Enterprise Software Licensing from a Legal Perspective

Selling to enterprise organizations provides extraordinary opportunities for software vendors - opportunities to either establish lucrative relationships with reliable customers, or create burdensome "one-off" deals that can cause your organization major headaches.

In every business relationship, a power dynamic exists. When small software vendors contract with large companies, the balance of power almost always favors the enterprise. Software and SaaS (software as a service) vendors can, however, minimize the friction in the procurement process by understanding recent trends in enterprise software licensing and following a few recommendations.

Licensing Trends in Software Procurement

Over the past several years, the software industry has witnessed a "bureaucratization of enterprise procurement," according to Stephen Gillespie, an attorney at Fenwick & West LLP who represents technology companies.

Typical of this bureaucratization trend, once a vendor makes an informal sale to a business unit within an enterprise, the vendor is then shipped off to the procurement department to negotiate and finalize the formal terms and price. Frequently, the internal advocate who made the initial decision to buy is not involved in the formal procurement process, which can put the vendor at a significant disadvantage during negotiation. The removal of the internal advocate from procurement occurs for a variety of reasons, most of which revolve around getting the best deal for the enterprise. Some enterprises may even have formal policies which forbid the internal advocate from participating in procurement.

Requests for proposal (RFPs) are also becoming more common when an enterprise is in the market for software. Under this trend, price is often negotiated during the initial RFP phase of procurement, while legal terms are negotiated second. Vendors are disadvantaged by this process, because after having offered a low price to get through the RFP process, vendors are then left with little leeway to negotiate price for terms during the legal negotiations phase.

In general, the terms and conditions in software licensing agreements are also becoming more onerous for the vendor. For example, some enterprises are requiring vendors to agree to Most Favored Nation (MFN) Protection clauses, under which the vendor guarantees they will give the enterprise the best price (and refund the difference if they ever sell at a lower price).

Other troublesome contractual terms that are frequently required by enterprises include:

  • Warranty Coverage: Enterprises are now requesting perpetual warranty coverage, as opposed to a limited coverage. When possible, vendors should try to impose the limits of time and types of events that trigger warranty coverage.
  • Limits of Liability: Enterprises are also making requests for "no caps" on liability, which is a huge threat to the vendor. This can affect the vendor's insurability, and may cause premiums to go up during the insurance underwriting process. Again, vendors should try to negotiate limits up to the value of the contract and/or for specific instances that trigger liability. When possible, vendors should strive for balance and reciprocity in these clauses by demanding the same protections and concessions from the enterprise.
  • Source Escrow Release: Here, enterprises request the vendor to put its source code into escrow, and release it to the enterprise in the event of contractual termination. While releasing the source code may be reasonable if the vendor goes out of business, it is not a recommended procedure to be followed for simple breach of contract.
  • Intellectual Property: Enterprises are taking a "we pay, we own" approach to vendor intellectual property. This attitude can cause a lot of problems for the vendor, because IP, arguably, makes up the lion's share of a software vendor's assets. On the other hand, an enterprise will rarely benefit from owning the vendor's code, trademarks, and copyrights. Vendors should be quick to point out this lack of benefit to an enterprise who wants to own the source code for their particular project.
  • Publicity: Increasingly, enterprises are cutting back on allowing vendors to announce deals or partnerships. Unfortunately for small software vendors, publicity clauses are an important way to establish credibility and grow business.

 

How Vendors Can Respond to the Trends

In light of the trends favoring enterprises, Gillespie recommends that software vendors can respond by following a few tips to help guide them through a difficult procurement process:

  • Build strong allies in the enterprise organization. Work the relationships. When you get to the procurement stage, try to get your internal advocate to attend.
  • Link price to terms so you can trade value. Use a written term sheet that establishes the price in relation to a few key terms that are important to you, such as warranty, publicity, caps on liability.
  • Always trade value for value, also called value-based negotiations. Basically, focus on and trade to obtain terms that are valuable to you. If the enterprise wants you to go down in price, tell them you can only agree if they agree to concede on something important to you.
  • Be willing to walk away. Understand the terms that you can absolutely not concede. Always be aware your "line in the sand." Usually, the enterprise will call you back the first time you walk from the deal.