8 Key Provisions for Your SaaS License Agreement

Early stage software publishers and SaaS/Cloud application providers are always on the prowl for additional revenue. With limited resources, though, it’s not possible to go after every market at once. White labeling a SaaS/Cloud application or licensing software can be a good way to access other markets with little additional investment by utilizing a strategic partner licensee.

You must to be careful when licensing, though. The wrong license terms could effectively give away part of your valuable intellectual property with little benefit in return.

Always Restrict Exclusivity

Typically, strategic partner licensees will search for exclusive license arrangements. Exclusive licenses protect strategic partners from internal competition from your software after they’ve spent time and money to grow a market. From their viewpoint, that’s a valid business reason for an exclusive license, but it doesn’t address the risks to your company.

You must take into account that an exclusive license effectively transfers your intellectual property to the licensee. Any and all caveats, limitations, or restrictions on that transferred intellectual property need to be spelled out in the license.

For example, you might limit the license to a specific time or a specific market. You might also reserve the right to terminate the license if the licensee isn’t meeting performance goals (e.g. getting enough sales).

As with any contract, you can’t unilaterally redo the license after the fact to fix any inequities or problems. So, it’s absolutely essential that you include all of the necessary terms at the outset. Remember, do not try to impose an artificial page count on a business contract (or in this case, a license); doing so will lead to poorly-drafted and ineffective documents.

The following are eight key provisions to include in the terms of your software license agreement.

Royalty Rates

This provision will address the amount paid by the licensee for exercising the license rights. The license should tie the royalty rate to the licensee’s revenue and include a “minimum per” rate. Usually this is a royalty specified as a percentage of gross sales with a minimum set dollar amount per copy or per user. With this type of arrangement, your royalty revenue increases as the licensee’s revenue increases, and the “minimum per” rate motivates the licensee to price the product correctly and not give away or bundle your product just to sell its higher-margin products. Without a “minimum per” rate, the licensor might realize no royalty revenue at all from a bundled sale depending on the allocation by the licensee.

Minimum Revenue

This is the essence of the license—money for the right to utilize your software or application. If the licensee isn’t successful generating revenue with the license, you’ll want to try another strategic partner. This provision gives you that right by specifying the minimum amount of royalty the licensee must pay for the right to continue the license. If the licensee fails to pay royalties at or above the specified number, the license terminates.

Vertical Market Match and Description

A vertical market is the specific industries, trades, professions, or customer base where a vendor offers services or goods. This license provision should limit the exclusive license to a very specific vertical market that matches the existing market where the strategic partner licensee already has distribution. By limiting the license to their existing vertical market, you ensure that the licensee will make sales to its current customers and won’t spend months trying to expand into new markets.

Having a specific market description will avoid your company from being excluded from related markets merely because the licensee is considering developing them. You can always add a non-exclusive market and later make it exclusive if the licensee does well with that market.

Restrictions on Market

When I was a product marketing manager (prior to becoming a lawyer), my former employer developed and patented a unique system that it licensed to another company for a different product in a different vertical market. Unfortunately, the license did not exclude the licensee from using the patent to produce another product for sale in another market.

When the licensee’s original market became less profitable, the licensee developed a product that competed with my employer’s product and started selling in my employer’s market. Prices and gross margin dropped fast. No longer was my employer’s technology sole source. My employer had unwittingly created its own competition through a faulty license.

This provision prevents this unfortunate mishap by excluding the licensee from selling to markets outside of the specified vertical exclusive market (especially those that might compete with your company’s current markets).

Grant of License Rights

This provision expressly states what rights a licensee gets with the software. Should the licensee only be permitted to license to end users or should it be permitted to set up a sub-licensee distribution chain? Will the licensee modify the software or application and therefore need the right to create derivative works? Only necessary rights should be granted, and it should be clear in the license that no others are provided.

Termination

The termination provision should specifically state that the license terminates if there’s a breach of the agreement. You’d be surprised at the number of times the grant of license rights provision includes the term “irrevocable” while the termination provision fails to state explicitly what causes termination. Plus, the provision should determine what happens to post-termination payments by the licensee’s customers. What is the likelihood that the licensee will pay timely after termination?

Audit Provisions

This provision provides the licensor with the right to audit the licensee’s books and records to determine if the licensee is paying the right amount and making payments on time. Without this right you’re flying blind and relying on the honesty of the licensee because you have no right to verify what is being paid.

Source Code Escrow

This provision requires your company to give a copy of the software source code to an escrow agent, which will be held until the occurrence of a specified release condition. These conditions are what matter here. Ultimately, you want to be sure the licensee can’t get its hands on your source code except in the direst of circumstances (e.g. your company folds or files for bankruptcy protection). Missing a deadline or failing to correct a bug should never permit a licensee to get access to your source code.

Not Time to DIY

Entering a license agreement without provisions that protect the licensor (your company) can result in a free transfer of your company’s valuable intellectual property to the licensee. Once your company’s IP is out of the proverbial bag, it can’t go back in again.

You only have one chance to draft a license the right way. Your best course is to engage competent legal counsel to ensure that all of the necessary provisions are included in your next license agreement.