This alert discusses five key themes that drive negotiating and implementing sourcing arrangements in PE-backed companies. For each theme, we discuss the strategy, risks and negotiating considerations with a focus on legal, operational, financial and risk mitigation perspectives.
TSA – Planning and Exiting
Strategic Considerations
At closing, if the target is to be carved out of the seller, or had otherwise been reliant on the seller for enterprise business services, the target often relies on seller-provided TSA services. The scope of services varies but typically relies heavily on IT infrastructure, entangled software and data, financial accounting systems and the associated application support. Formerly shared resources, such as insurance, human resources, legal, compliance, regulatory efficacy, sales, marketing, branding and procurement, are frequently excluded from the TSA or provided on a limited basis. Leading up to signing, in the case of sign and close transactions, or otherwise between the signing date and closing date, the buyers must negotiate the TSA with the seller and meanwhile provide replacement shared services for any function excluded from the TSA. Carveouts initiated by “strategic buyers” are planning to acquire the target, “roll it up” into a larger enterprise, and leverage the acquiring firm’s shared services for the target. Carveouts intended to be “stood up” as a stand-alone entity present additional challenges given the often-short time frame of three to nine months between signing and close.
Providing for the shared services in advance of closing requires expedient yet careful vendor engagement by the PE sourcing team. Any function excluded from the TSA must be stood up or provided for by the buyer prior to closing or the announced deal may be delayed or possibly cancelled. Meanwhile, the TSA must address ongoing utilization of enterprise systems not excluded, including the related support and operational functions. The TSA will specify the price of every “rented” service and a spectrum of exiting timeframes, typically from six to 24 months in duration, depending on the complexity of the entangled infrastructure. The extent of carveout entanglements may also require reverse transition services from the target to the former parent enterprise for some period of time. This occurs when the carveout target has been providing intracompany services to legal entities remaining with the seller. Although outside of the scope of this discussion, careful consideration by the PE is required to determine if or to what extent the target or PE is prepared (with appropriate resources) to render these services.
TSA services are often expensive, inflexible and operationally fragile with potentially degraded performance quality (and accountability) because the entangled technology starts to age and the associated support staff start to attrit, rendering service level agreements (SLAs), if any, somewhat unenforceable or unachievable. As the TSA term progresses, a failure to execute a disciplined TSA exit through a carefully orchestrated plan to separate and migrate the services, can jeopardize business continuity and erode deal value. With the TSA serving as a bridge to operational continuity, the TSA must address both the day-one (post-close) “keep the lights on” services necessary to run the acquired business and a clear path to separation and migration of all key functions provided by the divesting enterprise.
Key Risks
There is no shortage of risks following closing, including day-one, fast follow (during the TSA term) and longer-term risks, which the PE firm must be prepared to address, including for example:
- Business disruption due to unidentified service gaps and incomplete or delayed separation;
- Failure to adequately stand up legal, compliance and regulatory systems timely and accurately;
- Loss of critical data, systems access or institutional knowledge due to attrition within the seller;
- TSA extensions at premium pricing and elevated one-time separation costs;
- Misalignment between the TSA term and vendor implementation timelines; and
- Limited cooperation from the seller due to the seller’s objective to minimize stranded costs associated with excess vendor capacity after closing
Negotiation and Mitigation Considerations
Front-end planning and organizational preparation is paramount to facilitate an effective and risk mitigated transition regime. While there is no single model for ensuring day-one operational continuity or expeditious and effective service exit, there are fundamental actions and guardrails that PE firms should undertake and implement to protect against costly service disruptions that could impair operations or impact the value of the acquired business, including:
- Early Identification and Procurement of Stand-Up Functions. The experienced sourcing team should know how to stand up insurance, human resources (including payroll and benefits), legal, compliance, regulatory efficacy, sales, marketing, branding and often facilities. Complex transactions will require procurement and configuration of laptops and networks that enable the transitioned workforce to remotely login to their former enterprise systems. A solid PE sourcing team can get this done.
- Parallel Planning Before Closing. The sourcing strategy should be developed pre-closing and ideally pre-signing. Even if stand-up contracts cannot be signed until post-close, vendor identification, scoping and implementation planning should begin during diligence.
- Granular Service Mapping. Inventory all services covered by the TSA, including shadow IT, data flows, shared licenses and third-party dependencies. Hidden dependencies are a leading cause of TSA-related issues. Importantly, the seller ordinarily must bear the burden of obtaining vendor consents for pass-through TSA services. Understanding that list of pass-through vendors and their role in operations is incumbent upon the buyer.
- Milestone-Based Exit Governance. Establish a cross-functional TSA exit management office with legal, IT, procurement and finance participation. Track exit milestones with contingency buffers. Early negotiation with the seller for exits that may exceed the base TSA term should be provided to the seller, as additional vendor consents may be required.
- Back-to-Back Protections. Where possible, align vendor implementation timelines and performance commitments with TSA expiration dates, preferably with sufficient schedule cushion prior to the required exit deadline to ensure stabilization of the impacted systems and services. The PE will also be well-serviced to include, where feasible, contractual credits for delays attributable to the vendor to foster accountability.
- Data Migration, Books and Records, and Access Rights. Ensure the TSA includes clear obligations for data access, format compatibility and transition assistance. Legal teams should verify data ownership and IP rights to avoid disputes. Typically, the seller is responsible for delivering data and physical records to the buyer, and the buyer is responsible for ingesting, converting, destroying or integrating the data into its systems.
A well-orchestrated TSA exit is both a risk management and value creation exercise. Delays or instability can impair revenue, regulatory compliance and employee morale. Yet an experienced team that can expediently stand-up day-one infrastructure, successfully negotiate a TSA, and drive TSA exits through timely migration to cost-effective replacement vendors and systems can measurably increase the value of an acquisition.
Commercial Terms – Structuring Scalable and Flexible Vendor Agreements
Strategic Considerations
Portfolio companies often undergo rapid change, for example through add-on acquisitions, divestitures, geographic expansion and digital transformation. Sourcing contracts must accommodate the dynamic environments in which most companies are now competing.
Key Risks
Even if pre-closing actions facilitate achieving short-term objectives by de-risking certain critical elements, longer-term risks and value-driven objectives require carefully orchestrated actions by the PE sourcing team. It is true that the service providers may well have the upper hand in terms of leverage at times, especially leading up to and soon after closing. However, an experienced PE sourcing team can tailor their efforts to address longer-term risks, including:
- Long-term (or medium-term) price lock-in, which as discussed below can be mitigated through benchmarking rights or scaled pricing;
- Inflexible minimum commitments;
- Inability to onboard acquired entities or carve out divested assets at scaled pricing; and
- Misaligned pricing models during growth or contraction.
Negotiation and Mitigation Considerations
Recognizing that there is no single elixir that will eliminate these risks, the PE sourcing team should pursue and range of structural and contractual levers that can ameliorate or avert downstream issues. Examples include:
- Modular Contract Structures. Use master agreements with scalable service schedules that allow services to be added, removed or resized with pre-ordained charging methodologies without renegotiating the entire contract or confronting the prospect of excessive or unanticipated change orders, which inevitably results in increased costs. Master agreements at the top-level legal entity should strive to cement pricing itself and all affiliates, including acquired subsidiaries, which could then execute simple order forms referencing the master.
- Volume Flexibility and Elastic Pricing. Negotiate tiered or usage-based pricing with clear adjustment mechanisms (such as unit rates based on volume bands other metrics, for example). Avoid rigid minimum volume commitments unless required for steep discounts or supported by a reliable expectation of significant growth. Concentrating offshore IT and outsourcing suppliers or offering rights of first refusal on new work can also yield discounts.
- Divestiture and Acquisition Flex Clauses. Include explicit rights to extend services to acquired entities and carved-out divested businesses. Address license portability, data segregation and assignment rights. Likewise, where possible, assign contracts down to subsidiaries about to be divested to improve pricing of an entity that is for sale.
- Termination for Convenience and Benchmarking. Termination rights, while potentially subject to exit fees unless carefully negotiated, preserve strategic leverage. Benchmarking clauses, deployed primarily for managed services, likewise create leverage by requiring automatic repricing, or a right to terminate without an exit charge, if the base pricing is substantially above then-current market rates or even the lowest quartile of rates for comparable services. To accommodate a case of termination for cause or convenience years ahead, a satisfactory transition assistance arrangement should be pre-negotiated. An experienced sourcing team can lead the extensive negotiations often required to achieve satisfactory terms and conditions related to termination of material vendors.
- Shorter Initial Terms with Extension Options. A shorter base term with unilateral renewal options, coupled with capped price escalations for the extension years, can offer an opportunity to balance price certainty and flexibility. Alternatively, longer initial terms can reap lower pricing. In either case, “auto renew” clauses with pre-agreed low inflation escalators can create value down the road.
The PE team and management executive team should view sourcing agreements as a component of their strategic capital allocation decisions. The legal and procurement teams must ensure the commercial structure does not constrain future value-creation initiatives.
Cybersecurity, Data Protection and Regulatory Compliance
Strategic Considerations
Cyber risk and data governance are board-level concerns and have become more acute with the emergence of AI solutions. PE firms face reputational, regulatory and financial exposure from portfolio company cyber incidents. Examples include:
Key Risks
- Data breaches or ransomware events;
- Non-compliance with GDPR, CCPA, HIPAA or sector-specific regulations;
- Weak third-party controls;
- Inadequate data classification and data loss protection controls;
- Inadequate incident response obligations; and
- Uninsurable or underinsured risk allocation.
Negotiation and Mitigation Considerations
Practically, it is often not possible or worthwhile to try to obtain full contractual protection for all cyber risk matters. An experienced PE sourcing team works closely with the vendor risk assessment team to understand and rank the risks across the vendor portfolio, then translates the ranking into “gives and gets” for each vendor. Larger, regulated portfolio companies and smaller companies willing to be early adopters of new vendors have more leverage. Given the cost of delays in terms of opportunity cost, it is sometimes best to select mature vendors or accept certain manageable risks and move ahead. That said, examples of preferred clauses include:
- Security Baseline Requirements. Contracts should include detailed security standards (e.g., NIST, ISO 27001) and technical controls rather than generic “commercially reasonable” language. Where applicable, contracts should specify access granting and termination protocols, timeframes and usage audit trails to accommodate an ever-changing workforce of users.
- Audit and Assessment Rights. At a minimum, contracts should include rights to receive third-party audit reports, such as SOC 2 Type II. The ability to test compliance is critical, but the requirement for on-premises due diligence has recently been mostly applicable to managed service outsourcing contracts given the rising predominance of SaaS technology. Additionally, if the service provider is a regulated company or a vendor of a government agency, audit rights are sometimes conceded in the interest of preserving pricing and implementation timeframes.
- Incident Response and Notification. Define notification timelines, such as immediately upon awareness or 24–48 hours depending upon the severity. Also agree upon cooperation obligations, and cost allocation for data recovery, forensic investigations and remediation. A common concession entails foregoing the right to receive notification regarding incidents of other clients of the vendor that do not impact security of the target or buyer.
- Data Ownership and Segregation. Clarify ownership of business and customer data, as well as derivative data. If the vendor reserves the right to distribute or use aggregated data across its customer, ensure that such data is anonymized and remains unattributed and unwatermarked. Clarify ownership and licensing rights of any co-developed source-code or operational processes. Require segregation in multitenant environments, secure the return or destruction of customer data upon termination in accordance with applicable data destruction policies and laws, and retain the associated logs.
- Cyber Insurance Alignment. Ensure vendors carry appropriate cyber insurance and align indemnification caps with realistic exposure levels. In the case of specific, high-risk, critical cyber events or data breaches, a “super-cap” (for example, 3X to 5X the base monetary cap on liability) has gained traction in the market. The super-cap, used in lieu of uncapped liability, is negotiated to balance the company’s need for heightened protection with the vendor’s or service provider’s financial risk tolerance. The PE procurement team should consider coordinating the portfolio company’s insurance coverage, particularly cyber policies, with the insurance coverages and liability caps of the vendor. Engaging with a high-risk, venture-stage vendor with limited financial resources may drive the need for a stop-loss policy at the portfolio company.
Cyber risk cannot be fully outsourced or eliminated, but it can be contractually managed. Legal teams must balance enforceability and practicality, while IT teams validate that security provisions are sufficiently robust and reflect a spectrum of operational realities. A portfolio company in the financial services, defense or health care sectors will have more stringent requirements than other less regulated or more risk tolerant industries.
Service Levels, Performance Governance and Accountability
Strategic Considerations
Operational excellence helps drive EBITDA. Poor vendor performance can negatively impact revenue, brand, productivity and customer retention.
Key Risks
- Vague or incomplete service descriptions;
- Weak or unenforceable SLAs;
- Insufficient remedies for chronic underperformance; and
- Lack of visibility into vendor operations through key performance indicators (KPIs).
Negotiation and Mitigation Considerations
Governance, continual engagement and partnering towards holistic performance are key to ensuring that vendors meet not only the contractual requirements, but also the ongoing operational demands of the company. Even strong SLAs, KPIs and service level credits are at risk of being somewhat ignored by ingrained vendors with high switching costs. Likewise, inexperienced sourcing teams sometimes give weak vendors a “free pass” in situations where the risk of declaring a breach and “upsetting” a long-standing, inexpensive vendor is deemed to be worse than slightly poor performance. A seasoned PE sourcing team can leverage the following tools to enhance and sustain vendor performance:
- Detailed Statements of Work (SOWs). Precisely define scope, deliverables, dependencies, and for deliverables-based implementations of system integrations, acceptance criteria. Ambiguity leads to disputes and change-order inflation and, in turn, cost overruns. PE sourcing teams can consider including an implied services or sweeps clause in both IT and other service agreements, ideally at the level of the master services agreement (MSA). These clauses encompass the functions, tasks and activities that are inherent in, or necessary for, proper delivery of the services but not expressly stated in a statement of work or schedule are impliedly included in (i.e., “swept” into) scope. This helps close potential gaps in scope thereby curtailing excessive change order requests.
- Meaningful SLAs and KPIs. Tie SLAs to business outcomes, not just technical metrics. For example, 24/7 system availability may matter less for some operations than transaction processing speed, response or resolution time for incidents or defect levels. The MSA should specify the periodic cadence for reporting the KPIs against the SLAs as appropriate for the service, such as quarterly, monthly and, in some cases, weekly or even daily.
- Governance Framework. Establish project-based and executive-level steering committees and operational review cadences. Governance should include periodic performance reviews, escalation procedures and, given the pace of technological change, innovation reviews. These meetings often serve as a catalyst for open communication at all levels, fostering a culture of working together on problem resolution, and of general partnership in the face of a changing surrounding ecosystem.
- Graduated Remedies. Depending on the magnitude of the available credit pool (anywhere from 8% to as high as 15% of the fees), service credits alone may be insufficient to incent and ensure service provider adherence to SLAs and performance standards. In addition to the SLA compliance meetings described above, contracts for material vendors should contemplate or require remediation plans for SLA defaults, step-in rights for critical failures and termination rights with transition assistance for chronic poor performance or repeated or uncured breaches.
- Change Management Discipline. Implement structured change-control processes to prevent cost creep, schedule delays and scope ambiguity.
For executives, governance over vendor performance ensures accountability. For procurement and legal teams, it ensures enforceable standards that preserve leverage throughout the contract life cycle.
Value Creation, Cost Discipline and Integration with PE Strategy
Strategic Considerations
Sourcing is not merely cost containment—it is a lever for digital transformation, operational efficiency and exit readiness.
Key Risks
- Over-customized or over-engineered solutions that impair future sale;
- Technology fragmentation across portfolio companies;
- Insufficient documentation for buyers at exit; and
- Hidden technical debt where future costs must be incurred to accommodate prior shortcuts.
Negotiation and Mitigation Considerations
Value-creation objectives cannot be realized through cost cutting or vendor pricing alone. Rather, sourcing arrangements must be structured to align operational execution with the PE firm’s broader investment strategy and exit horizon. A disciplined negotiation strategy should therefore balance short-term cost efficiency with longer-term scalability, integration flexibility and exit readiness. While there is no single contractual construct that guarantees value maximization, an experienced sourcing team works to employ a coordinated set of structural, commercial and governance mechanisms designed to preserve flexibility, promote standardization, and avoid embedded constraints that could impair future transactions or diminish buyer appeal. Thoughtful drafting at the outset can materially reduce technical debt, switching friction and transaction complexity at exit, thereby protecting valuation and enhancing strategic flexibility.
- Standardization Across Portfolio. Where appropriate, leverage portfolio-wide vendor relationships to negotiate better terms, including volume-based pricing, standardized security and compliance terms, and comprehensive termination rights, including for cause and convenience. Although master agreements cannot “group together” multiple portfolio companies, a solid executive relationship with key vendors can nonetheless drive the existence of an agreed upon set of negotiated terms applied across the portfolio companies. This both saves time and costs during contracting and leads to improved contractual results.
- Avoid Over-Customization. Although the ability to implement off-the-shelf solutions will depend, at least in part, on the inherited environment of the target, highly customized environments increase switching costs and may reduce buyer appeal. Additionally, it is unusual for a customized solution to outlast and outperform innovation within the vendor community for many years. When developing a sourcing strategy, an experienced PE sourcing team strives to procure and enable configurable, scalable platforms that offer the benefit of predictable performance and flexibility within a changing environment over time.
- Intellectual Property and Work Product Ownership. It is imperative that in-scope IP, including patents, derivative works and trade secrets, are transferred to the target acquisition or the PE buyers under the purchase and sale agreement. Likewise, if a service provider has provided its embedded IP to the target, vendor contracts should include unequivocal language granting the PE target a broad license to use that IP (i.e., a perpetual, fully paid up, irrevocable, assignable, worldwide license with rights to create and own all derivative works). Moreover, a clear and, preferably, minimally conditioned, vendor consent should be obtained in cases where the IP has yet to be separated from the seller’s infrastructure and thus is to be covered under a pass-through TSA.
- Exit Readiness Provisions. Material contracts should include assignment rights and cooperation obligations to facilitate the sale of the portfolio company. If possible, avoid change of control language that would reset any historical pricing to prevailing market levels or that would impose severe termination fees upon a sale. Also, the contract should require that, upon termination or expiration, the service provider provide transition assistance in the form or knowledge transfer, and cooperation with successor providers, such as delivery of data in common structured formats and the delivery of all pertinent documentation.
- Total Cost of Ownership (TCO) Analysis. When replacing legacy technology, consider implementation, transition, exit and termination costs, and not just headline pricing. For example, in the case of cloud migration from an on-prem solution, be careful to consider whether the purported financial and operational benefits of the new solution are achievable in the planned timeframe. Moving to a cloud solution may engender significant switching costs, and offers of steep discounts conditioned on a minimum spend have proven treacherous when the customer later discovers that it cannot achieve the full migration in a timely manner and hence must pay for services it is not capable of using.
Procurement and executive teams should align sourcing strategy with the PE firm’s target hold period and exit strategy. Legal teams should anticipate the questions a future buyer will ask.
Closing Thoughts
For PE firms, a robust sourcing organization is a strategic imperative—not an administrative function. The ability to stand up independent systems prior to closing for carveouts, negotiate and execute a disciplined process for TSA pricing, services and exits, and negotiate flexible and secure vendor arrangements, directly aligns the sourcing strategy with positive value-creation objectives.
The five key considerations discussed above require experienced and coordinated leadership across legal, IT, executive and procurement teams.
When implemented thoughtfully, disciplined sourcing can:
- Reduce operational risk;
- Improve cost transparency and predictability;
- Enhance cybersecurity protection;
- Support M&A flexibility; and
- Increase exit attractiveness and valuation.
In the dynamic world of M&A, particularly when driven by private equity, sourcing excellence is not optional but is foundational to sustainable value creation.
Cynthia Meyn is an independent transaction execution specialist focusing on financial services mergers and acquisitions. Previously, Cynthia served as executive vice president of PIMCO and managing director of Morgan Stanley, among other executive roles.