Hard on software

When managing a merger, acquisition or disposal deal, there are countless factors to consider in assessing the value of a company. One that has grown in importance over the past five years is the valuation of a company's software assets. Done properly, an accurate factoring of a company's software will help both sides ascertain the reasonable, tangible worth of the asset. If ignored, or done carelessly, your clients – whether the acquiring or acquired company – could be left holding the bag if what has been passed on is unlicensed or counterfeit software.

Preventing risk is your job and adhering to legal and ethical corporate governance standards is the goal of any reputable company. Working closely with your client to effectively manage their software assets and ascertain their true value in a transaction will help you complete successful transactions and avoid the many traps that have left companies getting less value, and more headaches, than they bargained for.

If you think this is a remote possibility, think again. The Business Software Alliance has estimated that 25 per cent of the software in use by UK companies is illegal. Its own survey in January this year showed that 82 per cent of companies surveyed did not have effective systems to manage their software. A number of major UK law firms, which advise their clients on intellectual property (IP) rights, have themselves discovered that they have been running illegal software as a result of being supplied with counterfeits. Apart from the embarrassment for the firms involved, it highlights the ease with which this issue can be overlooked, even by organisations knowledgeable in the law.

Some basic guidelines

As an initial matter, company lawyers need to be aware of the procurement policies and supply chain management of their clients. Lawyers need to get a full picture of the company's due diligence to ensure that it is sourcing genuine, fully licensed software for its own use or, in the case of software resellers, for re-distribution to customers.

There are some questions to bear in mind. If the company is an end-user of software, do they have proper proof of licensing from the software vendor? Have they retained the software and, if so, have they received it in the same manner as advertised by the vendor on their website – a CD, with user manual and certificate of authenticity, for example?

What price has the company paid for the software and is it consistent with the vendor's estimated pricing?

If dealing with a reseller of software, find out who their supplier is. Are they an 'authorised' dealer of the vendor's products? Was the inventory supplied in a form markedly different from the vendor's advertised product? Did the supplier offer an unusual explanation to justify a low price, such as stock overruns, liquidation product, or fire sale?

Of course, none of these factors alone will be determinative, but in advising your client, you should insist on a sufficient level of due diligence to help guide your assessment on the legitimacy of the software and its value to the transaction. Company after company has been bitten by their failure to do just that. In one case, a mid-sized technology solutions provider, after successfully completing a merger with a smaller organisation, discovered to their utter dismay that they had also purchased a hefty liability in excess of £1m arising out of the acquired company's dealings in thousands of pieces of counterfeit software bought from illegal suppliers and, ultimately, passed on to end customers.

Clearly, under these circumstances, the safest thing for the acquiring company to have done – given they were buying a software reseller – would have been to examine the integrity of the supply chain processes utilised by the merger candidate. In addition, a company in this situation would be well served by insisting on proper warranty protections for past IP infringement, including liabilities arising out of the distribution or use of illegal software.

Given that vendors may have various restrictions or limitations in the way that certain licenses are transferred, lawyers should be sure to examine the transferability of such licenses before completing the sale or assigning a value to the software assets. If they have confirmed this, they should be sure to include a provision calling for the transfer of the software with the hardware assets as part of the deal.

Corporate governance practices are being scrutinised today, perhaps like no other time in our past. Coupling that consideration with your interests in reducing your client's risks, a good case exists for investing time and effort, sooner rather than later, to ensure that they, and any future acquisitions, own and deal only in legal software.

Chris Oldknow is a senior associate at Microsoft