Common (and avoidable) divestiture headaches

As more companies act on their transformation strategies, many see divestments as a way to put more resources into growing their core businesses. This is one reason that nearly 9 out of 10 companies plan to divest assets in the next two years, an increase from around 4 out of 10 just last year. Though the number of global divestitures is increasing, effectively executing a divestiture can be a complex and challenging process. These are a few of the common software headaches companies run into when divesting parts of their business and the reasoning behind properly addressing these issues in your software or cloud agreement well before a divestiture.

Transition use services

Once a divestiture is initiated, there is pressure to split up as soon as possible so that both companies can focus operationally on their unique goals. But the divested company will need to carry on with its usual business activities while they work to develop the infrastructure to function as a separate entity, and they will depend on the parent company’s software to do so.

This is where things can get messy since Transitional Service Agreements (TSAs) provide certain services and licenses from the parent company to the divested entity, and in many cases the parent company responsible for providing these services and licenses may not have obtained the right to do so from their software providers.

Most organizations do not research their license rights in each of their software and cloud agreements which can be a problem when they begin to draft the TSA. However, once the divestiture agreement is signed, the divested company will be legally separated from the parent company and the software use rights granted to the parent company may no longer be provided to the divested entity, even though nothing operationally has changed yet.

License assignment to the divested company

As the transition use services period nears completion and the divested entity is deploying its own infrastructure to fully operate as a separate entity, companies face yet another challenge of license assignment.

Ideally, the parent company would like to transfer the software licenses and associated support to the divested company once the transition is complete, as it no longer needs these excess licenses and can reduce its ongoing support fees. The divested company would also like to receive these licenses to avoid additional license costs and only having to pay the corresponding support fees; plus, in their mind they purchased the business or negotiated the rights to the assets as part of the divestiture.

However, the license rights are granted only to the parent company, and the software vendor will only allow licenses to be assigned to the divested entity if these rights are explicitly stated in the software license agreement.

This causes a few problems:

• The parent company ends up with excess software licenses and support fees.
• The divested entity will need to negotiate pricing and buy new software along with a new support fee stream that may be higher.
• In the event licenses are assignable, the software vendor may still be able to raise support fees based on the now lower license quantities and the parent company will lose the discounts it previously had in place. This also applies to cloud agreements where renewal discounting protections are conditioned on renewing for at least the same license quantities and products.

Software vendor shakedown

Events such as divestitures disrupt an organization’s technology landscape and represent an opportunity for the software vendor to extract more money from the customer. As soon as a software vendor learns about a divestiture, they will look at your agreement to see if a company has the right to provide transition services and assign licenses.  If those rights do not exist, the software vendor will jump at the opportunity to negotiate a new license agreement or transition services rights fees under the guise of a compliance situation that could result in an audit if not addressed immediately.

During a time where employees feel immense pressure to smoothly transition into separate companies while maintaining business activities, meeting strict TSA deadlines, managing employee morale of the for-sale company, etc., audits are the last thing a company wants to deal with. But, if a company doesn’t have a deep understanding of their licenses and use rights prior to the divestiture, an audit could uncover compliance violations and result in substantial fees.

Software vendors can benefit from divestitures by:

• Selling new software to the divested entity
• Charging additional fees to allow the parent company to provide transition use services
• Charging penalty fees if the divested company is using the software after it is legally separated from the parent company
• Performing an audit that potentially uncovers multiple noncompliance elements
• Potentially terminating the license agreement due to breach of contract if fees are not paid promptly

Avoiding divestiture headaches

Though divestitures are challenging endeavors, these issues are easily avoided by following best practices from the start. Negotiating transition use rights and license assignment rights in the event of M&A activity in software agreements upfront could save companies from incremental software and services fees in the event of a divestiture.

Regardless of whether a company anticipates a divestiture, it is critical to include language in the software license or SaaS agreement that allows for transition services and assignment rights, and to ensure that enacting these rights will not negate negotiated discounting and renewal terms, nor result in the repricing of support fees.

If you don’t have these rights defined upfront, you can still try to amend the agreement to negotiate these types of protections for the future.