectively addressing the differences between an outsourcing transaction and an asset acquisition is key to the success of an outsourcing transaction.
- Where the asset acquisition includes ongoing service obligations between the parties (i.e., under a "transition services agreement"), solutions used to resolve the issues raised by outsourcing transactions may be useful.
Michael S. Mensik is a Partner at Baker & McKenzie (Chicago office) and is the Co-Coordinator of the firm's Global Information Technology Law Practice. He can be reached at [email protected]. Helen Lukajic is an associate in the firm's Global Mergers & Acquisitions Law Practice. She can be reached at [email protected]. Peter R. George is an associate in the firm's Global Information Technology Law Practice. He can be reached at [email protected].