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As promised in my previous Legal Briefing, here is some advice about things to think about when putting together a joint venture.
There are plenty of things you need to ask yourself when entering into a joint venture. A joint venture is about establishing an ongoing commercial relationship. Its success will therefore depend on the parties creating workable structures that encourage trust and the right level of collaboration. To do this, the parties must be clearly aligned on why they are coming together, what their business model and objectives should be, and how and where they will operate on a day-to-day basis.
What exactly is a joint venture?
There is no formal definition of what constitutes a joint venture. The expressions ‘partnering’ and ‘joint venturing’ can cover a wide range of different types of venture, with any number of different individuals or companies joining together as stakeholders.
A full-blown joint venture probably includes the following elements:
- The parties are all contributing to the venture, whether through financing, know-how or production capability or distribution channels.
- The parties are creating an economic unit with sharing of financial risk and reward.
- There is some level of joint decision-making.
But there’s no need to get pedantic about it. If you wanted, you could probably call almost any business arrangement other than the simplest transactional types a joint venture of some sort. For example:
- An investor may take a partial stake in a business in order to share risk and reward with the other owners, and will usually have some control rights. But a passive investor won’t perform commercial activities.
- A sales agency arrangement will involve contributions from each party (the principal supplying goods and other support; the agent providing a sales team and potentially marketing) and sharing of financial risk and reward (because the agency will usually work on a commission and will thereby be rewarded depending on how successful the business is). But an agent has to follow the instructions of its principal.
So a joint venture could involve many types or combinations of commercial arrangement or business structure. The process of putting a full-blown joint venture together, combining different types of legal concepts and business structures, can be an interesting challenge, both commercially and in terms of the legal structure and documents.
Planning a joint venture
Full-blown joint ventures can take a lot of time and effort to get off the ground. They’re complicated, often combining the one-off transactional components of an M&A deal with the requirements for ongoing operational flexibility and adaptability, governance and future-proofing of a long-term commercial arrangement. They don’t, therefore, fit neatly into a standard process.
The best approach is to start from basic principles. Ask and resolve basic questions about each party’s aspirations, objectives and concerns whether short, medium or long term. Try to anticipate what might happen in future and how each party might want to deal with it. Then put together the terms for a working relationship which addresses these issues.
It is important to plan the venture carefully. Parties should:
- Make sure the internal business case is robust and realistic.
- Try to get as much alignment as possible on the venture’s business model.
- Get the commercial, legal and tax structure right.
Sorting these aspects out upfront should allow the deal terms to be negotiated much more smoothly.
A full-blown joint venture may involve a number of different agreements and documents, for example:
- Joint venture agreement/shareholders’ agreement (and possibly tailored Articles of Association, particularly if different types of shares with different voting, distribution or return on capital rights are going to be used).
- Implementation agreement, governing the steps needed to establish the joint venture, including transfer of assets and/or equity ownership of relevant corporate vehicles.
- Secondment agreements
- Services agreements
- IP assignments and/or licences
- Supply agreements
- Distribution or agency agreements
- Third party financing
- Management agreements
Some key terms to cover in a joint venture
What each party contributes will affect what respective economic and control rights they will have. Contributions could take the form of cash, assets, or other commercial contributions such as discounted supply terms or licensing of knowhow or IPR rights, or provision of expertise or management resources. The types and extent of contributions might vary from time to time, and this could have a knock-on impact on economic and control rights.
How should cash contributions be made? By share investment, or loans, or some kind of mixture such as convertible loans? By guarantees of third party loans? What terms should apply?
What continuing contribution obligations should the parties have, to cover future funding requirements or if the joint venture is initially making losses?
Where parties contribute technology or other forms of IPR, who should own this? How can it be shared effectively whilst protecting each party’s interests?
- Economic rights
How straightforward will this be?
It could just involve the sharing of profits. But how do you factor in the value of various expenses or other contributions covered by each partner in working out how to share profits? When and how should profits be distributed? Should certain loans or liabilities be paid off first?
Or it could involve the sharing of possible ultimate exit values.
Or it could include the benefit of various commercial arrangements with the other parties or with the joint venture corporate vehicle.
- Control and management
Who is going to be responsible for making what decisions? Will some decisions need all parties to agree, and others not? Will one party have a bigger investment on the joint venture and therefore expect more control? Will different parties have different responsibilities for different types of decisions? What kinds of veto rights might other parties have?
- Ongoing commitment, and non-compete
How can the parties ring-fence the joint venture activities so none of them is able to circumvent the objectives behind the joint venture? For example, what if one party loses interest in the joint venture?
How long is the joint venture expected to go on for? What is the exit strategy? Is there a shared exit objective, eg to sell the joint venture business to a third party or even to one of the joint venture partners? What if one party wants to end or get out of the joint venture before the others? All this can get quite tricky, but it needs to be thought about and addressed as well as possible from the start.
- Change control issues, disagreements and fall-outs
How can these be dealt with?
Good tax advice will be needed in putting any joint venture deal together.
Do you want to run your joint venture through a joint venture company?
Purely contractual joint venture?
Many joint ventures involve one-off arrangements with two or more businesses looking to share resources or work together on specific initiatives. There may be various reasons why you might prefer a purely contractual arrangement rather than set up a limited company. For example:
- The parties may prefer to retain full ownership and control over their own assets, business and employees, rather than transferring them to a company partly owned by other parties.
- With a joint venture company you need to set out detailed rules as to how it is managed (eg how its directors are appointed) and what controls each party might have over decisions (eg using veto rights).
- Each party might be looking to get something different out of their investment and involvement in a particular project, which cannot be easily achieved by each having shares in the same company. (Sometimes a joint venture might involve a combination of a joint venture company in which parties may share common ownership and interests, and separate trading arrangements between the parties themselves or the parties and the joint venture company.)
- If the parties are looking for flexibility, for example, when the duration of the venture is short or the venture concerns a one-off project, a contractual joint venture may be preferable to an incorporated joint venture.
- A purely contractual arrangement may be easier to terminate and then extricate yourself from than a joint venture operated through a joint venture company as a separate legal entity. (But then again, it may not…)
- A contractual joint venture usually has no effect on the direct taxation of the joint venture parties as there is no transfer of their respective businesses to a separate legal entity.
Or joint venture company?
There may be even better reasons why you might want to set up a joint venture company. For example:
- If the joint venture is meant to be a separate trading business it is easier to do this through one stand alone company.
- A company has its own legal identity. It can enter into its own contracts with third parties. Joint venture parties can contract with it, rather than just with each other. It can own its own money and other assets.
- Depending on how a contractual joint venture is structured, there may be a risk that it is considered to be a partnership – leaving the parties exposed to other liabilities of the other parties. A limited company has the benefit and clarity of limited liability for its shareholders.
- A company is the easiest structure to raise finance for. It can borrow money, and can offer security over its own assets for its borrowings.
- A company has its own accounts and tax treatment.
- A joint venture company will develop an underlying value which means the shares in it will also have a value, and can be sold. Using a joint venture company may be the best way to plan for an exit.
- A contractual joint venture has the advantage that you can make it as informal as you like. But the absence of a defined legal structure to base it around makes it quite hard to put detailed rules together should you want to do so, and things can get quite messy. The drafting of a ‘partnership’ or collaboration or co-operation agreement may be more complex than the drafting of a shareholders’ agreement and articles of association, involving more bespoke, tailored drafting for the particular structure and circumstances. For example you may start having to think about having to address various different areas of law, such as more complex contract laws, laws of bailment, trust law or agency law.
- If you want some food for thought about some of the kinds of things you should think about when setting up a joint venture company, have a look at my article on joint ventures and shareholders agreements.
I hope this helps, and I look forward to working with you on your next joint venture!