6 outsourcing questions to ask during an M&A

Merger and acquisition activity is at record levels, requiring selling companies to renegotiate outsourcing arrangements for their divested entities.

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Merger and acquisition deal announcements hit an all-time high of in 2015, from Anthem and Cigna to EMC and Dell. And experts expect robust M&A activity this year. But just as major mergers lead to major integration efforts for IT, they also spell significant work around outsourcing arrangements. In fact, the selling company is typically responsible for negotiating new sourcing services agreements before a divestiture is complete. 

[ Related: New IT outsourcing model boosts bottom line ]

Not only is the seller often obligated contractually to ensure that the divested entity can operate once it is removed from the seller’s IT infrastructure, “there is always a risk that the sale may be delayed or cancelled, and unless the seller negotiates the right to terminate the new agreement if the sale fails to occur or exercises its right to terminate for convenience, it is now contractually bound to receive those [IT] services,” says Derek Schaffner, an attorney in Mayer Brown's Washington DC office and member of its business and technology sourcing practice. What’s more, if the seller is actively involved in M&A transactions, the company will want to handle the issue of outsourced IT services well in order to maximize future sales prospects, Schaffner says.

[ Related: Acquisitions help IT service providers in India stay relevant ]

However, addressing outsourced IT contracts prior to a merger or acquisition can be tricky. There is often a lack of clarity around both the previous consumption of IT services by the divested entity and the future requirements of the purchasing company. Here are six questions the selling company must consider to do this well.

[ Related: 10 outsourcing trends to watch in 2016 ]

1. How accurate is your historical IT outsourcing information?

The volumes of IT services used by the divested entity may not have been measured individually, which can be problematic for pricing. For example, it may not be possible to discretely identify invoice volume in a finance and accounting deal. In such cases, the buyer and the IT service provider may ask for a period of time (typically six months) to develop a baseline of IT services volume followed by an adjustment in pricing at a later date.

“The seller should push to include contractual provisions that describe a formulaic method to set the new volume baseline,” says Schaffner. “If the new volume baseline is significantly higher, the new owner may be faced with a large one-time invoice. To the extent that the new volume baseline deviates significantly from the initial assumption in either direction, the provider’s solution may not be appropriately sized and the parties will need to engage in further contract negotiations which may increase the absolute price or the cost per unit price.”

2. Do you understand the buyer’s unique requirements?

“The buyer may have a different risk profile and set of policies that the provider will need to adhere to,” says Schaffner. However, the acquirer does not have any contractual standing to negotiate terms until the new agreement is assigned to them, and the seller is not always aware of the buyer’s specific positions. The service provider may be willing to accommodate changes after assignment, but bargaining power may be reduced at that point.

Schaffner suggests that the seller solicit buyer input upfront on key legal, commercial, and technical terms. “Subject matter experts of the acquirer should have the opportunity to vet the statements of work, service levels, and pricing since operational ownership will transfer to them after the sale of the divested entity,” he says. “Likewise, the acquirer’s legal representatives should be consulted to provide input on items such as liability caps, termination rights, and intellectual property rights.”

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