SaaS and Licensing are often mixed up and thought to be similar models. While the concept of these two models may be similar, they are based on different business models and therefore require the execution of different agreements by the participating parties.

This piece is not intended to present the distinctive attributes of SaaS model vs. licensing model, but to highlight the key points of difference in the agreement pertaining to each model.

Transaction Type

Foremost, it is important to understand the substantial distinction between SaaS and licensing models. In the licensing model, the software is treated as a tangible product, so the provider (better known as the licensor) provides the customer (better known as the licensee) with a copy of the software, either by physical means (such as a cd) or by providing it for download via the internet. The software is then installed by the licensee on his or a third party’s hardware, and in any event, it is installed on hardware that does not belong to the licensor.

Besides the software itself, the licensor grants the licensee with a license to use the software. Typical licenses usually carry restrictions regarding proper usage, such as the number of users permitted to use the software, the number of computers that the software may be installed on, geographic restrictions, redistribution provisions and other usage related restrictions. Licensing transactions may also include additional services necessary for the implementation and operation of the software, such as training, customization and integration services.

On the other hand, SaaS requires a typical services agreement, according to which the customer subscribes to the software provider’s service, which includes access to the software over the internet. The software isn’t provided or installed on the customer’s hardware, and the customer gets no access to the source code. Similar to licensing, a typical SaaS transaction also carries restrictions, such as the number of users permitted to use the service, usage volume restrictions, and may also include additional services such as training and integration services.

Maintenance, Updates and support

Since the licensee receives a copy of the software in a license transaction, it is essential that the license agreement addresses maintenance, updates and support issues, such as the eligibility of the licensee to receive future updates to the software, the licensor’s obligations to fix bugs and errors in the software, and the licensor’s obligation to provide the licensee with software support and training.

In SaaS, the software remains on the provider’s hardware at all times and is accessed via the internet, so any updates or maintenance are already included in the service by definition and require no special attention in the agreement. However, since the delivery of the software in a SaaS model is highly contingent upon the provider’s infrastructure and network availability, a SaaS agreement is typically attached to a Service Level Agreement (SLA). The purpose of the SLA is to define the level of service the provider undertakes to provide. The most common SLA’s include the service provider’s commitment to a minimum uptime to ensure the software’s availability, and other commitments pertaining to the availability of the service, time frames for fixing errors and response times.

Data Security and Privacy

Since a SaaS transaction generally involves storing the customer’s information with the service provider, data security is of great importance compared to the licensing model, in which the software, and all information, is stored on the licensee’s premises and therefore all security aspects are handled by the licensee.

Unlike a license agreement, a SaaS agreement will typically include a data security clause stipulating the vendor’s undertaking to provide a high level of data security and the measures the vendor intends to take to safeguard the data. A SaaS agreement should also address issues as ownership of data, recovery measures in case of a failure and compliance with applicable privacy laws.

Finding the proper balance between providing adequate safeguards that will meet the customer’s demand on the one hand, and not over-promising a level of security that can’t be provided in practice, on the other hand, are key to any SaaS agreement due to the liability risk potential in cases of data security breaches.

Indemnifications

The different risks involved in SaaS and license transactions require different indemnification clauses in the respective agreements. Generally, indemnification provisions consume a significant part of license agreements compared to SaaS agreements, mainly due to the different characteristics of the two models, as described above.

In a license agreement, the provider (licensor) will typically provide the customer (licensee) an indemnification from third-party claims regarding intellectual property, such as claims that the licensed software infringes third-party’s IP rights, with the usual exclusions for claims arising due to customer’s modification of the software or unlawful use of the software. In addition, the licensee will also be required to provide the licensor with indemnifications, typically covering any claim arising or connected to the licensee’s use of the software.

In a SaaS transaction, the customer doesn’t receive possession of the software, so copyright infringement is not an issue. However, the customer could face claims regarding patent infringements, so appropriate indemnifications are required in that respect.

A SaaS provider will typically indemnify the customer in cases of third-party claims regarding breaches in the data security, as well as violations of privacy rights. Since the processing of any data will only take place in accordance with the customer’s instructions, the customer will have to take full responsibility for the legality of the data being processed on his behalf via the platform, and will have to indemnify the SaaS vendor for third party’s claims alleging the processing of the customer’s data infringes IP rights or breaches applicable privacy laws. Furthermore, the customer will typically be required to indemnify the provider should the provider be subject to legal proceedings relating to the customer’s data.

Fees

Fee structures also vary between SaaS and license models. In a license transaction, it is common practice for the license fee to be paid up front and in full, and the license will be either perpetual or for a defined period.

This approach isn’t suitable for the SaaS model, where flexibility and scalability are key, so a SaaS transaction is commonly based on a subscription model, according to which the subscription fee is spread out and paid periodically.

These distinctions have implications from a tax and accounting perspective since the tax liabilities accrue at different times in the revenue cycle.

The bottom line is that SaaS and licensing models are very distinct business models, each requiring attention to distinctive key issues. It is, therefore, wrong to assume the same agreement can suit both models, and specific expertise in each of these models are key to ensure the agreement will be set up properly and provide adequate protection for all parties involved.

The information contained herein is for informational purposes only and is not legal advice or a substitute for legal counsel.