Purchase Price Royalty for SaaS Business Didn’t Include Professional Fees

Introduction

The seller’s purchase price royalty for sale of a software as a service business did not include post-closing hourly professional fees.

The deal

The seller is a Seattle based systems integration firm that developed a cloud-based application that lets businesses deploy a user-friendly interface on top of Microsoft’s SharePoint platform. It sold this software line to buyer, another systems integration company.

The purchase price was 30% royalties from the first 3 post-closing years of net “product license fees” up to a cap of $5 million.

The business model for the product was a subscription service.

Unfortunately, the buyer’s post-closing subscription service from the software was not enough to generate any royalty. However, the buyer did generate hourly professional fees for customers using the software that if included as “product license fees” would generate royalties for the seller.

These professional fees were for consulting services that the buyer offered to customers to customize and/or supplement the otherwise standardized software functionality. Examples of such services included migrating customers’ existing on-premises intranet (an intranet that is hosted on a customer’s servers), to a cloud-based intranet service like Microsoft SharePoint, and building customized intranet portal components that layer on top of or alongside the default software webparts.

According to the buyer, some of its larger customers requested these additional services, which cannot be accomplished simply using  the software. The buyer charged an hourly fee for the staff time spent on such services, and billed customers for these professional services fees separately from the monthly subscription fee for software. Such professional services were central to the buyer’s business even before the buyer purchased software from seller.

The lawsuit

The buyer did not include the professional fees as part of seller’s product license fees. The seller sued the buyer in a Missouri federal district court. The seller claimed that the royalties applied to the professional fees.

The royalty was computed under the asset purchase agreement based upon a percentage of the “product license fees.” However, the term “product license fees” was not defined in the APA.

The buyer argued that the term “product license fees” included only those fees paid by a customer for a monthly subscription to the product and did not include the professional fees received from the buyer’s provision of consulting services. The court agreed that the term “product license fee” is unambiguous and meant the monthly subscription fees that customers paid to access or use software; and that the professional services fees did not fall within this definition.

This case is referred to Blue Rooster LLC v. Perficient, Inc.Case No. 4:17-CV-02689-AGF, United States District Court, E.D. Missouri, Eastern Division, (May 2, 2019)

Comment

The royalty was the only profit that the seller was going to see out of the sale of this business. In 20/20 hindsight, the seller would have wanted a definition of product license fees in the asset purchase agreement which would have included the professional fees.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

 

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

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