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Sale of part of business

Hi all,

About 4 years ago a company approached us to write an add-on for their accounting software product.  The deal was they would pay us a royalty based on the number of users who signed up.  We spent a lot of time developing it and because of the projections they showed us, I thought, why not as we would start getting a return after a few years.

4 years on, we are now making really good money from it and this company wants to buy the rights from us so they can stop paying the royalty to us.  The amount they want to pay is about 4 years worth of royalties.  They have also said that if we don't sell it to us, they will probably start writing their own version.

We are happy enough to sell because we think the relationship is in decline and we don't want a messy dispute.

They are in a hurry (probably so they stop paying the monthly royalty to us) but we need a bit of time to draft the sale agreement, consider tax implications and plan what to do with the 3 or 4 people who will need to be deployed elsewhere (the royalties are about 40% of total revenue so we would start running at a loss). They have asked to see the source code before the sale as part of "due diligence". 

Is this normal? Considering the threat of writing their own, I don't know whether this is a good idea.  They say they will sign a pre-sale agreement which has a due diligence clause which restrains them from using the source.  Is this good enough?
Richard J Send private email
Thursday, May 15, 2014
 
 
Let's put it this way; it's not unreasonable.

If you were to buy a software product, you'd want some idea as to the quality of the source code in the same manner a car or home buyer gets a mechanical or structural inspection.

Of course, as it often the case, the devil is in the detail and your caution is not without reason.

So perhaps the point to haggle over is not that the source code will be revealed to the but how. You will 'concede' showing them the source code if they agree to the method. For example, could you meet face-to-face: you bring a print-out of (or laptop with) the source code and they bring a few of their software engineers to examine it.

Good luck with the sale.
Marcus from London Send private email
Thursday, May 15, 2014
 
 
Thanks @Marcus. That is a good point. They are 2000km away but it could be done as you say.  I will suggest it but I know they will pusgh back.

They have actually said they want "immediate access" to the source to start evaluating how they will integrate the code in more tightly into their core product. 

Considering the product has been installed by about 1500 customers and badged with their name, it looks like they waived their DD rights some time ago.  I think they are using the DD clause as a way of getting their hands on it sooner. And their objective is to get access 30-60 days ahead of the sale.
Richard J Send private email
Thursday, May 15, 2014
 
 
"They have actually said they want "immediate access" to the source to start evaluating how they will integrate the code in more tightly into their core product"

You should assume they aren't being completely honest with you.
Ducknald Don Send private email
Thursday, May 15, 2014
 
 
One thing That I didn't make clear is that the product is sold as a monthly subscription. This means our revenue / royalty continues to increase each month and is climbing at around 20% each year. Although this will obviously decline as the product reaches saturation.

I make this point because it gives you an idea about the motivation of the buyer. I guess we could just sit back (now) and make more money each year. Of course we don't do this. We put a lot of effort in to improve the product and keep existing users paying, as well as encouraging others to try the product. They (the buyer), on the other hand, see that trying to buy us out will benefit them in the long.

And, of course, this was the reason we took the risk in the first place.
Richard J Send private email
Thursday, May 15, 2014
 
 
"said they want "immediate access" to the source"

Which of course means you get immediate access to the cash?

Sarcasm aside, if you were selling your house would you let the prospective buyer move in 30-60 days before exchanging contracts? Neither would I. Once they're in and have stained the carpet, it's a little difficult to evict them when they want to haggle over the price in 59 days from now. If you hand over the source code, your bargaining power drops precipitously close to zero.

For me, their urgency also raises an eyebrow. Really; in the grand scheme of things, what's waiting an extra 30-60 days going to deprive them of that the last 4 years hasn't? Beyond which I take it your add-on is already functional so they're not losing anything on that front.

Perhaps your position could be: 'I appreciate your eagerness to integrate the source code in to your core product, and I'm prepared to provide you a controlled review of the source code prior to exchange (and even provide integration consultation) but our attorney (solicitor) has advised the we are unable to provide you with the source code until exchange of contracts'.

My wife and I always use the absence of the other for making a decision when dealing with salespeople. When we're both present we defer to our accountant.

Also, they're asking you to make a concession. They need to reciprocate.

"I guess we could just sit back (now) and make more money each year."

Not nesessarily. Without knowing anything about the complexity of your application - and perhaps this is part of their motivation to see the source code - in their position I'd be weighing up the costs (time+money) of reproducing the functionality myself compared to buying you out.  Does your existing contract with them cover this?

All the best -
Marcus from London Send private email
Thursday, May 15, 2014
 
 
I absolutely would not give them the full source until they had paid. Not even in paper form. Tell them can fly over an engineer to inspect the source in your office (preferably on a PC with no USB port or network cable!). Or maybe send them the interface (but no implementation) of some key source files.
Andy Brice Send private email
Thursday, May 15, 2014
 
 
@Marcus
We don't have a formal written contract as such.  Just an exchange of emails over time and the fact that we have been conducting business according to the agreement over the past 4 years. At the time, the clear understanding was that we would take some of the features in our existing product and integrate it into their product.  They also asked that we removed some of these duplicate features from our product so that customers would move to the new product (which some have). We have probably "lost" 20% of our customers to the new product on the understanding the increased volume would make up for it.

@Andy, @Marcus 
I just got off the phone from my accountant and lawyer and they say that we should not provide code.  The lawyer agreed when I said that due diligence should be unnecessary - they have been selling the product for over 4 years branded as their own and therefore know what it can and can't do.
Richard J Send private email
Thursday, May 15, 2014
 
 
You don' t have to give complete source code. Just parts (not modules) so that they cannot build their own product from it.
Gautam Jain Send private email
Friday, May 16, 2014
 
 
I agree with those who say they already know what the software is capable of, they already know it's stable and works etc.

What they're really trying to buy is the source code; giving them the source code before they've bought it would be plain silly.




AC
Reluctantlyregistered Send private email
Friday, May 16, 2014
 
 
Thanks everyone for your comments. You have made me feel a lot better as I don't feel so quite alone.

A couple of emails have been exchanged since. I stuck to my guns on the source. I said that no source until money changes hands. I did, however, offer to answer questions about the code. After all i know it well and will tell them the truth. I also said that the code is vast (almost 6000 files, 60 assemblies and 250mb of source files) so it might be easier and faster to ask questions rather than read my badly styled code :)

As expected, they did not like this and said the size of the code was even more reason for them to have access sooner. They offered to sign a confidentiality agreement. My lawyer says that while legally binding it could be painful and hard to enforce. (ie we would have to get court orders etc).

My next move will be to get them to sign the confidentiality agreement and then allow them to fly into town for a few days if they want to look at the code.  I am sure they won't get through too many of the 60 projects in that time (not without falling asleep regularly).
Richard J Send private email
Friday, May 16, 2014
 
 
Charge a non-refundable fee to review the source code, paid in advance. If they are serious about the deal this should not deter them.  I believe this is not an uncommon practice in the industry.
Bill Anonomist Send private email
Friday, May 16, 2014
 
 
And make sure they can't take a surrepticious copy of the source (e.g. on USB key)!
Andy Brice Send private email
Saturday, May 17, 2014
 
 
@Bill
They have offered to pay some money in advance. As they already pay us a royalty each month, this was not attractive to me.

@Andy
Really good point. Before I read your post I was looking into USB locking methods. It is almost impossible to do this easily.  I did find a way though. Maybe someone would care to comment.

My idea was to allow RDP access to a machine with the source and kill rdpclip.exe to stop copy and paste to the desktop.  We would log in to the session so they could not restart without knowing the password. Of course they could restart rdpclip.exe but we could write a little service to keep killing it. And I would have someone chaperoning them.

Also disabling internet access to stop them uploading (my chaperone may need a toilet break).
Richard J Send private email
Sunday, May 18, 2014
 
 
>Also disabling internet access to stop them uploading

Just remove the network cable and gaffer tape the USB port. You'll soon spot if they are trying to bypass these measures!
Andy Brice Send private email
Monday, May 19, 2014
 
 
@Andy
Loved that suggestion to Gaffer tape the USB. I think that is the way we'll go. I will make sure the colour blends in so it is not so obvious.

For those interested in this saga, I told them today that it was no deal on the source code and they backed down. They do want someone to demonstrate that the source builds to a finished product. Seriously? I am pretty sure they would notice if our code did not build after supplying built code for last 4 years.

Anyway, the deal is still on track after a few tense moments. If anyone is interested in knowing how it pans out, let me know and I will continue to update this thread. After all, it isn't everyday you get approached to buy your IP (at least it is my first time).
Richard J Send private email
Monday, May 19, 2014
 
 
Record the screen during an editing session showing how code is organized and built. You can show 3 or 4 pages of code and show to them how the full program is built according to the dev tool you are using.
fp615 Send private email
Monday, May 19, 2014
 
 
Yes, please do keep us updated. Sounds like interesting times.
M.B. Dude Send private email
Wednesday, May 21, 2014
 
 
Here is an update for those interested and possibly may help others if they find themselves in this situation.

The deal looks like proceeding. We have agreed to terms. They wont get the source until payment, but we will show them it building at a code viewing immediately meeting prior to sale. We even were able to say that no guarantees and code is sold as is, but we will provide maintenance for 6 months (at a rate to pay all staff wages plus margin). We also retain the rights to use source in other products as long as we don't compete against the same product. Win - win. I have handed it over to the lawyers to tie up loose ends.

Assuming the deal is finalised, I can say that we were able to get what we wanted because we were prepared to kill the deal. They approached us, and they wanted it more than us.  I will be glad to move on to another project though as this one has exhausted me after 4 years.
Richard J Send private email
Friday, May 23, 2014
 
 

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