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Don’t Blow a Deal in Due Diligence: Add Software Licensing Compliance

by Marsha Murry

Don’t Blow a Deal in Due Diligence: Add Software Licensing Compliance to Your Checklist

The last thing you need as a company seeking funding or preparing to go public, is to be blind-sided by inability to produce proofs of legal possession of company assets. Due diligence that uncovers a house not in order can rob you of much-needed capital. It’s a deal killer. There are too many pristine deals vying for investors’ dollars for you to find yourself abruptly left at the alter. And you can bet investors are taking a long look at due diligence these days.

The one asset that is repeatedly overlooked in company due diligence checklists is software licensing compliance. A recent study finds most companies can produce only 40 percent of their license documentation. If you cannot show the paper trail, you are exposing your company to costly litigation and material financial harm – including loss of investor interest.

Yet, many companies are not aware they are using unlicensed software and that it violates copyright laws. You may be unwittingly running applications without proper licensing. When companies minimize legal and financial liabilities and assume a casual attitude toward their hardest working asset, it raises a red flag for investors. You expose them and your boards of directors to unnecessary risk they didn’t bargain for. Investors fund the future. They do not pay for past infractions. It’s your business and your reputation at stake. You could lose them both.

How You Are Exposed - The software that is so tightly integrated into today’s business is easy to lose control over. Employees “share” programs, load personal copies onto company machines or install software to use while working at home. The software industry has found nearly 37 percent of all installed software is unlicensed and 25 percent of all business computers house unlicensed programs.

The IS director at an architecture firm remarked that much of the difficulty in managing the software was tied to the company’s blossoming from 30 to 100 employees in less than a year. He stated they were still thinking at a 30-person level. The firm paid a $200,000 fine to authorities.

More than half of the respondents to a 2001 survey said they were unaware of their own corporate policies regarding intellectual property. Of the same group, 54 percent claimed they didn’t know if it is permissible even to share files. How do you know if your licenses permit you to install a copy of a desktop application on a laptop to use while on the road?

Licenses are complex and each manufacturer has its own versions – plural – of the license agreement. It is simple to lose track of permissions from vendor to vendor, title to title and version to version. Since software compliance is black-and-white, you are either in compliance or out – a position upheld in the courts – and it is easy to get blind-sided.

Beyond Losing the Deal - The software industry takes a hard stand on license infringement and has instigated enforcement actions against companies of all sizes. During the last several years, companies have paid millions of dollars in fines and settlements. Industry enforcers take a heavy-handed approach. A president of a $1 million Waltham MA environmental research firm told Businessweek, "They marched in here like storm troopers. They kicked employees off their computers, rummaged through the machines in search of stolen goods." He settled for $48,000 instead of being pinned with a "multi-million-dollar liability."

Companies suffer lost productivity and disruption to operations when enforcement authorities demand audits. While the fine levied on a San Jose organization last year was $50,000, management estimated the real cost at $200,000, including buying licenses, inventory software and settlement negotiations. It lost countless hours to the months-long audit and legal wrangling.

It’s not enough that companies are put through the paces of responding to charges and saddled with huge fines; they also are made examples of in the press. Non-compliance subjects a company to humiliating publicity. A California manufacturer was portrayed as criminal in the press after an employee distributed illegal copies of software before quitting, tipping off enforcement agencies on his way out. It put corporate officers at risk for criminal fines and jail time even when executives had no knowledge of the employee’s actions. Despite these circumstances, the company settled for $85,000.

Non-compliance raises red flags for investors. It taxes revenues, profitability, public opinion and valuations. Consequently, executives want to make certain their companies take control, remain above reproach and protect their assets.

Dramatic Rise in Enforcement Activity Enlarges Urgency and Scale - It’s not a matter of whether a company will be audited. Rather, it’s how soon a company will be turned in. Chances of getting turned in to enforcement agencies increase with every round of layoffs. Over 90 percent of the investigations are triggered by tips from disgruntled current and former employees. Unhappy customers are the second largest group to report violations. A creditor not getting paid fast enough also lodged allegations.

Each year, the industry policing and watchdog agency, Business Software Alliance (BSA), steps up its enforcement activity. In 2001, the average fine and settlement was $87,750. The average paid in January 2002 jumped to $91,750. Civil fines are severe – $150,000 for each computer on which an unlicensed software program is installed. Fines multiply. Settlements are imposing, causing material financial harm to corporations.

Nearly 70 percent of the cases investigated in 2001 were small and medium-sized enterprises (SME). Settlements for small companies are disproportionate to their size and ability to pay. For example, a $2.3 million 53-employee manufacturer with net loss of $4.1 million settled for $135,000 – or more than 5.8 percent of their revenue. Defending and settling legal actions is costly and incurs award of damages and attorneys fees.

In addition to tip web sites and toll-free hot lines, agencies sweep U.S. cities quarterly. Software developers such as Adobe, Autodesk, FileMaker, Macromedia and Symantec field in-house units to enforce copyrights and protect their revenues. Some vendors randomly inquire of businesses and check against their registration databases.

Complexity of license agreements, widespread potential for unknowing misuse of applications, and legal and financial exposures mine the landscape for sabotaging your deal.

You can take steps now to get your house in order and prepare for due diligence.

Most executives want to ensure they remain in control of valuable assets, but find themselves short on staff to put controls into place. Licensing provisions are complex and ever-changing. With budgets constrained, most companies cannot afford the resources to become compliance experts.

“It’s not that we didn’t have the licenses, it’s just we didn’t meet their expectations,” said a CEO of an electrical supply provider in Milwaukee WI that paid $25,000 for licenses they believed they already owned. “The company could not produce proofs of purchases to BSA’s satisfaction.” An attorney who represented the company and several others in settlement talks advises accurate record keeping as a solid defense against any inquiries made by BSA.

You can adopt a comprehensive license management program that encompasses software usage policies, staff training, streamlining purchasing procedures, accurate record keeping and documentation, third-party random audits and independent verification and validation.

Tom Weiland, Vice President of Sales and Client Services at Software Management Systems (SMS) in Issaquah, said, “We’re experiencing a much higher level of interest from CFOs in whose laps this usually ends up. It seems between successive downsizings and companies that are adding staff rapidly, this task has grown more difficult.”

Implementing a sound software licensing compliance program with an independent software asset manager can save time and money and reduce liability for copyright infringement. A third-party service with experience managing software licenses can conduct periodic random audits to assure ongoing compliance. More importantly, an independent service provides third-party verification and validation in case you are called to task. An independent software asset management partner helps you pass rigorous due diligence, keep your licenses straight and assure investors of the merits of your deal.

“This was an expensive lesson, but we pride ourselves on our business integrity and now have extensive, all-encompassing management practices and controls in place which are more consistent with our business philosophy,” acknowledged a CEO of a Sunnyvale laboratory.

Learn more about software asset management, gaining control over software licensing and protecting your assets or order a copy of the Executive Guide to Software License Asset Management by visiting www.swmanagementsystems.com. Marsha Murry can be reached at 425-313-9969 or "mmurry at swmanagementsystems.com".

First published June 1, 2002





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