SaaS Companies Should Avoid these Contract Mistakes

Companies building a business delivering services from the cloud (a.k.a. “Software-as-a-Service” or "SaaS") should seek to avoid common contracting mistakes and thereby minimize the risk and maximize the value in the relevant customer relationships. Let’s take a look at some common mistakes and how to avoid them.

Making Customer Termination too Easy.

Some SaaS providers will either agree to accept a termination for convenience clause or even go so far as to include such a provision in standard terms. If a customer is allowed to terminate the agreement at any time, the SaaS provider may ultimately lose money on the transaction as customers need to pay subscription fees for some minimum period for the SaaS provider to break even.

Further, if the aim is to exit the company, recurring revenue from agreements that run for a minimum duration (often 1, 2 or even 3 years) will help increase the company valuation.

Solution:

Include a minimum term (e.g., 1 to 3 years) and thereafter either having such term automatically renew for the same period upon each anniversary if the agreement is not terminated, say, 90 calendar days in advance of the anniversary. Alternatively, after a minimum term (e.g., 1 to 3 years)—a termination notice of, say, 90 calendar days can suffice, at any time, to effect termination.

Failing to Incentivize Longer-Term Contracts.

In those cases where termination isn’t made too easy, i.e., there is some initial term of the contract, say 1 year, there is still the issue of whether to offer longer initial contract periods, say 2 or 3 years, in exchange for reduced annual subscription fees.

To promote the SaaS Providers predictability of receivables and to increase the valuation of the SaaS Provider’s business to potential investors and acquirers, having longer term contracts (i.e., more recurring revenues down the line) is advisable.

Solution:

Offer longer period of initial binding contract periods, e.g., instead of merely 1 year that auto-renews annually, consider 2 and 3 year options for minimal terms with corresponding discounts in annual fees.

Overlooking Privacy and Security Issues.

The legal landscape applicable to SaaS providers is changing rapidly, especially as it applies to personally identifiable information. Some SaaS providers assume that since they don’t do business in Europe or aren’t located in California, they don’t need to worry about the various global privacy laws. What these providers don’t realize is that, given the global nature of the Internet, SaaS providers can be subject to international data privacy laws regardless of where they are physically located.

Solution:

Use a data-mapping exercise to ascertain the personal data collected, how that data is used, and with whom that data is shared. Once providers have this understanding, the necessary privacy policies and data-protection agreements can be produced. Also, obtaining cyber insurance is highly recommended.

Confusing Professional Services with SaaS.

Many agreements covering SaaS and other cloud-based services include the word “services” in the title. The word “services”, however, can also be used to describe a variety of other services, including support services, consulting services, development services and other professional services. Using a template not designed by a qualified attorney for SaaS services can create problems.

One example can be with respect to intellectual property provisions. Often, a professional services agreement will assign intellectual property rights to the recipient of the services while a SaaS agreement should include language to clarify that all intellectual property rights in the SaaS service are retained by the provider.

Another common difference has to do with subcontracting or data-sharing. A professional services agreement will often preclude subcontracting or the sharing of data without the consent of the service recipient, while a SaaS agreement should contemplate that some aspects of the service, like the hosting of the service, will involve subcontractors or other hosting-service providers.

Solution:

Ensure that a qualified attorney has prepared you SaaS agreement to adequately protect your company’s business interests and reasonably mitigate risks. Further, if professional services can also be provided by your company—such professional services can be clarified in your SaaS agreement along with the relevant payment, intellectual property, support, and other provisions relating thereto.

Failing to Precisely Define Rights / Limits in Using the Service.

At the heart of any SaaS agreement is the rights to use section. This is the section that describes the rights and the services being provided by the SaaS provider to its customer. It should describe the service being provided and who can access and use the service. Unfortunately, all too often right-to-use provisions do not carefully define who can use the service. Such provisions may authorize the customer and its “users” to access and use the service without defining the term “users”. When the term “users”, for example, is ambiguous, it can be difficult for a SaaS provider to preclude its customers from sharing the service with third parties such as its affiliates, vendors, subcontractors and other third parties. This can be problematic, especially if the provider’s pricing does not account for these additional users. It can also be a problem given that the third-party users are unlikely to be bound to the applicable legal agreement between the provider and its customer or any other appropriate terms of use.

Solution:

SaaS providers carefully draft the rights being granted and specify in detail the permissible users. If the scope appropriately includes third parties such as affiliates, vendors, subcontractors, and/or consultants, the contract should ensure: (i) those third parties are subject to appropriate terms and other restrictions on use, (ii) if any such party breaches the contract, the direct customer will be liable, and (iii) your pricing should perhaps be based on numbers of users or the amount of information processed via the service to ensure your company is reasonably monetizing for the broader uses and user groups, as well as for any increased support obligations and business / legal risks.

Failing to include a Suspension Right.

As in any business, sometimes things don’t go according to plan in a SaaS provider’s customer relationships. Some customers may miss a payment, introduce a security risk (such as uploading unlawful content) or otherwise breach the contract. Typically, a SaaS agreement will give the parties a right to terminate for breach, but sometimes that is too drastic of a remedy and a SaaS provider merely needs the ability to suspend the service (in whole or part) for a short time in order to correct an issue.

Solution:

From the provider’s perspective, a good SaaS agreement will include a suspension-of-services right that will allow the provider the ability to suspend the service (in whole or part) for a short period in order to address issues such as a customer’s failure to pay, security risks introduced by a customer, other customer breaches of the agreement, and/or third party or technical issues that the SaaS provider must reconcile to ensure the service operates as intended.

Assuming the SaaS Agreement covers the Entire Relationship.

A SaaS agreement may only cover a part of the business arrangement with a customer. In addition to a SaaS agreement, providers may also need a separate contact (or additional language added to their SaaS agreement) to cover matters such as implementation services, support services, privacy, and security issues (which are often covered in a data-processing agreement or a business associate agreement), a service-level agreement, professional services agreement or other issues.

Solution:

SaaS providers should carefully consider their entire product and service offering and then review the contracts in use to ensure adequate coverage of every aspect of the arrangement.

Including a Service Level Agreement (“SLA”) by Default.

An SLA will guarantee the SaaS Provider’s customer some level of compensation (generally in the form of payment credits) if the service in question does not meet certain availability (a.k.a. “uptime”) requirements and if the SaaS Provider fails to rectify any errors within a specified time (depending upon the category of error). The mistake is having the SLA as part of the standard terms is that many customers will not require an SLA and the SaaS Provider is thereby onboarding needless risk.

Solution: Have an SLA on-hand for when this is required by a customer; however, consider charging a separate fee for the inclusion of the SLA in the contract.

Including Unreasonable Terms.

Often, in an effort to protect their business, new SaaS companies can be tempted to propose agreements and terms that are aggressive and one-sided. However, those types of agreements can lead to excessive and drawn-out negotiations with customers that can be expensive and slow down the sales cycle.

Solution:

Instead, SaaS providers should strive to strike a reasonable middle ground by adopting standard terms that protect their businesses without being overly one-sided. ?Astute SaaS providers will evolve their contracts as their products and businesses mature. They will see what provisions create concern among their customers and will look to revise those provisions to make them more acceptable. Being able to streamline and shortcut the negotiation process can be a significant help to a company’s sales efforts.

There are, of course, many other issues that may arise in SaaS contracts. A rather conservative investment in good business templates can empower your company to optimize returns, mitigate risks, and also accelerate deal closures.

If you would like assistance with preparing your company's SaaS contract library, feel free to contact me. Otherwise, I advise on a broad range of matters in helping companies scale business to the world.

Gary Guttenberg, Attorney

[email protected]

+46 70 752 16 80

www.b2world.com

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