Diligence That Stops at the Demo
Software escrow and source code questions in technology due diligence
Software escrow in technology due diligence addresses a question most financial models assume away: whether the software behind an investment can be maintained if its authors leave, the company fails or a customer invokes its continuity rights. Investors in Indian software companies increasingly treat that question as core diligence rather than a closing formality.
What should diligence ask about source code?
Five questions reveal most source code risk before signing:
Question | Why it matters to value |
Does the company own the code its employees and contractors wrote? | Gaps in the ownership chain can impair the core asset |
Where does the authoritative codebase live, and who controls access? | Concentrated access creates key-person risk |
Do customer contracts oblige the company to maintain escrow? | Unmet obligations are breach exposure |
Have existing deposits been independently verified? | Unverified deposits may not build |
What open-source licences does the code carry? | Some licences impose disclosure obligations |
On ownership, Section 17 of the Copyright Act, 1957 vests work made by employees in the course of employment in the employer, while work by independent contractors generally requires a written assignment under Section 19.
Why do customer escrow obligations matter to investors?
Enterprise customers in regulated sectors often require escrow. Banks and NBFCs, for example, must obtain source code or an escrow arrangement for critical applications under paragraph 12(f) of the Reserve Bank of India’s IT Governance Master Direction of 7 November 2023. An unmet escrow obligation is a breach risk. A poorly drafted one may give a customer release rights on a change of control, which the investment itself could trigger. Diligence should therefore read the release conditions, not merely confirm that an escrow agreement exists.
How does a verified deposit reduce diligence risk?
A verification report from an independent escrow agent is third-party evidence that the codebase can be built from documented materials. It reduces reliance on management representations and on the memory of a few senior engineers, and it gives the investor a baseline for post-investment monitoring.
Quick answers
Does maintaining escrow weaken the company? No. Escrow is ordinary commercial practice; the risk lies in loosely drafted trigger events.
Can an investor or lender be a beneficiary? In some structures, subject to negotiation with the licensor and existing beneficiaries.
Investors can discuss deal structuring with the EscrowNXT team on +91 44 45535571/72.
EscrowNXT, a Chennai-based software escrow provider founded in 2005, supports investors, acquirers and enterprises with verified escrow arrangements. Further information is available at www.escrownxt.com. This article is for general information only and is not legal advice.
