Open-Source Software Risk in VC and PE Technology Diligence

Open-source software rarely kills a technology investment by itself. The risk is that nobody can explain which components are in the product, which licence terms apply, whether source-code disclosure obligations have been triggered, and whether the company can give clean warranties at signing.

For VC, PE and strategic buyers, the diligence question is practical: does the target know its software bill of materials, or is the investment relying on founder memory and informal engineering practice?

Why This Matters

Most Indian software companies build with open-source components. That is normal. The issue is whether the company has managed those components as legal inputs to a commercial product. A permissive licence may require preservation of notices. A copyleft licence may create wider obligations if code has been modified, linked or distributed in a particular way. A dual-licensed component may require a paid commercial licence for the target's actual use case.

The legal starting point is copyright. The Copyright Act, 1957 protects computer programs as literary works and gives copyright owners exclusive rights that matter when code is copied, adapted, issued or licensed. Open-source software is not unowned software. It is licensed software, and the licence conditions determine what the company may do.

Contract risk is the second layer. Customer agreements, acquisition documents, investment warranties and vendor terms may require the company to disclose open-source use, confirm compliance, identify copyleft components or promise that no third-party code restricts commercial exploitation. The Indian Contract Act, 1872 matters because these promises become deal allocation points, not just engineering hygiene.

The third layer is electronic contracting and IP preservation. Section 10A of the Information Technology Act, 2000 supports electronic contracts, while section 81 preserves rights under the Copyright Act and Patents Act. In diligence, that means online licence acceptance, repository terms and click-through developer tooling should not be ignored.

What Counsel Should Review

Start with a software bill of materials. Counsel and technical reviewers should ask for the target's dependency inventory, package manifests, container images, repository lists, build scripts, licence-scan outputs and any internal exceptions. The review should cover production code, mobile apps, SDKs, firmware, APIs, developer tools and customer-delivered deployments.

Next, classify licence types. The review should separate permissive licences, weak copyleft licences, strong copyleft licences, source-available licences, proprietary third-party code and dual-licensed components. The Open Source Initiative licence list is a useful public reference for OSI-approved licences, but diligence should still read the exact licence text attached to each component and version.

Distribution matters. A SaaS business, downloadable enterprise product, embedded-device company and on-premise deployment model do not create the same licence analysis. Investors should understand whether the company distributes binaries, ships source, modifies open-source components, links libraries, provides containers, grants customer audit rights or includes open-source notices in release materials.

Review customer and investor documents against the code reality. If the company has promised that it owns all software outright, that statement may be too broad. If it has promised that no open-source software is used, the statement may be false. Better drafting distinguishes company-owned code, properly licensed third-party code, open-source components and remediation commitments.

Finally, test remediation before closing. Common fixes include notice file updates, replacing high-risk components, obtaining commercial licences, correcting repository permissions, updating customer disclosures, narrowing warranties and adding escrow or indemnity mechanics where the risk affects valuation.

Typical Timeline And Cost Range

A red-flag open-source review for one product can often be completed in 1 to 2 weeks if the company has current repositories, build files and scan outputs. A broader PE or acquisition diligence review across several products, legacy modules and customer deployment models may require 3 to 5 weeks.

The efficient approach is phased. First, identify high-risk licences and unexplained components. Second, map them to actual use and distribution. Third, decide which issues must be fixed before signing, which can be covenanted before closing and which should be handled through disclosure schedules or price protection.

Common Mistakes

1. Treating open-source software as free of conditions. Cost is not the same as unrestricted commercial use.
2. Running a scan without legal review. Tool output is useful, but it still has to be mapped to product architecture, distribution and contract promises.
3. Giving absolute ownership warranties. A software company usually owns some code, licenses some code and depends on third-party components under specific terms.

How KAS & Co. Can Help

KAS & Co. helps investors, acquirers and software companies assess open-source licence exposure, software ownership, diligence disclosures, remediation plans and transaction warranties for India-linked technology deals. For a focused review, contact KAS & Co..

FAQs

1. Is open-source software a problem for VC or PE investment?

Not usually by itself. It becomes a problem when the company cannot identify the components, comply with licence conditions or match its customer and investor warranties to actual software use.

2. Should diligence always require a code scan?

A code scan is usually helpful, but it is only the starting point. The result should be reviewed against the product architecture, deployment model, modification history and commercial contracts.

3. What is the biggest issue with copyleft licences?

The main issue is whether the company's use, modification, linking or distribution triggers obligations that conflict with its commercial product model or customer commitments.

4. Can open-source issues be fixed before closing?

Often yes. Fixes may include replacing components, adding notices, obtaining commercial licences, correcting disclosures, narrowing warranties or creating post-closing remediation covenants.

Sources

• The Copyright Act, 1957 - India Code
• The Indian Contract Act, 1872 - India Code
• The Information Technology Act, 2000 - India Code
• OSI Approved Licences - Open Source Initiative