There are various statistics banded about as to the success rate for joint ventures. A fairly conservative consensus puts that at around 40%. So why do many businesses still choose to embark on joint ventures?
Having the right “JV” partner can open up new markets and distribution networks, and logic dictates that combining distinct skills and resources of separate but complimentary businesses should make achieving common objectives easier. As compared to going it alone, a joint venture eases the level of resource commitment (financial or otherwise) of each joint venture party.
What then are the factors that contribute to that statistical failure rate? Establishing and running a separate joint venture vehicle often means additional cost in both monetary terms and human resource. If contributions are not purely monetary there may be disagreement as to the value each party brings to the arrangement and, in turn, expectations as to control and financial return.
Inherently, a joint venture has as its origin separate businesses with separate leadership, used to autonomy in decision making. That can also create tensions as to the division of control in relation to their joint enterprise. If those originating businesses operate in the same space then competing interests can also come into play.
A joint venture agreement will not be a panacea for commercial issues such as those. It can however set the framework identifying to each of the parties the others’ expectations, and bring into focus potential problems at the establishment stage, which they may otherwise come up against further down the line, when less easily resolved.
So, if, as a prospective joint venture partner, you have concluded due diligence on your proposed confederate(s) and determined that a separate company is the right model, what exactly should the agreement governing the venture cover? While such a shareholders agreement will to an extent be bespoke to the particular circumstances, there are common aspects one would expect to be included.
Purpose and objectives
For obvious reasons, identifying the exact nature and scope of the new undertaking’s activities is fundamental. The term of the agreement should be set out – is the venture to be finite to achieve a specific project within a given timeframe, or endure for the longer term? Expectations as to turnover, and any geographical limitations (e.g. excluding territories in which a shareholder already operates) should also be incorporated.
Contributions and financing
The agreement should state the parties’ initial contributions, and any future commitments they are bound to provide. Those might include, for example, cash, assets, facilities or intellectual property. If, by their nature, the contributions create associated legal relationships, (e.g. the licensing of intellectual property rights or the secondment of employees), the terms of those relationships should also be stated, possibly by way of separate stand-alone agreement.
If secured third party financing is to be obtained then one should anticipate recording the requirement for charges over company’s assets and, potentially, secured guarantees from the shareholders, which, to one degree or another, would undermine the effectiveness of using a limited liability company to ring-fence the risk of the venture.
Identified as one of the key areas of friction, it is critical that the agreement identifies the respective shareholders’ powers. If the equity in the business is not to be divided equally, shareholders with smaller interests will often insist on minority protections, giving them a veto on critical decisions, such as the issue of further shares or acquisition / disposal of major assets.
If the essential nature of the respective shareholders’ ongoing commitments, financial returns or voting rights are not to be identical, then it may well be that having separate classes of shares will deal with that most effectively.
Balance of power is not an issue confined to shareholder level. The directors will be the company’s governing mind, so the joint venture parties will invariably want the ability to appoint a representative to the board, and to ensure the board meeting quorum and voting rights are structured so as to achieve the agreed balance of board level decision making powers.
Unrealistic profit expectation is another common cause of discord. The desire for a speedy return on investment may need to be tempered by the need to meet third party financing obligations or to reinvest into the business. Accordingly, care should be taken before deciding to record in the shareholders agreement a commitment to fixed dividends.
The agreement should also address how a shareholder will be able to exit the joint venture, and in what circumstances the venture should terminate, as well as the consequences of termination. Those might include forced buy-sell mechanisms aimed at achieving a speedy determination of share value if deadlock arises on exit from the venture. The parties will also want certain provisions of the agreement to survive termination, for example confidentiality and non-compete / non-solicitation clauses.
The above is by no means an exhaustive summary of the provisions which a joint venture shareholders agreement might cover. Among others, issues such as tax, dispute resolution mechanisms and employment matters may well have to be catered for. However, this provides a flavour of the type of provisions that, if included, should produce an agreement providing a solid foundation for the sound operation of a joint venture.
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The information and opinion expressed in this briefing does not purport to be definitive or comprehensive and are not intended to provide professional advice. For specific advice, please contact Parslows, We are not responsible for, and do not accept any responsibility or liability in connection with, the content of this document or any reliance upon it.