With the ever-increasing connectivity and collaboration in the business world, forming an alliance between one company and another with complementary resources and expertise is a key concept across virtually every industry. When collaborating with other organizations, it is imperative that both companies go in with a plan to discuss how both parties will benefit from the collaboration, the risks of the collaboration, and how to structure the relationship. Although there are many ways to enter into such a relationship, one consideration is for the companies to form a joint venture.
What is a joint venture?
A joint venture involves two or more businesses combining their resources and expertise to achieve a particular set of goals. By joining forces, the companies combine for more resources, greater capacity, and access to other markets, while also sharing the risks and rewards of the venture. Joint ventures offer both companies the freedom to combine contributions of two or more companies in creative ways. However, this capability also makes these deals inherently challenging to negotiate and structure compared to other types of agreements. The companies contemplating a joint venture must make key choices that will govern their relationship including asset contribution, operating structure, exclusivity, ownership, branding, IP rights, exit, and more. Getting both companies aligned on all these dimensions requires diligence and can be demanding.
Company Partner Selection
An ideal joint venture relationship allows one company to benefit from the other party’s market access, resources, and expertise in areas where that company lacks those resources and vice versa. Generally, joint ventures between companies with different product markets and functional capabilities perform better than joint ventures between companies with similar capabilities. Conversely, joint ventures between companies that have similar product markets and functional strengths tend to run into problems. Management and governance of the venture is fraught with difficulty because the companies are natural competitors and may seek to play similar roles in the venture.
Culture and Values Match
Assuming the companies have the necessary capabilities, they should judge compatibility based on their culture and values. An assessment of the key attributes of a partner’s company culture can quickly reveal if there will be major issues. For example, a company that is highly entrepreneurial with a high risk-tolerance will not be a good match for a company that is highly process-oriented with a conservative risk approach.
Structuring the Relationship
In order to limit their liability, investors and other parties often establish a joint venture under a separate legal entity such as an LLC, corporation, or limited partnership. Without the formal legal structure, the members would be liable for the actions of each other. Forming the legal entity often results in increased expense of setup and governance, along with consuming a significant amount of ongoing management time. Depending on the deal objectives of the companies, the companies may be willing to trade the benefits of limited liability to avoid the ongoing burdens of management of the entity. In those cases, a preferred arrangement may be to prepare a series of agreements to govern the relationship, such as licensing, marketing, supply and distribution agreements, that would closely approximate the joint venture entity functions.
Assuming the companies move forward with an entity-structure for the joint venture, they will want to formalize how the venture will be managed and controlled. The members will need to know how this separate legal entity will be handled on a day-to-day basis. The members should consider voting rights on important decisions to be made governing the entity. For example, a corporation appoints a board of directors for governance whereas an LLC has members vote rather than directors. LLCs can have managers who are given control of certain operations of the business. The members can allocate certain voting and veto rights to key matters affecting the business such as purchasing and selling property, bringing in new members, acquiring financing and more.
Distribution of Profits
A key consideration for the venture is how the members will split the profits that they make from the collaboration. The members do not all need to be compensated equally and the allocation can be split a number of ways. For example, some parties may be compensated higher due to their having greater involvement in the management and operation of the venture. The entity could have passive investors that are compensated at a lower rate. A joint venture agreement should discuss how distributions are determined, such as periodically or perhaps upon the occurrence of specific events such as sales or revenue milestones.
At the formation of any business, it is important to begin with the end in mind; the companies must consider how the venture will eventually terminate. The companies must consider the procedures that will make the business dissolution economical for all of the parties involved in the venture. A joint venture agreement should specify the types of events that will trigger termination and outline specific and orderly procedures for exit from the venture. For example, the need for a business termination may arise when one of the members dies, the number of members drops below a certain number or the need to permanently remove a member for incapacitation, misconduct or discord. Will the joint venture completely dissolve or should there be an allowance for one or more members to buy out the ownership share of the exiting member? What if a member decides to leave or if the other members want to remove the member? An orderly procedure must be detailed in the agreement so as to avoid litigation and to keep the dispute from sinking the business.
At GARZA, we understand the complexities and many considerations that go into partnering with another company in a joint venture. We are here to guide you through the process and make sure your company’s interests are protected throughout.
Call us at 208 557-8705 as you set out on your venture. Let us help you unravel the complexities involved in joint venture formation.