In today’s economy, companies are increasingly looking at different business structures to bring new ideas, technology and products to the market. One common and constructive solution is a joint venture arrangement. In a joint venture, businesses or individuals combine their resources, expertise and skills for a specific project. It gives them the opportunity to collectively focus on a common goal, while diffusing the risk, liabilities and costs. The parties in a joint venture generally structure it by forming a separate entity for the new line of business or by entering into one or more contracts with each other and sometimes with outside parties.
Joint venture arrangements have many benefits to potential partners. The parties may each gain (1) supply and distribution opportunities that may not be accessible to such party independently, (2) entry to domestic and/or international markets that were otherwise unavailable, (3) a reduction in expenses and costs associated with such venture, and (4) access to assets of other party (i.e., intellectual property, licenses, manufacturing capabilities, etc.). For smaller companies, there are additional benefits such as a source of capital, improved credibility in the market, and the ability to compete with larger businesses.
As with any new arrangement, parties must weigh the benefits against the disadvantages of the business structure. The drawbacks to a joint venture arrangement generally relate to the partnership between the multiple businesses. Each company lacks total control over the new enterprise. Depending on the specific details of the business organization, there may be issues among the parties regarding each party’s flexibility and participation as well as each party’s commitment of time and resources to the project. There may be too much dependence on one party in the arrangement. These types of struggles lead to a somewhat high rate of failure for joint ventures.
As a first step in considering the benefits and disadvantages of a joint venture arrangement, potential partners should negotiate and execute a confidentiality or nondisclosure agreement with each other. This agreement will secure privacy and protection for the exchange of their confidential information during the due diligence phase and the negotiation of any joint venture agreement(s) between the parties. The parties should closely consider the objectives of each party, and whether their goals appropriately coordinate, and the requirements of the new business and each party’s abilities to meet those necessities.
Before negotiating a definitive joint venture agreement, the companies will generally conduct a mutual due diligence investigation, during which each company researches the business of the other company. The parties will typically exchange, among other items, corporate information, financial records, asset and liability information, and sales/marketing information. During its investigation, each company should closely consider the costs and benefits of entering into a business arrangement with the other party and what issues and concerns should be addressed in the business structure.
In forming the joint venture, most companies choose to form a separate entity for the arrangement rather than entering into one or more contracts. Even with the formation of a separate entity, the parties will most likely have additional contracts that address their involvement and participation in the new business (i.e., licensing, manufacturing, services, etc.). Through the formation of a joint venture entity, the parties can limit their liability and also detach the operations and assets of the new line of business from each party’s existing business.
A party may ultimately decide that a joint venture is not the best structure for developing its technology and concept. Other options for such company include merging or acquiring another company to meet its needs for the new line of business, proceeding independently with its existing resources, or entering into an independent contractor arrangement. Mergers and acquisitions can be costly, and, depending on the acquisition, a company may acquire more assets than it needs or raise regulatory concerns depending on the industries of the two businesses (i.e. antitrust). An independent contractor agreement is generally used for a specific business need and not the broader requirements of a new line of business.
Companies should assess a variety of business structures in pursuing a new development opportunity, but joint venture arrangements can potentially offer a multitude of benefits and advantages.
Issues/Matters to Consider for a Joint Venture Agreement
Although drafting and negotiating the terms of the agreement are very specific to the type of project and relationship between the parties, the following provisions and comments provide some general information to consider.
Choice of entity for separate JV entity
- Corporation, limited liability company and partnership are the most common types of structures for joint ventures. Which type of entity is appropriate from liability, tax and management perspectives for the potential partners?
Purpose(s) for entity
- It is important at the outset for the parties to agree on the scope and general description of the project so that there are no misunderstandings as the project progresses. If there are changes to the scope, the parties can mutually agree to modify the purpose at such later date.
Term; termination; remedies
- To the extent that the parties are able and the project allows, the parties can set forth the duration of the joint venture; if necessary, this term can be amended, but by providing a term, the parties may be able to keep each other on task with certain milestones and deadlines.
- Alternatively, the parties may determine that a perpetual duration is more desirable.
- Termination is one of the most highly negotiated provisions in any agreement; each party should be prepared for what happens if the other party breaches the agreement or otherwise fails to fulfill its obligations; what if the project becomes too costly or is not completed within a certain timeframe – should these matters be breaches of the JV agreement?
- Should there be any remedies if one party breaches or defaults? Should such remedy be specific to the type of default?
Management; voting rights
- How will the parties manage the joint venture? equally?
- Will the day-to-day operations be managed by designated officers or managers? more significant actions by a Board of Directors or Managers? how will such directors or managers be elected or appointed by the respective parties?
- If the parties do not have equal voting rights, will there be certain actions that require supermajority approval?
Capital contributions/profit participation
- Will the parties equally contribute the start up resources (i.e., cash, fixed assets, intellectual property)? will either party provide services as all or part of its contribution?
- Will the parties share equally in the profits of the joint venture?
- Authorization for each party to enter joint venture.
- Any conflicts under existing agreements, laws, regulatory authorities, etc.
- Information regarding any assets (i.e., equipment, supplies, intellectual property, contacts with customers, vendors, suppliers, etc.) and liabilities.
- Noncompete during and after joint venture – negotiate the scope, duration, and territory.
- Nonsolicitation of employees, contractors, vendors, suppliers, etc.
Restrictions on transfer
- Restrict parties ability to transfer or sell their interest in joint venture.
- Consider if a right of first refusal is appropriate.
Events of sale
- Consider whether the bankruptcy, dissolution, change of control (i.e., merger, sale of stock, change in Board, etc.), legal proceedings against a party to the joint venture should trigger a right for the joint venture and/or other party or parties to purchase such member’s interest in the joint venture.
- Should such right to purchase be mandatory or optional? for all or some of the events?
- How will the parties resolve a matter that results in an impasse between the parties?
Ownership of developments, derivative products, intellectual property
- After the termination or expiration of a joint venture, who will own any products or developments arising from the project?
- Service, licensing, manufacturing, development, distribution, investment.
Click here to view the full digital version of the The Innovation edition of SML Perspectives.