Summary
- PE firm wanted to invest $100m in an industrial company
- It assumed the company’s intangible assets (software) were valuable
- Lawyers reported no material risks in due diligence
- EverEdge audit revealed extensive use of open-source software
- Investors retreated from deal citing legal ambiguities
Background
A private equity firm was asked to increase its investment in a large industrial company, focusing on its core intangible asset software, not its tangible machinery.
The Problem
About 80% of all software code used in for-profit businesses today is open-source. This software was written by someone else for free and placed into the “commons” for anyone to use. While open-source software is useful for companies moving quickly, it can be a legal minefield. Also, about 40% of code in use today is distributed under non-commercial licenses.
Open-source code is deployed everywhere, from the smallest plugins that help websites run smoothly to software for entire operating systems (Linux).
The target company had taken large scoops of open-source code, mixed it with their proprietary code and slapped a price on it.
The Risk
While the final software product worked well, the use of open-source code led to ownership headaches since the company hadn’t tracked what was theirs and what was in the “commons.” Strangely, due diligence by an expensive law firm found no material risks which indicated to the PE group that the deal could go ahead.
However, the PE group wasn’t entirely certain of the legalities and to get a second opinion it engaged EverEdge to perform an audit of the company’s code base. As EverEdge lifted the hood, it discovered extensive use of open-source code, commercially toxic licencing deals and worrying levels of cybersecurity liability.
The Outcome
What appeared from the outside to be an industrial company with plenty of tangible assets and a functioning software suite turned out to be a tech company that didn’t fully own its software code. This oversight spooked the PE investors after they learned of the questionable legal status of the company’s core intangible assets. The deal ultimately fell through.
The Takeout
Take the time to understand the terms and legalities associated with the any open-source software you may be using to mitigate any risks that could occur down the track regarding cyber security issues, licensing bottlenecks or restrictions around usage. The broad lesson is that when something is free for everyone to use, investors know they won’t make any profit from it.
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