Given the fact that we often get involved in M&A strategy and the occasional transaction in the sector here with one of our affiliates companies at Spend Matters, we have a bit of a privileged view into the universe of potential activity likely around the corner in coming quarters. Our current analysis suggests that the pace of M&A activity that began in earnest in Q4 2010 is likely to continue throughout 2011. For this reason, we think it’s imperative that procurement, legal and IT organizations prepare themselves for the chance that their current vendors might be acquired (some of our past advice and observations on the subject can be found here, here, here and here). Aside from coming up with the right general strategies and preparations for the potential takeover of the owners of your licensed (or rented) application assets, it pays, as my friend and colleague Brian Sommer recently pointed out, to look specifically at the opportunity that material change of control clauses present to reduce potential risks to your business and provide some reward based on your contributions to a vendor’s success at selling itself.
In the above-linked post, Brian asks the question: “should you be insisting on a material change of control clause in your contract/license? The answer is absolutely YES.” Essentially, Brian suggests, one structure for these clauses is to “require the vendor to refund monies based on how soon the firm was sold. The theory behind such a clause is like a sinking bond fund requirement: the longer you get to use and get value out of your software ‘investment’, then the lower your liquidated damages are. If the vendor is sold after ten years, for example, you may get nothing for damages as you got full value for your investment. However, if the vendor is sold within the first year of your licensing, shouldn’t you get something for all of those implementation fees, license fees and maintenance monies paid to get this now obsolete solution partially installed?”
Brian notes that vendors “absolutely hate these clauses…they believe that if too many of their contracts contain language that a potential acquirer would find economically challenging, then the value of their firm is adversely affected.” Of course software providers are most likely to push back when they encounter additional considerations in these clauses that extend beyond the outright company sale. For example, a clause might “also cover the loss of key software executives.”
Regardless of how onerous you want to get with vendors in negotiation, you’ll have far more leverage in larger suite deals than one-off module situations (my experience in this sector suggests that it’s hard to get vendors to budge when a total deal is <$1 million in value over its contract term). Moreover, make sure that you allow adequate time in these discussions towards the end of a quarter to get what you want (incidentally you should always negotiate towards the end of a quarter, but hopefully you knew that already). The legal wrangling and back and forth between your counsel and said vendors could take days or weeks, hence the extra time to budget for. But in the end, it could very much be worth it.
Incidentally, folks like Brian Sommer and fellow Enterprise Irregular Vinnie Mirchandani are specialists in helping negotiate general software licensing agreements and terms and can be an invaluable resource to turn in areas such as material change of control clauses.
While I like Brian and Vinnie and respect their advice (and being pro-customer myself), this clause isn’t worth fighting that much for.
First, virtually none of the enterprise-class software suppliers are going to give this language to you, regardless of how long you hold your breath. They’re bigger than most of their customers and can simply say “no” with greater force. Regardless, even if you wanted such language, what you’re essentially asking for is your money back simply because the supplier changed hands. At a minimum, the language would be tempered with sub-clauses that limited money back conditioned upon detrimental effects of the change in control (which would be hard to necessarily prove). At the end of the day, suppliers don’t want anyone messing with recognized revenue.
Next, for mom-and-pop shops, you could probably squeeze them for this language… but do you think, if they’re essentially going out of business, that they’re going to have the money to give back? Probably not.
What is MORE valuable to enterprise-class customers is the ability to support a product long after the supplier goes away. For that reason, we typically recommend getting source code escrow language that allows for the distribution of source code in the event of a dissolution or change in hands that results in a lack/diminishment of support.
On the other hand, the M&A-related language that’s MUCH more customer favorable is language that allows for a) a divested entity to take a pro-rata amount of the software with them after divestiture for free without negatively affecting cumulative discounts received by the primary customer; b) the combination of licenses with the best set of license terms for acquired entities; c) the ability to add licenses to unlimited-use license counts based on organic AND inorganic growth (such as results from M&A activity); and, if you can get it, d) the ability to completely transfer a subset of licenses to an affiliate with acceptance of materially identical software licensing terms.
These M&A-related terms will come in handy much more often – and you’ll actually stand a chance of getting them included in the contract, too.
[…] See what colleague and fellow Enterprise Irregular, Jason Busch, had to say regarding a prior post I did on Material Change of Control clauses in software […]