FAQ:
What is a Joint Venture?
Janel Vaughan
Introduction
As business projects get larger, technology more expensive, and the costs
of failure too large to be borne alone, businesses feel the need to work with
joint ventures. In general, a joint venture (“JV”) is an association of two or
more entities (whether corporate, government, individual or otherwise)
combining property and expertise to carry out a single business enterprise and
having a joint proprietary interest, a joint right to control and a sharing of
profits and losses. Regardless of
the scope of the undertaking, the nature of the JV or the respective degrees of
equity or management involvement, a JV must: (1) be a separately identifiable
entity; (2) have an ownership interest in such entity by each joint venture
partner (“JVP”); and (3) have an active management involvement or deliberate
rejection of the right to such involvement by each JVP.
In increasing numbers, businesses have been reaching beyond national
boundaries in an effort to locate new opportunities for growth, new markets,
and new venture capital. Each foreign market offers unique opportunities and
risks, and many firms naturally look to JVs with one or more partners for
assistance in entering new markets. JVs have become a major feature of the
international business landscape due to increased global competitiveness and
technological innovation.
JVs are common and successful in several industries. For example, in the land
development and construction industries, JVs are often used to obtain sufficient
financing to acquire large land tracts or to undertake major building
projects. JVs are also common in
the manufacturing, mining, and service industries. A JV may be formed to
conduct research and development work on a new product or technical
application, to manufacture or produce various products, to market and
distribute products and services in a specified geographic area, or to perform
a combination of these functions. The function of the JV will be linked to the
overall objectives of the parties and will dictate to a large extent the
substantive terms of the JV arrangement.
The formation of a JV can be a complex process. After a compatible JVP is
selected, the specific goals of the enterprise must be defined, the structure of
the JV must be negotiated, numerous legal issues must be recognized and
resolved, and potential areas of conflict between the JVPs must be identified
and reconciled. If the JV is formed under the laws of a country other than the
United States, the JVPs must take the time to understand the requirements of
the foreign country’s corporate law.
Reasons for
Forming a Joint Venture
There
are many motivations that lead to the formation of a JV. They include:
- Risk Sharing – Risk sharing is a
common reason to form a JV, particularly, in highly capital intensive
industries and in industries where the high costs of product development
equal a high likelihood of failure of any particular product.
- Economies of Scale – If an
industry has high fixed costs, a JV with a larger company can provide the
economies of scale necessary to compete globally and can be an effective
way by which two companies can pool resources and achieve critical mass.
- Market Access – For companies
that lack a basic understanding of customers and the relationship/infrastructure
to distribute their products to customers, forming a JV with the right
partner can provide instant access to established, efficient and effective
distribution channels and receptive customer bases. This is important to a
company because creating new distribution channels and identifying new
customer bases can be extremely difficult, time consuming and expensive
activities.
- Geographical Constraints – When there
is an attractive business opportunity in a foreign market, partnering with
a local company is attractive to a foreign company because penetrating a
foreign market can be difficult both because of a lack of experience in
such market and local barriers to foreign-owned or foreign-controlled
companies.
- Funding Constraints – When a company
is confronted with high up-front development costs, finding the right JVP
can provide necessary financing and credibility with third parties.
- Acquisition Barriers; Prelude to
Acquisition – When a company wants to acquire another but cannot due
to cost, size, or geographical restrictions or legal barriers, teaming up
with a JVP is an attractive option. The JV is substantially less costly
and thus less risky than complete acquisitions, and is sometimes used as a
first step to a complete acquisition with the JVP. Such an arrangement
allows the purchaser the flexibility to cut its losses if the investment
proves less fruitful than anticipated or to acquire the remainder of the
company under certain circumstances.
Basic
Elements of a Joint Venture
- Contractual Agreement. JVs are established
by express contracts that consist of one or more agreements involving two
or more individuals or organizations and that are entered into for a
specific business purpose.
- Specific Limited Purpose and Duration.
JVs are formed for a specific business objective and can have a limited
life span or be long-term. JVs are frequently established for a limited
duration because (a) the complementary activities involve a limited amount
of assets; (b) the complementary assets have only a limited service life;
and/or (c) the complementary production activities will be of only limited
efficacy.
- Joint Property Interest. Each JV
participant contributes property, cash, or other assets and organizational
capital for the pursuit of a common and specific business purpose. Thus, a
JV is not merely a contractual relationship, but rather the contributions
are made to a newly-formed business enterprise, usually a corporation,
limited liability company, or partnership. As such, the participants acquire
a joint property interest in the assets and subject matter of the JV.
- Common Financial and Intangible Goals
and Objectives. The JV participants share a common expectation regarding
the nature and amount of the expected financial and intangible goals and
objectives of the JV. The goals and objectives of a JV tend to be narrowly
focused, recognizing that the assets deployed by each participant
represent only a portion of the overall resource base.
- Shared Profits, Losses, Management,
and Control. The JV participants share in the specific and identifiable
financial and intangible profits and losses, as well as in certain
elements of the management and control of the JV.
Structuring
the Joint Venture
Structuring any JV may pose a challenge. This is especially true where
parties are from different jurisdictions and various cultural backgrounds are
involved. After parties have decided on fundamental issues such as the
commercial nature, scope and mutual objectives of the joint venture, the JVPs
must determine the geographic location of the venture and what form or legal structure
the joint venture will take.
Generally, the structure chosen will be between different types of
partnerships, corporations, or some form of a limited liability company,
depending on the tax and tort liability each JVP wants to be exposed to. The
precise tax and legal features of vehicles of the same general type will vary
from one country to another, but the U.S. forms of businesses can be broadly
classified as follows:
- Corporations – Corporations are
a commonly preferred choice for JVs. The legal status of a corporation is
clear, and its ability to own assets, incur liabilities and enter into
legally binding contracts is obvious to third parties. The liability of
shareholders for the corporation’s debts and obligations is limited to
their capital investment in the corporation, something that is not always
the case with other entities. From a tax perspective, corporations may be
undesirable because they generally lack pass-through tax status, making
its shareholders unable to set off profits and losses generated by the JV
against income or expenses from other activities. Also, the net income of
a corporation is likely to be subject to corporate tax in the jurisdiction
it is located, be it in the U.S. or elsewhere. Such tax payable by the
corporation may not be credible against taxes payable on dividends and
other profit distribution from the corporation and its shareholders.
However, the presence or absence of tax treaties between respective
countries may still make the corporation profitable.
- General Partnerships – All
partners in a general partnership have personal liability for debts and
other obligations incurred by the partnership. One advantage of a general
partnership in the U.S. and many other countries is that normally no
income or franchise tax is imposed on it. Also, all partners can act on
behalf of, and legally bind, the partnership via third parties.
- Limited Partnerships – Under a
limited partnership there are two distinct types of partners, general and
limited. The general partner carries responsibilities similar to the one
he carries in a general partnership, including the ability to legally bind
the whole partnership and being personally liable for debts and
obligations of the partnership. The limited partner, on the other hand,
mainly contributes capital and receives a specified share of the profits.
The limited partner is excluded from active management of the partnership,
but is exempt from personal liability for debts and obligations of the
partnership.
- Limited Liability Company – A
limited liability company is a hybrid between the partnership and the
corporation in that it provides the JVPs with insulation from the
liabilities of the LLC as in a corporation, while generally being
classified as a partnership for U.S. tax purposes. All members may take
part in management. Hybrid vehicles such as the LLC are not recognized in
all parts of the world.
Managing
the Joint Venture
Some JVs are dominant parent enterprises
– projects are managed by one parent like wholly owned subsidiaries. The
dominant parent selects all the functional managers for the enterprise. The board
of directors, although made up of executives from each parent, plays a largely
ceremonial role as the dominant parent executives make all the venture’s
operating and strategic decisions. Having managers from only one parent can lead to frustrations
for the managers as well as parent company executives.
A dominant parent enterprise is appropriate where a JVP is chosen for
reasons other than managerial input – i.e., financial backing, access to
resources, patents, or because it consumes a large amount of the product to be
made. Dominant parent joint ventures are also appropriate when a company takes
on a partner solely in response to pressures from a host government. In such
situations, a foreign company often prefers to find a passive local company
that (1) has no knowledge of the product, (2) is willing to be a passive
investor, and (3) is neither a government agency nor controlled by the
government. The passive partner, who
may be supplying technology or money, must trust the competence and honesty of
the dominant parent. If the local
partner never learns the business of the JV, the dominant parent’s bargaining
position with the host government will remain strong.
Other JVs are shared management ventures,
where both parents manage the enterprise. Each parent supplies both functional
managers and executives to serve on the board of directors. Here, the board of
directors has a real decision-making function.
One type of shared management venture is the 50:50 JV. This type of JV is
characterized by 50:50 participation in which each partner contributes 50
percent of the equity in return for 50 percent participating control. Under
such participation, each JVP is equally at risk, and is not subservient to the
other JVP as would be the case where majority control is vested in one party.
This sharing of interest and control also raises the possibility of deadlock
during disputes and early termination of the JV.
It is important to note that not all shared management ventures own equal
shares. JVs are flexible so that
they can be structured in such as way that one JVP has more than a co-equal
role in the JV (e.g., 40/60).
Shared management is critical in ventures where both JVPs are needed for
managerial input, as in manufacturing situations where one parent is supplying
technology and the other knowledge of the local market. However, deteriorating performance in a
shared management venture obliges each parent to become more involved in the
operation of the venture. Unless either parent is willing to defer to the
other’s knowledge or expertise, the decision-making process can become slow can
confused and trigger a series of events that can lead to the destruction of the
venture.
Because the amount and type of help needed from a partner may change over
time, some companies opt to begin their venture under a shared management that
they can later convert to a dominant venture. However, once both parents have
become accustomed to operating the venture, such transitions become difficult
to make.
The high failure rate of shared management ventures suggests that
dominant ventures outperform shared management ventures. Since shared
management ventures are not consistently used for riskier business tasks, their
high failure rate is a strong indication that they are more difficult to
operate than dominant parent ventures. Parents of the venture may, and often
do, disagree over strategic and organizational decisions. Differences in the
parent venture’s priorities, direction, and perhaps values result in confusion,
frustration, and slowness in the decision-making process and may place a joint
venture at a distinct competitive disadvantage. As a result, if a partner is
chosen for reasons other than managerial input a dominant parent structure will
usually be best.
Majority
ownership and dominance of a joint venture do not always go hand in hand. A
parent holding only 24% of one venture’s shares may be its exclusive manager.
Similarly, one parent may dominate a venture, despite the fact that it is a
50-50 deal.
International
Joint Ventures
International JVs are those in which one of more or the parties is
located outside the United States or those in which the operations of the JV
take place, or are directed toward, territories abroad. About three-quarters of
all JVs are international. Many countries have created a wide range of economic
incentives for using a JV structure for foreign investment. Because such
arrangements necessarily involve two or more sovereign jurisdictions, international
JVs present special problems. The international JV must consider the host
country’s investment laws and regulations and often obtain the host country’s governmental
approval.
Jurisdictions outside the U.S. offer a variety of business arrangements
that may or may not be suitable for a JV. In most jurisdictions, JVs will be
able to choose between organizational structures such as corporations and
partnerships with the same basic features as those used in the U.S. However, the structures, tax regimes,
and labor practices of each country vary and must be carefully analyzed. For
example, “S.A.” generally designates corporations in various countries,
including France, Switzerland, and Poland. S.A., the abbreviation for Société anonyme, translated literally as
“anonymous company,” is equivalent to U.S. public liability companies. Aktiengesellschaft (abbreviated A.G.) is a German term that
refers to a corporation that is limited by shares and owned by shareholders.
The U.S. equivalent term is “public company.”
International JVs frequently involve a local and foreign company. In some
cases, economic incentives that the host country provides may be the deciding
factor in a foreign party’s determination of whether the rewards of the
proposed venture outweigh the risks associated with entering an unfamiliar
market. Of course, the value of the incentives depends on the ability and
willingness of the local government to deliver on its promises, as well as the
diplomatic skills of local managers in dealing with regulators.
In countries where foreign inward investment is restricted for a variety of reasons, a JV with a local firm may be the most preferred, or even the only, entry route for the foreign investor. Egypt generally requires foreign investment to take the form of JVs, but will make exceptions in appropriate cases. In Egypt, foreign equity in the JV is generally limited to 49 percent, however a 100 percent foreign-owned company may be approved to operate in the free zones, in the oil industry, or to complete specific contracts.
JV laws in developing countries tend to vary in the manner they apply to
different sectors of the economy. In India, the government has identified 37
high priority areas covering most of the industrial sector that are vital to
India’s national interests or able to bring in new, needed technology. JVs in
these areas involving up to 74 percent foreign equity receive automatic
government approval within two weeks. Greater than 74 percent and areas outside
the high priority list are open to investment but governmental approval is
required and it is not automatic. In Nigeria, the maximum allowable amount of
foreign equity depends on the economic sector involved. These restrictions often
force technology transfers and/or managerial control to the domestic partner.
JVs in developing countries are considered less stable than those in developed countries. Although the opportunity to obtain local management is sometimes regarded as a major advantage of joint venturing, the need to work with local management can sometimes be a major problem in developing countries. For example, local management styles and expectations may lead to clashes with foreign partners. Potential conflicts among the management team are material and often result in early termination of the JV. Also, the advantage of having local managers who know how to deal with government officials may evaporate if a change in leadership occurs.
Managers
of international JVs may not only have communication problems because of
language barriers, they may also have different attitudes toward time, the
importance of job performance, material wealth, and desirability of change.
Such differences can delay the creation of an effective, cohesive management
team. JVPs in developing countries may have an imbalance in levels of expertise
and management styles resulting in poor integration and cooperation.
Termination
of Joint Ventures
Any number of events may lead to the termination of a JV. Many
termination events are anticipated and provided for in the joint venture
agreement. For example, a breach of the joint venture agreement may trigger
termination, as will other events, such as failure to meet research and
development deadlines. A JV may terminate upon achieving its objectives. Alternatively,
a JV may terminate upon failing to meet its objectives. The agreement could provide that one
JVP buy the other out or sell its shares, or vice versa.
Excessive costs, failure to achieve projected income, or unforeseen
capital requirements may make the continuation of a JV unattractive. In
addition, a change in the JV’s objectives or those of a shareholder may also
lead to the early termination of the JV. Changes in objectives may result from
a JVP’s internal strategic redirection, competitive advances, or market changes
beyond the control of the JV or its shareholders. Disagreement by JVPs on
fundamental management issues may also lead to termination.
An obvious disadvantage of sharing capital obligations is the need to share profits generated from the actual operation of the JV. Issues can arise in this area not so much because of the cash contributed, but because of the fact that the parties will also be contributing intangible assets to the business, such as intellectual property rights and technical expertise. Technology and management sharing can potentially create significant problems among the parties. In particular, one party’s mastery of the other’s technology can lead to improvements on that technology beyond the intended services of the JV, a factor that tends to discourage companies from disclosing their technologies for fear of losing the competitive edge to their JVP.
Many commentators argue that JVs offer a structure for reducing the “free
riding” of the local JV partner because both partners contribute to the costs
associated with the exploitation of the technology in proportion to their
expected benefits. The theory is that a JV partner will have an incentive to
focus on protecting the results of the JV activities rather than trying to
replicate independently the results for its own account.
Examples of
Recent Joint Ventures
| Parties to Joint Venture: | IBM (U.S.) and Lenovo Group(China) (2004) |
| Percent Participation: |
18.9/81.1 |
| Dollar Value: | $1.75 billion |
| Subject: | IBM sold its PC division to China-based Lenovo Group. Companies entered into a joint venture that would make Lenovo the third largest PC maker in the world, behind Dell and Hewlett Packard, and give IBM an 18.9 percent stake in Lenovo. |
| Parties to Joint Venture: | Skype Software (Denmark) and Tom Online (China) (2005) |
| Percent Participation: |
49:51 |
| Dollar Value: | $1.75 billion |
| Subject: | Skype formed a joint venture with Tom Online, China’s leading wireless Internet provider. Joint venture developed, customized and distributed a simplified Chinese version of the Skype’s Voice Over Internet Protocol software and premium services to Internet users and service providers in China. |
| Parties to Joint Venture: | Areva SA (France) and Energy Constellation (U.S.) (2005) |
| Percent Participation: |
50:50 |
| Dollar Value: | $11 billion |
| Subject: | Areva SA, a multinational industrial conglomerate that deals in energy, and Constellation Energy, that generated trades, supplied and distributed energy, formed a joint venture, UniStar Nuclear, to sell next-generation nuclear plants in the U.S. Areva will be the prime contractor for the new plants, providing the first load of nuclear fuel, while Constellation will run the plants and hold their operating licenses. |
| Parties to Joint Venture: | Pontiac Land Group (Singapore) and West Paces Hotel Group (U.S.) (2006) |
| Percent Participation: |
50:50 |
| Subject: | Pontiac and West Paces formed a joint venture known as the West Paces Hotel Group Asia. Headquartered in Singapore, this hotel management company will introduce new luxury hotels across Asia. Pontiac Land will focus on business development and securing strategic partnerships in Asia with leading high net-worth families and institutions. West Paces Hotel Group, headquartered in Atlanta, Georgia (USA), will contribute management and operations expertise in designing properties geared toward affluent travelers. |
| Parties to Joint Venture: | Siemens AG (Germany) and Nokia Corp.(Finland) (2006) |
| Percent Participation: |
50:50 |
| Dollar Value: | $19.9 billion |
| Subject: | Siemens AG and Nokia Corp. combined their fixed and mobile network infrastructure businesses in a joint venture known as Nokia Siemens Networks. The JV formation was a reaction to recent mergers in the industry, such as Alcatel with Lucent, and the rise of low-cost Chinese competitors such as Huawei Technologies Co Ltd and ZTE Corp. Nokia Siemens Networks became the second largest company, behind Ericsson, in wireless networks and third in fixed-line, behind Alcatel and Cisco Systems and is headquartered in Finland. |
| Parties to Joint Venture: | Hit Company (Rep. of Slovenia) and Harrah’s Entertainment (U.S.) (2007) |
| Percent Participation: |
50:50 |
| Dollar Value: | $700 million |
| Subject: | Slovenian gaming company Hit and U.S. casino operator Harrah’s Entertainment formed a JV to build a major new gaming and entertainment center in Slovenia, scheduled for completion in 2009 provided that the Slovenian government loosens gaming legislation. The project rests on the Slovenia government's willingness to tweak legislation: currently, foreigners can hold no more than 20% in a gaming venture, and the gaming tax is set at a high 30%. Harrah’s was in talks with the government on changes to the gaming law that would allow foreigners to hold a 50% stake. Harrah’s would also like the government to lower the gaming tax. |
| Parties to Joint Venture: | Posco (South Korea), SeAH Corp. (South Korea) and U.S. Steel (U.S.) (2007) |
| Percent Participation: |
35:30:35 |
| Dollar Value: | $93 million |
| Subject: | U.S. Steel partnered with Posco, South Korea’s leading steel producer, and SeAH, a tubular steel maker, in the venture to be called United Spiral Pipe LLC, to build a new U.S. facility that will produce spira- welded pipe for the natural gas industry. |
Sources
Dobkin, James A., Jeffrey Burt, Mark
Spooner, and Kenneth Krupsky, International Joint Ventures, Federal Publications Inc. (1st ed. 1986).
Gutterman,
Alan, A Short Course in International Joint Ventures, World Trade Press (2002).
Karalis,
John B., International Joint Ventures: A Practical Guide, West Publishing (1992).
Killing, J. Peter, How to Make a Global
Joint Venture Work, Harvard Business
Review, Vol. 60, pp120-27 (1987).
O’Brien,
Clare, ed., PLI Course Handbook – International Joint Ventures 2002
(No. A-835).