While the structure of the traditional software license has remained constant, the business approach of licensors and licensees has changed in significant ways over the past two years. Advances in technology have provided flexibility in the ways that software can be distributed, which has led to changes in the focus of license negotiations. Also, with the tight financing market, companies are turning to strategic licensing arrangements as financing alternatives. The standard off-the-shelf licensing deal for an emerging company is becoming increasingly rare. This article summarizes some of the changes we’ve observed.
First, customers now are exercising far greater control over the licensing transaction. Along with driving harder bargains, licensees are savvier technology purchasers having gone through the Y2K and Internet frenzies. They’ve also seen the problems caused by on-line services going out of business overnight and mission critical application providers falling into bankruptcy.
Second, users often want the ability to switch from a traditional license (where the customer takes possession of the application) to an ASP license (or vice versa) during the course of the license. As a result, the agreements for these transactions need to cover the variety of concerns that arise under both the traditional license and ASP relationships. It is important to remember that these two types of relationships are very different. For example, the licensor may have significantly fewer support and maintenance obligations when providing a traditional license than when acting as an ASP. When preparing agreements for these transactions, it is essential to match the major licensor obligations, including the support, warranty and indemnification terms, with the particular form of use of the application.
Third, even with lower priced products, licensees are focusing on maintenance and support levels and response times, and are requesting enhanced warranty coverage. For ASP services, data security has become a significant issue. ASP customers often require the right to perform security audits, and as a result, some of our clients are now including security audits as part of their standard service package.
In contrast to these pro-user positions, we have seen licensees consistently agree to more limited IP indemnification. Traditionally, licensors were expected to provide very broad IP infringement indemnification. Patent infringement was the greatest concern for licensors since this could be unintentional and a claim could arise after a product had been on the market for years. However, licensees now seem more willing to limit the scope of patent infringement indemnification. Limitations that we have found to be acceptable include indemnifications for patents, and in some cases only US patents, issued, or of which the licensor was aware, as of the date of the license.
Customers also seem far more concerned with the financial stability of technology providers. Financial due diligence of early stage licensors has become a common part of the software sales cycle. This is particularly true in mission critical software purchases and where emerging companies are engaged in transactions with large customers.
Finally, with the tight angel and venture capital markets, emerging companies are being forced to look for other sources of capital. Strategic investors have been a viable alternative; however, equity investments from these sources are significantly down. As a result, we have seen more companies turning to strategic source code licenses as a financing alternative. Under these arrangements, the licensor demands a license fee that is significantly higher than an object code license. A source license may lessen a purchaser’s concerns about the financial stability of the licensor, and provide licensees significant flexibility in adapting the application to its particular needs. Although these arrangements may only be appropriate for certain companies, in the right situation this can be a good financing alternative for an emerging company.
TLB Commentary: We are seeing a pick-up in licensing, but buyers are still being very careful. We believe that technology purchasing will continue to increase in the coming quarter, but licensees will continue to exercise significant leverage in their license negotiations.