Top 10 “Gotchas” in SaaS Agreements and How to Mitigate Them

If you are an IT deal maker, it’s likely that you will encounter a SaaS engagement in the near future, either being pushed by your organization’s business units or by highly incentivized SaaS sales reps. Your ability to identify and mitigate risk will determine the success of your SaaS deal. Though specific landmines vary from supplier to supplier, the main “gotchas” are common among all SaaS providers and are summarized here.

1. Renewal Caps.

Standard increases for SaaS vendors are high (7-10%), and there are a number of ways these vendors find loopholes to increase your price above this threshold. For example, some vendors require 100% of initial volumes to be renewed or your renewal caps are void. So, if you decommission a quarter of your volumes in effort to cut costs, SaaS vendors who use this language can increase your costs proportionally to keep you at the same annual cost level. Suppliers including Microsoft, Salesforce, ServiceNow, and Adobe find similar loopholes in language to inflict larger than average increases at renewal.

What you can do: Implement a 3-5% renewal cap that limits increases for all products. In addition, remove any language that limits the ability to downturn licensing at renewal so you can preserve license decommission flexibility. Start negotiations early (6+ months to execution date), obtain viable deal alternatives, and have net new license growth to create leverage to dictate renewal rights.

2. License Downturn.

If you over-purchase on SaaS licensing, you cannot downturn any unused products until renewal. Even at renewal, the feasibility of decommissioning product without a penalty fee is low. Since most customers agree to multiyear term lengths and SaaS costs are based on an annual recurring pricing model, it’s easy for shelf-ware costs to accumulate quickly.

What you can do: There are other terms you can negotiate into a contract to improve your flexibility and reduce the risk of shelf-ware, such as a clause that allows you to swap licenses during the term. This lets the customer swap out unused licenses for new products that may be needed, as long as the same annual cost level is preserved. Also, the customer could also negotiate a “ramp” in license volumes over the course of the agreement to further reduce costs and commit to more specific (and realistic) timetables for deployment.

3. Product Changes.

SaaS vendors that enact consistent changes to functionality and solution offerings typically have the legal ability to reprice and alter their customers’ contracts and products. Specifically, ServiceNow uses product changes and “end of life” to force re-negotiation on licenses, often for the same functionality. ClearEdge has seen cases where SaaS vendors used product changes and re-brands to increase price by up to 30% above the original amount.

What you can do: Implement contractual price protections for all existing functionality currently owned. This will protect against a vendor re-branding the same solution into new products, thus forcing customers to make new purchases or pay more at renewal for the same functionality.

4. Free/Promotional Products.

Free products are a great way for SaaS vendors to get their foot in the door, but they also provide the ability to charge premiums for those same products at renewal. In addition, free products are usually provided at very low volumes, so entitled capacity can easily be exceeded. The true-up/add-on rate for free licenses are typically priced at an extremely high level, thus locking customers into noncompetitive pricing when free products are heavily adopted by the organization.

What you can do: If products are included as free, but are not wanted by the business, remove them from your contract. For any free products that remain in your agreement, ensure that you negotiate competitive add-on rates, assuming you will have to expand in that license family at those predetermined rates.

5. True-Ups/Price Holds.

Many SaaS vendors do not publish true-up rates or price holds for additional licensing in their contractual agreements. As a result, customers have no contractual pricing for add-on purchases. For vendors that do offer price holds/true-up rates, premiums of 15-30% are typically applied.

What you can do: True-up/add-on rates should be negotiated and included in your contract prior to execution. This will reduce the need to re-negotiate rates for each add-on purchase. This is especially useful mid-term when the customer has less leverage over the vendor. To avoid expanding at non-competitive rates, aim for a 0-10% premium over your current contractual/offer price.

6. Suite/Platform Bundling.

Bundles often lump together products that may not be needed by every user. As a result, the customer pays a premium for the unused modules included in the bundle. Also, the lack of transparency in a bundle works to the advantage of the vendor, with any bundle change giving them the ability to increase pricing with little or no justification.

What you can do: Line-item transparency should be achieved before executing an agreement with any vendor, but not all suppliers have offerings outside of their suite/platform bundles. If you cannot achieve line-item transparency, mix and match different bundle levels to your user base requirements to cut costs. You could also negotiate the price of bundles based on the specific modules needed. For example, if you only need 50% of the functionality, negotiate for an additional 50% discount to accommodate for the customer use case.

7. Restricted Use Licenses (RULs) & Audit.

SaaS vendors commonly agree to “restricted” or “lite” versions of licensing at a lower cost than their full-use equivalent, which include the same level of functionality as a full-use license, BUT the customer contractually agrees to not use all the functionality provided. If/when a customer is found out of compliance by the contractual definition of their restricted-use licenses, all restricted licenses purchased will convert to full-use licenses and be billed at its respective list price.

What you can do: Remove language that states all licenses will need to true-up in the case of a violation. Only licenses that are out of compliance should be applicable for true-up, not the total pool of licenses purchased. Negotiate true-up rates that align with the contractual full-use price for the same license.

8. Service Levels (Uptime).

Service Level Agreements (SLAs) are not always included as an addendum to SaaS agreements, yet all SaaS engagements include a hosted service. It’s important that there are predetermined service level commitments included in your master agreement. Without an uptime availability percentage and remedies for failed performance, there is no way to hold the vendor accountable for solution downtime.

What you can do: Ensure you have an SLA addendum included in your agreement that has uptime commitments and remedies in the form of service credits for failed performance. Aim for an availability percentage above 99% (less than 88 hours downtime per year) for any vendor, since this is the industry standard. For remedies, its competitive to achieve a full daily fee refund for each day your solution is down below the negotiated performance level. To protect against consecutive quarters of failed performance, the customer should negotiate the right to terminate without any early termination fees.

9. Mergers & Acquisitions.

Typically, the customer who is experiencing a merger or acquisition must get permission from the vendor prior to assigning license rights (or pricing) to an acquired affiliate. If the acquired affiliate is also a customer of the SaaS provider’s solution, the existing affiliate contract must live out its term before assignment occurs. Due to the M&A contract language, you can inherit potentially poor pricing and terms from your affiliates, with little ability to right-size them to your price levels.

What you can do: It’s very difficult to get around this M&A language. Ideally, you will want to remove any language that requires the vendor’s consent to assign terms or requires an affiliate to live out their contract term before assignment can occur. One way around this language is to seize any large new growth instances you or your affiliate may have as an opportunity to renegotiate a whole new deal for all entities.

10. Divestitures.

If an organization divests into multiple entities, SaaS vendors will require that one of those entities inherit the full software contract and pay for all licenses entitled in the agreement. The other divested entities will have to re-negotiate new contracts for the licensing they require from the SaaS vendor. In this situation, the vendor is double dipping on license costs.

What you can do: Negotiate language into your contract that allows for licenses to be divested alongside any divestiture that occurs. This should allow you to assign a proportional number of licenses based on the size of the actual divestiture. Some vendors will cap the number of licenses that can be divested, so ensure your cap is high enough to accommodate any planned organizational splits.

Contract terms and conditions are an integral part of SaaS vendors’ sales strategies. Suppliers will not concede to competitive terms without significant buying power, because their success is tied to maintaining their standard contract language. Managing leverage is key to achieving better terms. If you are looking for more information on how to secure best-in-class terms on your next SaaS deal, download our SaaS Guide on the topic or contact ClearEdge to schedule a tailored SaaS Assessment and help plan your next deal.

- This article is based on information that appears in ClearEdge’s “Top 10 Gotchas in SaaS Agreements Guide”.