Charles Maurice looks at several of the key issues that should be thought through by deal teams when buying or selling SaaS businesses.
Whether you are acquiring an interest in a business or realising a long-held exit plan, developing a considered strategy prior to or at the outset of the deal may heavily influence the outcome. The technology sector is no different, and deals in this space are often driven by factors which are unique to the particular product or service on which the target business is based. Software as a service (“SaaS”) businesses are a good example of this in practice, and there are a number of practical considerations that ought to be borne in mind, whether it is with the aim of maximising the value in the business on the sell-side, or understanding the risk matrix of the business on the buy-side.
1. Service levels
Executives will be all too familiar with the service level and service credit model – often a real case of living and dying by the sword: without a competitive commitment on service levels a SaaS business may struggle to differentiate itself from its competitors and retain long term customer revenues. On the other hand, over commit and the business may be left to contemplate service credits, missed KPIs and, possibly, material breaches and claims for damages. Therefore a key point to understand in any diligence exercise is how the SaaS business approaches these mechanisms across its customer base, and whether there are common issues in the business that have the potential to affect multiple customer arrangements, leading to possible impact on performance and revenue.
2. Length of customer arrangements and payment model
Like many other businesses, a SaaS business will find it easier to attract the attention of investors if it can show a measure of security over its customer revenue. For example, a business whose customers are all locked into longer term deals is likely to be on safer ground in this respect than those businesses that are unable to show with confidence that their recurring revenue will continue to generate over time. There may be ways of justifying some forms of less certainty over customer revenue (ie long term deals attract onerous service commitments) or it may be that further comfort is available through the existence of early termination payments or a demonstrable track record of repeat customer revenue.
The inherent nature of providing a service is such that in many cases the provider is expected to stand behind the likely impact of the service. This is often the case in a SaaS context, particularly where the service supports a business critical function. This can differ from the expectation in a traditional software licensing model where it is not unusual to see a clause disclaiming licensor liability for the appropriateness of the software. For SaaS businesses therefore a key dynamic is the balance between taking responsibility for the service provided and avoiding liability which should properly rest with the customer – for example, it would be reasonable to expect a service provider to be liable for a failure of the service to perform in accordance with a given specification, however it may be less reasonable for the same provider to assume responsibility for the customer correctly observing its own industry compliance obligations simply because the SaaS component was part of the customer’s business processes. From a legal perspective this is (in part at least) the classic distinction between direct and indirect losses, and is a dynamic that needs to be fully understood on both sides of the deal.
Maintaining business as usual
As with the sale of any other service providing business, the transfer of a SaaS business will very likely mean that the deal happens at some point in the service lifecycle for each of the business’ customers. Maintaining continuity during the transaction and once it has completed is therefore a vital exercise and can bring its own challenges. Deal principals, for example, may well be one step removed from the operation of the business, but it is worth considering the scenario that arises where technical resource is involved in the process – as lawyers we know all too well the challenges that are often encountered in a due diligence exercise where the technical contact at the target business has barely enough time to focus on their day job, let alone answering questions from lawyers for potential buyers. Simply, thought needs to be given to how appropriate resource is made available at a target business to manage ‘business as usual’ whilst at the same time presenting information to buyers in a cogent way and, further down the track, managing any transitional periods where the target benefits from or provides services to the sellers.
Challenges also arise where, as part of a transaction, customers transfer from one platform to another. This is obviously deal-specific, but in a sale to trade buyers it is usual for there to be some form of integration between target and acquirer, including with respect to the platforms run by each business, and this can create tensions where customers either opt to or are forced to transfer from one platform to another. One classic example of this is in the context of a business providing CRM services, where a customer of a target business may be running a database of contacts including personal information on a particular platform. In order to transfer to an alternative, the customer of the target business will need to ensure that its relevant permissions from the underlying data subjects are unspecific with regard to the technology used by the customer – in most instances this might be the case, but there is a risk that an alteration to the way the customer processes the data brought about by the acquisition of the SaaS business will place the customer in a difficult position.
Clearly risks like this need to be mitigated as part of any M&A deal, and a purchaser will need to be clear (internally at least) what its post-completion intentions are for the business and that the way the business currently operates does not cut across this – another one for the lawyers to assist with.
First publishes in C-Suite.co.uk, February 2017