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Open Source Software: A Hidden Risk in an Otherwise Successful Exit?

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A software developer writes code on a computer monitor in a dimly lit workspace.

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For Australian startups, scaleups and high-growth technology businesses, open source software offers significant commercial advantages. It reduces development costs, accelerates product delivery and allows businesses to build sophisticated technology without developing every component themselves.

However, the legal implications of using open source software are frequently overlooked.

A company may have invested years developing a valuable proprietary platform, established a substantial customer base and attracted a prospective purchaser, only to discover that components of its software are subject to licensing obligations that were never properly considered.

The concern is not necessarily that the company does not own its proprietary code. Rather, open source licensing obligations may restrict how the company can commercialise or distribute its software, or require it to make certain source code, potentially including proprietary code, publicly available under the terms of the applicable licence.

For businesses contemplating an acquisition or other exit, these issues can affect valuation, transaction negotiations and the allocation of risk between buyer and seller

Key Takeaways

  • Open source does not mean unrestricted use. Software made freely available may still be subject to legally enforceable licensing conditions.
  • Licensing obligations can affect commercialisation. Certain open source licences may require disclosure of source code or impose conditions inconsistent with a company’s proprietary software model.
  • An exit can expose historical compliance gaps. Investors and purchasers may scrutinise open source licensing, intellectual property rights and compliance practices during due diligence.
  • Transaction warranties and indemnities can create significant exposure. Sellers may be required to warrant compliance with open source licences and provide indemnities for identified risks, potentially resulting in liability after completion.
  • Contractual protections matter. Developer agreements, customer contracts and transaction warranties should appropriately address third-party software and licensing obligations.
  • Early governance protects future flexibility. Open source compliance should be considered from incorporation, reviewed as the business grows and addressed well before a proposed sale.

What Is Open Source Software?

Open source software is software made available under licences that permit others to access, use, modify and distribute its source code, subject to specified conditions. It is widely used in commercial software development, allowing businesses to incorporate existing code into their products rather than developing every component from scratch.

Although open source software is generally available without licence fees, it is not necessarily free from legal obligations. The conditions depend on the applicable licence, which generally falls into one of two categories:

  • Permissive licences, such as MIT, BSD and Apache 2.0, generally allow software to be incorporated into proprietary commercial products, subject to relatively limited obligations, such as retaining copyright notices and attribution.
  • Copyleft licences, such as the GNU General Public License (GPL) and Affero General Public License (AGPL or Affero GLP), impose additional conditions that may, depending on how the software is incorporated, used or distributed, extend to requiring corresponding source code to be made available under prescribed licensing terms.

The distinction is particularly important for startups, scaleups and growing businesses developing proprietary technology. The choice of open source components, and the terms governing their use, can affect how a propriety software product is commercialised, licensed and ultimately sold.

Why Open Source Software Licensing Matters

A business relying on proprietary software as a competitive advantage may discover that its chosen licensing arrangements are inconsistent with how it intends to distribute or commercialise its product, or may complicate a proposed sale of the business or company.

However, using copyleft software does not automatically require a business to disclose its entire proprietary codebase. The legal position depends on the particular licence, the relationship between the software components and how the product is used or supplied.

For example, conventional GPL obligations commonly turn on distribution, whereas the Affero GPL can impose source-code obligations in certain circumstances involving software accessed remotely over a network. You can read more about GPL licences here: https://www.gnu.org/licenses/gpl-faq.html 

These distinctions are particularly relevant to software-as-a-service (SaaS) businesses, which generally provide access to software over a network rather than distributing it. While GPL licensing obligations generally arise on distribution, the AGPL may also require disclosure of corresponding source code where users interact with modified software over a network. The extent of any disclosure obligation depends on the applicable licence and how the software is incorporated into the product.

How Open Source Software Can Affect an Acquisition

A prospective purchaser of a technology business is not simply acquiring software that functions. It is acquiring the rights, contractual arrangements and commercial opportunities associated with that technology.

During due diligence, the purchaser may seek to establish whether the target company has sufficient rights to operate, develop, licence, commercialise and sell its proprietary software without material third-party restrictions.

Open source compliance issues can complicate that assessment and create additional legal and commercial risks for the proposed transaction.

For example, during due diligence, a purchaser may discover that:

  • components of the company’s proprietary platform incorporate software subject to unfulfilled source-code disclosure obligations;
  • the company has failed to comply with attribution, copyright notice or other licensing requirements;
  • software introduced by external developers is subject to open source licences that have not been identified or reviewed; or
  • contractual commitments made to customers are inconsistent with the company’s rights under applicable open source licences.

These findings do not necessarily prevent a transaction. However, they may require further investigation, remediation or changes to the proposed transaction terms. 

Depending on their materiality, unresolved issues may result in a reduced purchase price, specific indemnities, escrow arrangements or conditions to completion. In more serious cases, they may cause a purchaser to reconsider the acquisition altogether.

The commercial difficulty is often compounded by timing. Identifying and addressing historical licensing issues during a live transaction can be considerably more disruptive than managing them throughout the development lifecycle, potentially delaying completion or, in more serious cases, causing the purchaser to withdraw from the transaction.

The Contractual Risks Beyond Software Licensing

Open source compliance is not confined to the relationship between a company and the copyright holders of third-party software. It can also affect the company’s contractual obligations to customers, investors and purchasers.

Developer and Contractor Agreements

Growing businesses frequently engage external developers, consultants and offshore development teams.

Their agreements should address the incorporation of third-party software, including requirements to identify open source components, comply with applicable licences and obtain approval before introducing components that may materially affect the company’s commercial rights.

An assignment of intellectual property created by a contractor does not transfer ownership of third-party open source software incorporated into the deliverables.

The company must instead ensure that it has the necessary rights under the applicable licences.

Customer Contracts and Licensing Commitments

Technology businesses commonly give contractual assurances concerning intellectual property ownership, infringement and their right to supply software.

Broad warranties that software is entirely proprietary, free from third-party rights or subject to unrestricted commercial use may be inappropriate where open source components are incorporated.

Customer agreements should accurately distinguish between proprietary technology and third-party components, while ensuring that the rights granted to customers are consistent with applicable licensing obligations.

Transaction Warranties and Indemnities

In a share sale or business acquisition, purchasers may require detailed warranties concerning software ownership, third-party licences, compliance, and the absence of obligations to disclose proprietary source code.

Where historical compliance cannot be established, purchasers may seek specific indemnities, additional contractual protections or other remedies to address the associated risks.

Accordingly, the absence of appropriate open source governance can become a direct commercial issue in negotiating an exit, rather than merely a matter for the company’s development team.

Managing Open Source Risk from Startup to Exit

Open source software is not inherently incompatible with proprietary technology or a successful exit. The objective is to ensure that its use is legally understood, documented and consistent with the company’s commercial strategy.

Businesses should establish proportionate governance arrangements from their earliest stages, including by:

  1. Identifying components and licences: Maintain an accurate record of open source software incorporated into products, including relevant licensing terms and dependencies.
  2. Reviewing licence compatibility: Assess whether licensing obligations are consistent with the company’s intended use, distribution arrangements and commercial model.
  3. Controlling third-party contributions: Require employees and contractors to follow clear policies concerning the introduction and use of open source software.
  4. Aligning commercial agreements: Ensure developer, customer and licensing agreements accurately reflect the company’s intellectual property rights and obligations.
  5. Conducting periodic reviews: Reassess compliance as products evolve, new components are introduced and the business approaches investment, acquisition or exit.

These measures need not impose unnecessary complexity on an early-stage business. However, they should become more sophisticated as the company’s products, customer commitments and transaction exposure develop.

Where historical issues are identified, remediation may involve correcting notices, satisfying disclosure obligations, replacing components or negotiating alternative commercial licences. The appropriate response will depend on the licence and the circumstances.

Key Takeaways for Founders and Growing Businesses

Open source software can be an important source of competitive advantage. The legal risk arises when businesses incorporate it without understanding the conditions attached to its use.

For founders anticipating an eventual exit, the question is not simply whether the company owns its proprietary technology, but whether it has the rights necessary to commercialise that technology in the manner represented to customers, investors and prospective purchasers.

An exit may be the point at which these issues receive the greatest scrutiny, but the decisions that create them are often made at the company’s foundation.

We advise Australian and international businesses, investors and purchasers on managing legal risk, structuring transactions and navigating capital raisings, share acquisitions, business purchases and exits 

If your business is preparing for investment or an exit, or you want to strengthen the legal foundations supporting its technology, contact our corporate and commercial technology lawyers here.

This article provides general information only and does not constitute legal advice. The legal implications of open source software depend on the relevant licence terms, applicable law and the circumstances of its use.

Author

  • Kelly Tudhope

    Kelly is a corporate and commercial lawyer dedicated to the Australian startup ecosystem. She specializes in capital raising, governance, and regulatory compliance, helping businesses from early-stage to international scaleups navigate complex commercial transactions. Kelly is a member of the Australian Law Council SME Committee and holds a particular interest in climate-related regulation.

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