Understanding Joint Ventures: An Alternative to M&A
March 5, 2019
As our economy evolves and more companies specialize with niche approaches to the marketplace, many entrepreneurs are pursuing joint ventures (“JVs”). Although typically associated with large corporations, JVs can be effective structures for small-to-medium sized enterprises as well.
Put simply, joint ventures are arrangements that involve two or more separate organizations engaging in collaborative efforts and sharing of resources for their mutual economic benefit. Joint ventures come in different forms – they could be as simple as a contractual alliance between the partners (e.g., a long-term supply contract) or may require the establishment of a new entity (“NewCo”) in order to accomplish the intended objectives.
Advantages of Joint Ventures
There are actually many compelling reasons for pursuing a joint venture. First, your company is able to mitigate its own limitations by capitalizing on the capabilities and resources of a joint venture partner, resulting in enhanced innovation, establishment of new distribution channels, and access to greater technology capabilities and different skill sets. Firms can use joint ventures to enter new lines of business, share significant costs (e.g., research and development), and diversify their risks.
Furthermore, companies can utilize strategic alliances to pursue growth opportunities in new industry sectors adjacent to that of their core business or enter emerging foreign markets with a local partner. Additionally, depending on the structure, companies can use JVs to invest and partner with other firms without having to consolidate assets or operating results onto their own financial statements.
Hulu is an example of a joint venture that allowed its original venture partners to share the cost and risk of establishing an online media platform; enter into an adjacent industry sector to serve as a viable competitor to Netflix; and provide additional distribution channels for their media content. Starbucks frequently utilizes joint ventures to enter new, emerging markets; in 2012, it established a joint venture agreement with Tata Global Beverages to own and manage Starbucks stores in India. As of April 2016, the joint venture operates 84 locations.
Finally, a joint venture may be a viable alternative to pursue and maximize growth opportunities when a mergers or acquisition transaction is not feasible due to lack of available targets, regulatory concerns, and/or prohibitive costs. Under the right circumstances, joint ventures or strategic alliances can be less risky and less costly than a merger or an acquisition.
The Joint Venture Agreement
Joint venture agreements, whether serving as the contractual basis of a mutually beneficial alliance or the foundation of a NewCo, contain certain key elements. The JV agreement will plainly state the goals and objectives of the JV; outline each partner’s contribution of funds, property and other assets, skills and knowledge to the alliance; and clearly define each party’s ownership interest in the venture. The agreement will also detail the management/governance of the JV and lay out each partner’s right to share in the JV profits.
As stated earlier, joint ventures may be formed via formal structures or contractual agreements. There are two common entity types for consideration. Parties may structure a JV as a C-corporation. Under a corporate structure, co-venturers will be shareholders in the NewCo; their responsibility for JV liabilities is limited only to the extent of their investment. Additionally, minority shareholders may be accorded certain basic protections as it relates to fundamental corporate actions (e.g., sale of the company or a material change in governance structure).
Alternatively, JVs may be structured as limited liability companies (LLCs) or limited partnerships. A potential key benefit of a LLC or limited partnership structure is that it serves as a pass-through entity for tax purposes, allowing venture partners to recognize their pro rata share of profits and losses on their individual financial statements. The profits can be used to augment earnings from core operations, while any losses could be utilized to minimize a JV partner’s tax liability.
As with entities, there are a couple of types of contractual alliances to consider for joint ventures. Virtual JVs are collaborative contractual arrangements, through which the entering parties manage governance, as well as the risks and rewards germane to the business operations. No separate legal entity is formed, with the contract serving as the governing document of the relationship.
Long-term contracts represent another common form of strategic alliances. These contracts organize the parties around a specific task, such as purchase or supply agreements where one company brings product to the table and the other brings distribution channels. These contracts can be used by the entering parties to allocate risks and rewards of the partnership.
Factors that Impact JV Success
As with any other type of business entity or contractual agreement, joint ventures aren’t always successful. Many JVs fail due to flawed business plan, improperly crafted agreements covering key governance and financial terms and conditions, or poor working relationships between the partners. However, companies can take proactive steps to increase the likelihood of success for a JV.
JV management must have the full backing of the participating partners. Second, the joint venture must be properly capitalized at launch, with clear expectations on how and when additional funds will be contributed. As with any business collaboration, successful JVs are fueled by solid bonds of trust and clear communications among all parties involved.
No two companies are alike. Thus, participants from each company must understand the cultural differences and core competencies of the partner firms. There must be constant evaluation of whether progress is being made towards the JV’s stated goals and objectives (what’s working and what’s not working); this helps ensure that each partner is making appropriate contributions and will ultimately benefit and profit from the venture. Finally, the JV must develop enterprise-wide capabilities so that it’s a value add to the creating companies rather than a drag on their respective operations.