Open Source Software Risks in M&A

In today's fast-paced technology-driven business landscape, mergers and acquisitions (M&A) involving software companies-especially those utilizing open source software (OSS)-require a deeper level of due diligence. While OSS can speed up development and reduce costs, it also introduces significant legal, security, and compliance risks that can jeopardize the value or even viability of a deal if not properly addressed.

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Understanding Open Source Software in the M&A Context

Open source software refers to code that is made available to the public under specific licenses, allowing anyone to use, modify, and distribute it. OSS plays a pivotal role in the development of modern applications. However, each license-such as MIT, Apache 2.0, GPL, or AGPL-carries its own set of obligations, which can have a direct impact on proprietary software when improperly used.

Key OSS License Types and Their Legal Implications

Permissive Licenses (e.g., MIT, BSD, Apache 2.0):
- Few requirements for use and redistribution.
- Common in commercial software.
- Typically safe if credited properly.
Copyleft Licenses (e.g., GPL, AGPL, LGPL):
- Require that derivative works also be distributed under the same license.
- Can force disclosure of proprietary code if OSS is improperly integrated.
- Often a red flag in M&A due diligence.

Common Legal and IP Risks in M&A Involving Open Source Software

During the acquisition of a company that relies on software development, it is critical to assess whether OSS is being used in a way that could create unintended obligations or vulnerabilities. Key risks include:

1. License Noncompliance

Improper use of OSS-such as integrating GPL-licensed code into proprietary applications without compliance-can lead to:

Mandatory code disclosure
Revocation of license rights
Litigation from OSS rights holders

2. Code Contamination

If proprietary software incorporates code governed by restrictive OSS licenses, it may "contaminate" the proprietary codebase, rendering it subject to open source obligations. This risk can:

Reduce software value
Limit distribution rights
Impact product roadmaps

3. Incomplete OSS Inventory (Bill of Materials)

Acquiring companies often lack a complete and accurate Software Bill of Materials (SBOM), which can lead to:

Missed license violations
Difficulty assessing IP ownership
Post-closing disputes and indemnification claims

4. Security Vulnerabilities and Patch Obligations

Open source software can include known vulnerabilities. If a target company hasn't patched these vulnerabilities or doesn't have a plan to maintain OSS components, this may introduce:

Cybersecurity risks
Regulatory non-compliance (e.g., with data protection laws)
Increased liability post-transaction

Importance of Open Source Software Due Diligence in M&A

A thorough due diligence process tailored for OSS usage is essential for buyers to:

Identify license obligations
Assess intellectual property ownership
Evaluate the target's software development practices
Quantify potential exposure to compliance issues

Due diligence should include a code scan of the target's products to detect open source components, their license types, and associated risks. This step is especially important in transactions involving SaaS platforms, IoT devices, mobile apps, or cloud-based services.

Red Flags Buyers Should Watch For

When evaluating a target company, some red flags indicating poor OSS hygiene include:

No documented OSS usage policy
Absence of a compliance officer or legal review process
Reliance on third-party code without proper licensing
Historical legal disputes over software use

When these warning signs are present, buyers should consider deeper investigation or require representations and warranties in the purchase agreement to mitigate liability.

Mitigating Open Source Software Risks in M&A Transactions

To successfully navigate the risks associated with open source software in M&A, both buyers and sellers need to be proactive. Sellers should anticipate scrutiny and prepare documentation, while buyers must know what to look for and how to respond.

For Buyers: Best Practices to Minimize OSS Risk

Conduct a Code Audit
- Use software composition analysis (SCA) tools to generate a Software Bill of Materials (SBOM).
- Identify all OSS components and their corresponding licenses.
- Detect known vulnerabilities and license conflicts.
Review License Compliance
- Determine whether the use of OSS components complies with their respective licenses.
- Evaluate whether any proprietary code might be subject to copyleft obligations.
- Consider how license terms interact with the company's revenue model (e.g., SaaS vs on-premise distribution).
Evaluate Internal Compliance Procedures
- Ask if the company has an open source policy and how it manages license obligations.
- Investigate whether developers are trained on OSS usage and license identification.
- Review OSS approval workflows and any history of past violations.
Integrate IP and OSS Representations in the Purchase Agreement
- Require warranties regarding OSS use, license compliance, and IP ownership.
- Include indemnification clauses for potential license or security violations.
- If necessary, use escrow agreements to secure access to clean code versions.

For Sellers: How to Prepare for OSS Due Diligence

Sellers can improve deal outcomes by demonstrating responsible OSS management:

Assemble a Complete Software Bill of Materials (SBOM)
- Document all third-party components, versions, licenses, and usage context.
Establish or Refine OSS Policies
- Create internal guidance on OSS adoption, license vetting, and contribution practices.
Remediate High-Risk OSS Components
- Replace or isolate any code governed by aggressive copyleft licenses (e.g., GPLv3).
- Patch known vulnerabilities or provide a mitigation roadmap.
Consult with Experienced M&A Counsel
- Work with legal advisors who understand OSS risks and can help manage representations and warranties to prevent post-closing disputes.

Regulatory and Compliance Considerations

Open source software risk extends beyond private contract law. Regulatory agencies and compliance standards are increasingly requiring transparency and cybersecurity vigilance:

Software Supply Chain Security
- Government standards (e.g., U.S. Executive Order 14028) now call for improved transparency of OSS usage in federal contracts.
- Buyers in regulated industries may face greater scrutiny when acquiring companies with unvetted OSS components.
Data Privacy Laws
- If OSS vulnerabilities result in breaches of personal data, companies may be held liable under laws like GDPR, CCPA, or HIPAA.
- Understanding how open source tools handle sensitive data is essential in risk analysis.

When OSS Risks Are Discovered During M&A

If open source software risks are uncovered during due diligence, buyers have several options depending on the severity and timing:

Price Adjustments
- High-risk components or non-compliance may justify a purchase price reduction or holdback.
Indemnity Provisions
- Buyers can seek contractual protection for known or potential violations.
Remediation Requirements
- The deal can be conditioned on the seller correcting compliance issues before closing.
Escrow Arrangements
- Source code can be held in escrow with conditions for release based on future compliance milestones.

Contact an Attorney for Open Source Software and M&A Risks

Whether you are acquiring a tech company or preparing your own business for sale, understanding the risks of open source software is critical to protecting your legal and financial interests during an M&A transaction.

At Heritage Law Office, we assist clients in navigating the intersection of intellectual property, open source licensing, and regulatory compliance to mitigate exposure and close deals with confidence.

Contact us today by using our online form or calling 414-253-8500 to schedule a confidential consultation with an attorney.

Frequently Asked Questions (FAQs)

1. What is open source software in the context of M&A?

Open source software (OSS) refers to publicly available code that companies use to build their software products. In mergers and acquisitions, OSS must be reviewed carefully because its use can create legal obligations-such as mandatory code disclosure-depending on the license type. Failing to identify OSS usage can lead to unexpected liabilities post-acquisition.

2. Why is open source license compliance important during a business acquisition?

License compliance ensures that the acquired company has the legal right to use and distribute software built with OSS. If the company has failed to comply with license terms-especially with restrictive licenses like the GPL-it could face legal action or be required to release proprietary code, which could significantly reduce the value of the acquired technology.

3. How can a Software Bill of Materials (SBOM) help during due diligence?

A Software Bill of Materials (SBOM) provides a detailed inventory of all open source and third-party components used in the target company's codebase. This helps identify potential licensing risks, security vulnerabilities, and compliance issues before the transaction is finalized. It's a key tool in assessing the legal and operational risk of a software acquisition.

4. Can open source software affect intellectual property rights in M&A?

Yes, certain OSS licenses-particularly copyleft licenses like GPL or AGPL-can impose conditions that limit how proprietary code can be used or distributed. If a company's software includes OSS under such licenses, it may compromise the exclusivity or ownership rights of its intellectual property, which is critical in M&A valuation.

5. What should companies do if they discover risky OSS components after an acquisition?

If open source issues are discovered post-acquisition, the buyer should immediately assess the scope of the risk. Steps may include isolating or replacing problematic components, engaging legal counsel for license compliance, and notifying stakeholders if any security vulnerabilities affect user data. Future transactions should include tighter due diligence procedures to avoid similar risks.