Microsoft Licensing in M&A: License Carve-Outs in Divestitures

Microsoft Licensing in M&A: License Carve-Out in Divestitures

When a company divests or spins off a business unit, ensuring the new entity has the necessary Microsoft licenses on Day 1 is critical.

CIOs and CTOs must proactively manage Microsoft licensing during divestitures by either “cloning” the parent’s license agreements for the spin-off or arranging short-term transitional access.

This avoids compliance risks, prevents costly duplicate spending on licenses, and ensures the newly formed organization can operate smoothly from day one.

Read Microsoft Licensing in M&A: Consolidating Tenants and Contracts – Best Practices for Handling Microsoft Licensing When Companies Merge or Split.

The Challenge of Microsoft Licensing in Divestitures

Divestitures introduce unique licensing challenges. Microsoft Enterprise Agreements (EAs) and other volume contracts are typically tied to a specific legal entity and user count, which can be upended when part of the organization is sold or spun off.

Key challenges include:

• Day 1 Readiness: The new company requires immediate access to Microsoft software (Windows, Office 365, Azure, etc.) upon separation. Without planning, the spin-off could find itself unlicensed and unable to use critical systems on Day 1, disrupting operations.
• Compliance Risk: Following divestiture, the spun-off business is no longer considered an affiliate under the parent’s Microsoft agreement. If it continues using software licensed to the parent without permission, both organizations risk license non-compliance and potential audit penalties. Microsoft and other software vendors often monitor M&A activity and may initiate audits if licensing isn’t addressed.
• Duplicate Costs: Without a license carve-out plan, the parent company may end up paying for licenses it no longer needs (for users who have moved to the new company) until the contract renewal, while the new entity must purchase its own licenses from scratch. This double-spend scenario wastes money and erodes any cost savings from the transaction.
• Loss of Volume Discounts: The divested unit will typically be smaller than the parent, which means it may lose the economies of scale in licensing. A spin-off negotiating its own Microsoft deal might face higher prices per license if it can’t leverage the parent’s prior volume discounts or pricing agreements.

In short, without a strategic license carve-out, both the parent and the spin-off face financial and operational risks: shelfware and extra costs for the parent, and unbudgeted new licensing expenses (or even inability to function) for the new company.

CIOs/CTOs must address these issues well before the separation begins.

Cloning License Agreements for the Spin-Off

One effective approach is to “clone” the parent company’s Microsoft agreement for the new entity.

Cloning an agreement involves negotiating a new contract for the spin-off that mirrors the products, terms, and discounts of the parent’s deal, essentially copying and pasting the license entitlements into a fresh agreement under the new company’s name.

This strategy ensures continuity and fairness:

• Same Products and Quantities: The spin-off’s agreement would include the same Microsoft products (e.g., Microsoft 365 E3/E5, Windows Enterprise, Azure services, etc.) and user counts that the divested unit had under the parent’s EA. The goal is for all the software the new business unit was using to be covered under its own contract from Day 1, with no lapse.
• Preserve Discount Levels: If the parent enjoyed a large volume discount (for example, 20–30% off list prices due to its size), the cloned agreement extends that same discount percentage to the spin-off, at least initially. Microsoft will often agree to maintain comparable pricing for a spin-off for a limited time (e.g. the first year or first contract term) so the smaller new company isn’t penalized with higher costs. This can be framed as a condition of the separation to keep the software vendor “honest” and not gouge the spin-off.
• Aligned Terms and Conditions: The cloned contract attempts to keep key terms consistent, such as pricing protections, true-up rights, and product use rights, so that the new entity essentially steps into an arrangement as favorable as the parent’s. For instance, if the parent’s EA had a price cap on year-over-year increases or special flexible terms for reductions, the new company should seek the same.

From Microsoft’s perspective, helping clone the agreement can be desirable: they retain the same total volume of business (just split between two customers) and avoid losing the spin-off to competitors.

In practice, the parent company’s Microsoft account team will coordinate with the new entity (or the acquiring company, if the unit is being sold) to draft a new EA or enrollment quickly.

This often involves legal and procurement work on tight timelines, so starting early is essential. The parent can assist by sharing its current agreement details and advocating for the spin-off’s interests.

Real-World Example:

A manufacturing firm spinning off a 500-employee division negotiated a cloned Microsoft Enterprise Agreement for the new company. The parents’ EA provided Office 365 and Windows licenses at a 25% volume discount.

By cloning the deal, the spin-off secured the same 25% discount on its 500 seats, paying approximately $150 per user instead of $200 at retail, saving roughly $250,000 in annual costs.

At the same time, Microsoft allowed the parent to remove those 500 users from its own EA at the next anniversary (instead of waiting until the end of the 3-year term), preventing about $100,000 in wasted spend on unused licenses.

This win-win cloning approach ensured the new company was fully licensed on Day 1 and that neither side paid double.

Transitional Licensing via Short-Term Access (TSA)

In some cases, it may not be feasible to have a new agreement in place right at closing, or certain systems might take time to separate.

Here, a Transitional Services Agreement (TSA) can provide a safety net.

A TSA is a contract between the parent and the spin-off (or buyer) where the parent agrees to continue providing certain services, including IT and software access, for a defined transition period (often 3, 6, or 12 months) after the divestiture.

Key points about using TSAs for Microsoft licensing:

• Temporary Shared Use: Under a TSA, the new entity is permitted to utilize the parent’s Microsoft licenses for a limited period following separation. For example, the divested business unit may continue to use the parent company’s Office 365 tenant, Windows images, or Dynamics 365 system for a few months while it establishes its own environment. This prevents any sudden cut-off in access when the deal closes.
• Vendor Consent: It’s crucial to ensure the Microsoft agreement permits this usage. Many enterprise contracts have an “affiliate use” clause that doesn’t automatically extend to a divested entity once it’s no longer under the parent’s control. Ideally, the parent would have negotiated a divestiture clause up front (allowing usage by a separated entity for X months). If not, Microsoft’s consent should be obtained in writing. Typically, Microsoft will agree to a time-limited extension for the spin-off to use the software under the parent’s license, especially if both plan for the spin-off to become a direct customer thereafter.
• Responsibility and Fees: During the transition period, the parent company usually continues to report and pay for the licenses being used by the spin-off (since they are still under the parent’s agreement). The TSA between the companies can include provisions for how the spin-off reimburses the parent for these licensing costs for the duration of the TSA. It’s essential to clearly define who bears the cost to avoid confusion or disputes later.
• Scope and Duration: Define exactly which software and services the new entity can use, and for how long. For instance, a TSA might allow the spin-off to run on the parent’s ERP system or Office 365 tenant for up to 9 months. After that, the spin-off must migrate to its own licenses and infrastructure. Keeping the timeline tight creates urgency for the new entity to secure its own Microsoft agreements and complete any data migration (such as moving to a new Azure AD/M365 tenant) promptly.

Using a transitional licensing approach buys time to execute a smooth separation. However, TSA arrangements are temporary by design. Both the parent and spin-off should work in parallel to finalize permanent licensing.

The TSA period can be used to negotiate the cloned agreement or to complete technical migrations (e.g., splitting out users and data to a new tenant or deploying new license keys in the spin-off’s name). It’s a safety cushion, not a long-term solution.

Negotiating with Microsoft for a Carve-Out Deal

Whether pursuing a cloned agreement or a TSA, a successful license carve-out hinges on negotiation with Microsoft.

Since Microsoft’s standard contracts don’t automatically account for mid-term divestitures, you will likely need to engage Microsoft (often through your Volume Licensing Service Provider or Microsoft account rep) to craft a solution.

Key negotiation considerations include:

• Partial Termination or License Transfer: Microsoft generally does not allow reducing counts mid-contract for an EA, unless an exceptional event, such as a divestiture, occurs. Prepare to present the case: e.g., “We are divesting 20% of our workforce. We need to transfer those licenses to the new company or terminate them from our contract.” Microsoft may offer options such as transferring perpetual licenses (allowed via a formal license transfer process) or letting the parent terminate a corresponding portion of subscription licenses if the spin-off signs a new agreement. Make sure any license transfer complies with Microsoft’s rules (usually, only fully paid perpetual licenses can be transferred outright; cloud subscriptions cannot be “transferred” but can be re-provisioned under a new contract).
• Ensure Continuous Coverage: Insist on arrangements that leave no gap in licensing. If the spin-off signs a new EA effective Day 1, coordinate the effective date and provisioning so that, as soon as the clock strikes midnight on separation day, all users and servers are legally licensed under either the parent or the new entity. If a slight gap is unavoidable, obtain written assurance (or a short-term amendment) from Microsoft that it will not consider this a compliance violation, provided the new contract is executed promptly.
• Credits for Unused Term: In negotiations, if Microsoft cannot allow mid-term license reductions for the parent, try to obtain a credit or offset for the unused portion of those licenses. For example, if the parent must pay out the year for licenses that are now going to the spin-off, ask Microsoft to credit that value toward the spin-off’s new agreement or against the parent’s future renewals. Microsoft might not refund money, but they could apply credits or allow the parent to use that value for other Microsoft products (e.g., Azure credits, etc.). This way, money isn’t simply wasted.
• Maintaining Relationship Leverage: The parent company likely represents a big account for Microsoft, and the spin-off will be a net-new customer. Use this leverage: the parent can indicate that how Microsoft handles the divestiture will influence the goodwill in the ongoing partnership. Suppose Microsoft wants to keep both businesses as happy customers. In that case, it should offer flexible solutions (like special pricing for the spin-off and the ability for the parent to adjust commitments). Don’t be afraid to escalate to Microsoft account executives or licensing specialists at a high level; large enterprise customers often receive custom terms in M&A situations, but as the saying goes, “if you don’t ask, you don’t get.”
• Document Everything: Any concessions or special arrangements should be documented via amendments or addenda to the contracts. For instance, if Microsoft agrees that “DivestedCo can use ParentCo’s licenses for up to 6 months post-close,” get that in writing with signatures. If a portion of licenses is being carved out into a new agreement, ensure the paperwork (such as Microsoft’s internal forms for license transfers or affiliate changes) is completed and acknowledged by Microsoft. This protects both parties during any future true-up or audit – you can demonstrate to auditors the agreed-upon terms for the divestiture scenario.

Remember that Microsoft’s own contract terms (notably the Microsoft Product Terms and the EA agreement) contain clauses about mergers, acquisitions, and divestitures.

Typically, there’s a statement that if a merger or divestiture causes a significant change (often defined as a 10% or greater change in seats), Microsoft will work in good faith to accommodate the changes within the context of the agreement. Leverage that clause during discussions, it implies Microsoft expects to negotiate in these cases.

Come prepared with a clear plan for what you need (e.g., “200 E3 licenses to move to NewCo, remaining 800 stay with Parent, prices unchanged, new EA for NewCo effective immediately, and Parent’s EA quantity drops at renewal”).

With a solid plan and early engagement, most license vendors (Microsoft included) will cooperate to adjust contracts rather than risk losing business or causing customer dissatisfaction.

Cost Impact and Risk Comparison

To illustrate the importance of a proactive license carve-out, consider the following simplified scenarios for a divestiture of a unit with 200 Microsoft 365 users (all on Office 365 E3) mid-way through a parent’s EA:

In the above comparison, it’s clear that proactive planning (whether via a TSA or a cloned agreement) dramatically reduces wasted spend and compliance risk.

The “no carve-out” scenario is the worst-case: the parent pays for unused licenses and the spin-off pays full freight anew, effectively, Microsoft gets paid twice for the same set of users, and the companies bear unnecessary costs. This situation can be avoided with early action.

Another risk to note is audit exposure. If licensing is not sorted out, the spin-off might be running software without a valid license contract in its name, which is a huge red flag in any software audit.

Microsoft could potentially levy back-charges or penalties for unlicensed use.

By addressing the licenses in the divestiture agreement and working with Microsoft, CIOs ensure that both entities remain audit-ready and legally compliant throughout the transition.

Finally, consider the operational risk: beyond dollars and compliance, failing to secure licensing can slow down or derail the separation’s IT disentanglement. Employees at the new company might lose access to essential tools (email, Office apps, cloud services) if accounts are shut off prematurely or not re-provisioned.

Planning the license carve-out in tandem with IT separation tasks (like migrating user accounts, establishing a new Azure AD tenant or on-prem AD trust, etc.) is vital for a smooth Day 1.

Recommendations

To ensure a successful license carve-out during a divestiture, CIOs and CTOs should:

• Engage Microsoft Early: As soon as an M&A divestiture deal is on the table, inform your Microsoft account manager or reseller. Early notice allows time to negotiate terms or new agreements, ensuring that both the parent and spin-off are covered from Day 1.
• Inventory and Map License Needs: Perform a detailed inventory of the Microsoft licenses used by the divested business unit. Identify which products and the number of seats or cores the new entity will require. This becomes the blueprint for either transferring those licenses or securing equivalents in a new contract.
• Negotiate a Carve-Out Amendment: Don’t assume standard contracts will suffice. Proactively negotiate an amendment to your EA (or a side agreement) that addresses the divestiture – whether that’s partial termination of licenses, a transfer of licenses, or permission for transitional use. Get Microsoft’s commitments in writing to avoid ambiguity later.
• Clone the Agreement When Possible: Aim to have the spin-off sign a new Microsoft agreement that mirrors your terms and pricing. Facilitate introductions between Microsoft and the new entity’s procurement team. By advocating for a cloned deal, you help the spin-off hit the ground running and preserve volume pricing for at least the initial term.
• Include Licensing in the TSA: If a Transition Services Agreement is used, make sure it explicitly covers software usage. Define how long the spin-off can use the parent’s licenses, and include a plan for cutover to the new licenses. Also, outline cost reimbursement, so both sides know who pays for what during the transition.
• Plan the Technical Cutover: Coordinate with IT teams to migrate services such as Office 365/Azure AD tenants, Exchange mailboxes, or any on-premises servers that the spin-off requires. Use the transition period to migrate users to the new environment before the TSA expires. The license plan and IT plan should work hand-in-hand.
• Avoid Shelfware at Renewal: If you’re the parent company, adjust your license counts at the next EA anniversary or renewal to remove users who have departed. Mark your calendar and work with Microsoft so you’re not stuck paying for licenses for employees who no longer work for you. Consider negotiating a one-time true-down at separation if the timeline aligns – Microsoft might be willing to accommodate to maintain goodwill.
• Use Advisors if Needed: Consider consulting a software licensing expert or a SAM consultant who has experience navigating M&A scenarios. They can help spot pitfalls, negotiate with Microsoft on complex terms, and ensure you’re not leaving money on the table (or exposing yourself to compliance issues). The cost of expert help is often far less than the cost of a licensing mistake in a divestiture.
• Document and Communicate: Document every agreement, new contract, or exception in the separation plan. Internally, brief both organizations’ IT and finance teams about the licensing plan to ensure clarity. After Day 1, continue to monitor that the new company is procuring renewals or replacements for any interim arrangements, and that the parent isn’t accidentally still servicing licenses for the spin-off beyond the agreed period.

By following these steps, CIOs can ensure that a corporate spin-off is license-ready from day one, avoiding legal landmines and unnecessary costs, and allowing both the parent and the new company to move forward with their IT strategies unencumbered.

FAQ

Q1: Can we transfer Microsoft licenses directly to the new company in a spin-off?
A1: It depends on the license type. Perpetual licenses (like on-prem server or Office 2019 licenses owned outright) can usually be transferred to a new company in connection with a divestiture, with Microsoft’s approval and proper paperwork (a volume license transfer form). Subscription licenses (like Office 365 or Microsoft 365 subscriptions, Azure subscriptions, Software Assurance benefits) cannot be “transferred” in the same way – instead, the new entity needs to acquire its own subscriptions. In practice, you might achieve the outcome by canceling the parent’s subscriptions for those users and having the spin-off initiate new subscriptions under its own account (ideally timed back-to-back so that users aren’t affected). Always notify Microsoft and follow their formal process to avoid compliance issues.

Q2: What does “cloning” a Microsoft agreement entail?
A2: Cloning means setting up a new volume licensing agreement for the spin-off that is virtually identical to the parent company’s agreement. This includes the same products, similar volume, and, critically, the same pricing and discount levels the parent enjoyed. For example, if the parent had an Enterprise Agreement with a 15% discount off the list price for Office 365 E5 licenses, the cloned agreement would provide the new company with the same 15% discount on its licenses. Cloning often involves Microsoft treating the new entity as if it were part of the original deal for negotiation purposes. It’s essentially a way to “copy-paste” the contract benefits so the new company isn’t starting from zero. Cloning must be negotiated with Microsoft – it’s not an automatic right – but Microsoft will often accommodate to keep the new business.

Q3: How long can a divested entity use the parent’s licenses under a transition arrangement?
A3: The duration is determined by negotiation and should be spelled out in the Transition Services Agreement (TSA) or a contract amendment. Typically, transition use is permitted for a short period (3, 6, or 12 months) following divestiture. This gives the new company time to set up its own licenses. The exact timeframe will depend on the complexity of the separation and what Microsoft agrees to. It’s rare to extend beyond a year; the goal is to transition to proper licensing for the new entity as soon as possible. Both parties should plan milestones (e.g., tenant migration completion, new license contract start date) to ensure the new entity is fully independent by the end of the allowed period.

Q4: What if the parent’s Enterprise Agreement still has years to run? Will we still be required to pay for licenses we don’t need after the spin-off?
A4: Without proactive negotiation, the parent would normally be obligated to maintain the originally contracted quantities until the EA term ends, meaning you’d pay for those now-excess licenses. However, in divestiture situations, you have leverage to negotiate a solution. Microsoft may allow a pro-rata termination or quantity reduction for the licenses tied to the divested users, especially if the spin-off is committing to a new agreement for those same licenses. If Microsoft is inflexible mid-term, ensure you true-down at the next renewal (your EA allows you to decrease to your actual user count at the end of the term). Additionally, you could seek a credit: for example, if you must pay out the year for 200 unused licenses, ask Microsoft to credit that value toward an Azure purchase or the spin-off’s first bill. The key is to raise the issue – Microsoft won’t usually volunteer a concession unless you request it and present the business case.

Q5: How do we handle cloud services like Office 365 or Azure AD when splitting off a company?
A5: Cloud services add technical complexity to the licensing split. The spin-off will likely need to establish its own Microsoft 365 tenant (for Exchange Online, SharePoint, and Teams, among others) and possibly its own Azure tenant. Plan a migration of user accounts, mailboxes, and data from the parent’s tenant to the new one. Licensing-wise, the spin-off will need its own subscriptions for those cloud services (either via a new EA, CSP, or Microsoft Customer Agreement). One strategy during transition is to use features like Azure AD B2B or tenant-to-tenant migration tools to move users gradually. During the TSA period, users might still authenticate against the parent’s tenant but be migrated to the new tenant’s licenses as they become available. It’s crucial to coordinate the IT migration timeline with the licensing timeline – for example, don’t cut off the parent’s licenses until all user mailboxes have been moved to the new tenant that has its own licenses. Early and detailed planning with your cloud architects is needed to avoid disruption.

Q6: What contractual clauses can we include upfront to make future divestitures easier for licensing?
A6: When negotiating your Microsoft (and other software) contracts, consider adding a divestiture-friendly clause. This could state that in the event of a divestiture, the customer (you) has the right to assign or transfer licenses to the new entity, or allow its use by the new entity for X months, without incurring additional fees (subject to Microsoft’s consent, which shall not be unreasonably withheld). Some customers also negotiate flexibility to reduce license counts beyond the usual rules if a portion of the company is sold. While Microsoft’s standard EA has some built-in language about working in good faith, a more explicit clause can be sought, especially if you anticipate spin-offs. Similarly, ensure there’s an assignment clause that allows you to transfer the entire agreement to an affiliate or a successor, which is important if the whole company or a major part of it is acquired or separated. These provisions can save a significant amount of time and leverage when an M&A event occurs.

Q7: If our company is acquiring a business instead (the opposite scenario), do we need to worry about license carve-outs?
A7: In an acquisition (where you are the buyer), the focus shifts to integrating licenses rather than carving them out, but there are parallels. You’ll want to review the acquired company’s Microsoft licenses to determine if they can be consolidated into your existing agreements or if they need to be maintained separately until the next renewal. While you might not be carving out, you might choose to “merge” agreements. Also, check if the acquired firm was relying on a parent company’s licenses (if they were previously a spin-off themselves or part of a larger organization); if so, ensure they have their own licensing or negotiate a transfer as part of the deal. In any M&A direction, the principle is to ensure no users are left without a valid license and to optimize costs by eliminating redundant contracts. After the merger, you may consider unifying EAs or consolidating some users under a single contract to secure better discounts. Essentially, license planning is crucial in both divestitures and acquisitions – divestitures, you’re splitting licenses, acquisitions, you’re combining – and both need Microsoft’s involvement to do it right.

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