Ten Things to Consider When Forming a Joint Venture

1.         Know your partner.    This is obvious.  Go beyond the obvious.  Do as much research as you can so that you understand the corporate culture of the party you will be partnering with.  Do not assume that the individuals you have been talking to at your prospective partner have the same values and vision as the organization they represent.  Has the organization done joint ventures before?  What were the results?  Can you talk to someone at their former partners?  There is more at risk than the hoped for financial results.  Your reputation can be adversely affected by the acts of your partner, even acts that are not directly related to the joint venture itself.

2.         Know your partner’s national culture.  If your partner is located in a country other than your own, invest the time to learn how your partner’s national culture could affect your joint venture.  Learn business etiquette in your partner’s country.  Learn how contracts are perceived, how problems are solved and how partners are expected to behave in your partner’s culture, even if the location of the joint venture operations is elsewhere.  Cultural values and perspectives shape the way people think and act, and the only certainty is that every culture is different.  The more diverse the cultures of the two partners, the more likely it is that unexpected disagreements will develop. This is not a simple undertaking but it is worth the effort.

3.         Decide on the respective roles in detail at the start.   Do not assume that a general description of a partner’s role implies that all related tasks are included in the role.  Create a list of tasks—both expected and those arising in the event of possible contingencies—and assign them to the respective partners.  If there are tasks that neither partner can or will perform, choose the third-party contractors for those tasks before the venture is formed or at least have a clearly defined selection procedure.  This list of assigned roles should include less-than-obvious responsibilities such as risk management and emergency planning.  If the management team of the joint venture is responsible for these areas, this should be clearly delineated and written policies should be required.  Shared management responsibility sometimes results in circular finger pointing when things go wrong.

4.         Discuss contingencies before the agreement is signed.  The only constant in this world is change.  Discuss the “what if’s” with your prospective partner and try to determine how the joint venture will respond to the various changes that might be encountered:  changes in market conditions, competition, personnel or equipment shortages, new regulations, loss of key customers, etc.  This type of discussion serves two purposes.  First, it may lead to adaptive processes and procedures in the joint venture’s structure that allow for greater flexibility when needed.  Equally important, it can give you a better understanding of how easy it will be to get your prospective partner’s cooperation when you believe that changes will be needed.

5.         Create a detailed joint venture agreement.   There are certain areas that should always be covered:

  • Structure of the joint venture (ownership, voting rights, governing body)
  • Objectives (or a reference to a business plan)
  • Financial contributions each will make (up-front and callable or contingent)
  • Composition of the management team and any key individuals to be assigned
  • Contributions of intellectual property to the joint venture and ownership of      intellectual property created by the joint venture
  • Allocation of profits and losses.
  • Liabilities of partners to each other and indemnities.
  • Rights to business opportunities found by but not suitable for the joint venture
  • Distributions
  • Dispute resolution procedure

This list is just a beginning.  Leave as little as possible “to be worked out later.”  More likely than not, later will be harder.

6.             Clear performance indicators.  Establish clear performance indicators for each party to the joint venture.  What if the projections in the business plan are not met? It is not uncommon for the two parties to have different expectations about what the joint venture can achieve at different times in the future and if those expectations are not met, how it will affect the respective contributions of the parties.  For example, if one party is providing the financing and the other party is providing expertise, will the former feel that its financial commitments should be reduced if there are delays in achieving the profit targets?  Performance indicators will provide both parties with a better understanding of what each can expect from the other and it will also probably raise important questions about the changes that should occur if the performance indicators fall short.

7.         Establish an open dialogue.  Generally speaking, unless there is a problem joint ventures do not generate as many meetings or senior-level discussions as would be the case if the joint venture project were simply a project of one of the partners.  Perhaps this is because there is usually travel involved or because the collegial environment inside a single organization is missing.  Or perhaps it is because discussions may disclose differences of opinion and such differences, while easy to resolve within a typical corporate organization, are not so easily resolved in a joint venture.  Whatever the reason, it is important for the joint venture partners to meet regularly face-to-face to discuss progress and to discuss openly all of the issues either party may wish to discuss.  This type of regular dialogue not only mitigates the risk of misunderstandings but also brings attention to matters that, if not discussed, can grow into serious disputes.  It can also foster personal relationships between individuals that prevent the parties from becoming suspicious of each other.

8.         Keep good records.   Who keeps the financial, operational and other records?  Which records are kept and where are they kept?  Who has access?   What records are required by regulations in the location of the joint venture’s operations and in the country of each partner?  How are the records protected?   It is easy to underestimate the importance of the answers to these and similar questions.  The advantages of good record-keeping are of course well known but there is an additional advantage in the case of joint ventures: If a key person who was assigned to the joint venture by one of the parties leaves his or her employer, it will be harder for the person’s replacement to reconstruct the “corporate history” of the joint venture by “asking around”.  The records will have to speak for themselves.  One approach might be to store all the records in a cloud that is accessed through the Internet independently of either party’s IT network.  The access could be controlled through assigned user names and passwords, and permissions could be assigned for adding, deleting and editing documents.  In addition, interested parties could be notified when documents are added and the storage system could have an access log showing who logged-in and when.

9.         Select advisers carefully.   Again, this seems obvious but it should not be considered routine.  Select legal, accounting, tax and strategic advisers who are practical, creative and knowledgeable about the reasons joint ventures can go awry.  Advisers that a company has used in the past with good results may not be the right choice if they lack experience in joint venture planning.  In addition, it is useful to think about who will act as legal counsel to the joint venture after it is formed.   Often, neither partner wants the other partner’s regular counsel to be giving advice to the joint venture because of the potential for a conflict of interest.

10.       Have an exit plan.   When a couple is planning their marriage, the last thing they want to talk about is how they would handle a divorce.  People planning a joint venture are not much different.  Unlike divorce, however, the process of unwinding a joint venture is not spelled out in the law.  It is a creature of contract and if the contract is silent, the parties must negotiate the terms of separation at the time they want to end their relationship. This is often a time when the partners have widely divergent views on what is “fair” and there may even be ill will between the parties.  One common way of addressing the prospect of “irreconcilable differences” in the future is to have a buy-sell agreement (or incorporate buy-sell provisions in the joint venture agreement).  It is important to create such an agreement at the outset of the joint venture because it can be very difficult to negotiate anything at the time of separation, even the process by which the terms of separation will be decided.  There are two types of buy-sell agreements:  traditional and so-called “guts ball” agreements.  In a traditional buy-sell agreement, the parties agree on an appraisal process to determine the value of the joint venture.  Either partner can initiate this process and the initiating partner agrees to buy the other partner’s interest at the appraised value.  The problem with this approach is that the appraised value, even if it is the average of three valuations by three independent appraisers, might be significantly above the initiating partner’s estimate of the true value of the other partner’s interest or significantly below the selling partner’s estimate.  In contrast, the guts-ball agreement does not require an appraisal.  Either partner can offer to buy the other partner’s interest at any time at a specified price.  The partner receiving the offer has two choices and only two choices:  accept the offer or purchase the offering partner’s interest at the same price.   In other words, the partner receiving the offer must either sell or buy, in either case at the price specified by the offering partner.  If the partner receiving the offer makes no decision, that is deemed an election to sell and the deemed election can be enforced in court.  This process is inherently fair because the offering partner could find itself in the position of either a buyer or a seller.  Therefore, it must offer a price at which it would be willing to buy or sell, as the other partner elects.  What could be fairer?  Speaking practically, such buy-sell arrangements are seldom exercised, but the fact that they could be is an inducement to the parties to resolve their differences through negotiation.

The ten points above are just a starting point.  Every joint venture is different and requires a plan that addresses all its unique aspects.  Still, it is well to remember that joint ventures often either fail or they disappoint one or both partners.  Be skeptical, be cautious and be clear.  Don’t let the excitement of the planning stage foster the assumption that the results will be so beneficial to both partners that the future will take care of itself.



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