Understanding Joint Ventures
In today's world, collaboration is everywhere. Tech companies like Uber, for example, are collaborating with taxi drivers. More than ever, Joint Ventures (JVs) are a great model. Particularly in growing markets in Asia, having a local business partner is a huge value-add that perhaps many are missing out on. There is only so much you can achieve by yourself. With a JV, you speed up growth, market penetration, and scale at a pace you perhaps couldn’t by yourself. What’s more, JVs may be the only choice for you (certainly in some countries) due to legal reasons!
Like in a marriage, pushing your individual agenda will get you nowhere. You should focus on the purpose of the JV and effectively deliver on it in order to unlock its full potential. JVs can be between equals, but also between bigger/older and smaller/younger companies. If you’re a large company, you’d need to give your partner freedom and space. Conversely, as a smaller company, don’t be afraid to step up and take ownership. Ultimately, clarity and trust are the foundations of a good JV. However, there are also pitfalls and potential areas of contention that arise in JVs. Once you’re able to foresee these pitfalls, you’ll be in a better position to set up a JV that will withstand bad weather and achieve great results.
As the old adage goes, together is better.
JVs versus Partnerships
First, let’s set the stage by understanding what a JV is and how it’s different from a Partnership. While there are many similarities between the two, the main difference between a JV and a Partnership is the structure. A Partnership structure is relatively straightforward. It’s when two individuals come together over a common interest and make an agreement. This could be a Partnership Agreement which, in summary, would outline your duties, rights and obligations. Then you have Joint Ventures, which fall under two categories: Unincorporated or Incorporated.
Let’s start with an Unincorporated Joint venture. This is where people come together over a project with shared outcomes and objectives; constructing a shopping mall for instance, where you’re bringing in either capital or some other economic resource. There’s usually a well-defined relationship between the partners (these could be individuals or companies) which is defined through various specific contracts. Between themselves, the parties might have a Partnership (or a similar) Agreement, but it may not have a fence around it. Of course, there are more complicated structures like limited liability partnerships, especially in the professional services industry. But such structures are quite specialised.
On the other hand, an Incorporated Joint Venture is a much longer term entity which has a life and legal status of its own. There’s usually a corporate structure and Share Capital. The relationship between parties in an IJV is that of shareholder partners and would typically be governed by a Shareholders’ Agreement.
Usually, such Joint Ventures are incorporated onshore and are subject to the country’s local corporate laws. If you form an Incorporated JV in Singapore, then it would be subject to the Singapore Companies Act. The laws in Singapore governing corporate entities (like IJVs), for example, may be completely different from those in Vietnam or Indonesia as these countries have completely different political backgrounds and Government model legacies.
You need to really figure out how much experience you have in a particular country among other factors you may not have thought about before setting up an incorporated JV. You need to have acute awareness of local regulations, business culture, and cultural practices. Many times, people enter countries to form Incorporated JVs only to be surprised to find that things in that particular country are run very differently.
Let’s say there are three real estate companies from three different countries who form an IJV to build a shopping mall. The ultimate beneficial owners are actually the shareholders of these companies. You’d need to write out the Shareholders’ Agreement carefully, with proper frameworks and procedures in place, such that each company is able to justify capital investment, personnel appointments, day to day business, and managing risks to their parent companies. It’s a complex process that can get quite expensive to put in place. Enlist the help of an experienced commercial lead to make this process efficient and ensure an ideal outcome.
Let’s say you have a very simple purpose, for example importing hockey sticks to Singapore. Instead of forming a Joint Venture, you should just enter into an Agency Agreement or a Distributorship, or if there is an intention of risk/reward sharing, then a partnership with a supplier in India or Australia. So when selecting the business model, you should think about the scale and amount of resources required to achieve your objectives.
Setting The Stage For a Successful Joint Venture
There are few things you should consider before forming a Joint Venture. It is important that you’re fully aligned with your partners in key areas. You should be clear about why you’re forming the Joint Venture, what your JV’s key strategy and main objectives are.
Let’s say you are in a Joint Venture and unexpectedly discover that one of your partners is connected with some of your vendors. It means that your partner may not have been entirely transparent and honest with you. Doing your homework, a thorough background check and due diligence is crucial. Don’t just look at financials, criminal records, or bankruptcy, for example. Dig deeper to find out what drives this partner, what the company’s values are. Do they abide by these values? What is their strategy? Give yourself enough time to know and understand your partner.
You should also consider the values and relative strengths and weaknesses of each partner. Are you getting into bed with somebody whose different values and beliefs will come back to bite you later when key business decisions have to be made? Different partners bring different strengths to the table. Some are strong in financial capability, others are adept at building local relationships, some have a core competence such as managing real estate. On the flipside, knowing your partners’ weaknesses is equally important. Some companies don’t understand local markets, which might end up costing precious time and resources. Finally, think about boundaries for both yourself and your partners and agree to never cross these boundaries.
Put this all together to form a shared Code of Conduct. In this agreement, you’d decide what is acceptable and what is not. For example, your Code of Conduct should include an agreement to never engage in bribery. List your key values, define them clearly and state how the JV will use them, so as to not encounter difficulties later on.
Have a clear picture in your mind about how this JV is going to work. Who is going to have operating control? Who runs the day-to-day business? What is the decision-making process? Outline all of this in your Shareholders’ Agreement and add in provisions for contingencies. You won’t be able to predict or account for every crisis that may happen. But for 90% of possible issues, you must have a solution already outlined in your agreement. This should be part of Enterprise Risk Management.
When you’re assessing any business or entity, these are the factors to consider in respect of all JV partners. While you may have hired very capable corporate lawyers to draft the Agreement, keep in mind that they’re only able to draft what you articulate to them. Your Finance team and business leaders need to communicate to the lawyers exactly what commercial provisions and procedures you want in place. If this is not done, there is a risk that you will be stuck with template or nameplate, and thus, less practical agreements.
And this is not a discussion you should put off until you sit down to draft the agreements. Every JV partner should have considered this carefully long before the JV is conceived, and certainly before you engage in negotiations or work with your lawyers. A good Shareholders’ Agreement will give you much-needed clarity or direction if complex situations arise. For example, what are the protective rights in certain situations or how are the rights and obligations allocated. The Agreement should cover matters and situations for which a total consensus between all partners is required in order to move forward. As a simple example, even if one partner has control over the JV, that partner shouldn’t have the right to sell the business without consensus agreement among all partners.
Points of Disagreement
There is a whole range of circumstances that could throw relationship between JV partners out of orbit. Change in operating circumstances, continued financial losses and opinions about implementation of the underlying strategy or lack of appropriate management personnel are among the top reasons that relationships turn sour. Another scenario is when a partner’s own circumstances change. For example, if your partner is having trouble in their other ventures and tries to influence the JV to achieve something that is not aligned with your objectives, that could lead to a relationship problem.
You should make sure you’re managing these circumstances skillfully. Do you have provisions in place that allow you to trigger a mechanism that will help you deal with situations differently? For example, your Agreement should have a provision stating that if the JV business incurs losses for a continuous period of five years, the JV partners can trigger a reassessment of the JV’s going concern value. This would require either an independent assessment or agreeing to liquidate, wind down, or sell the business.
Appointment of Executives and Managers for key operational positions is also usually a potential source of friction between partners in a JV. From the onset, make sure you’ve agreed upon the procedure for filling key positions in the JV Management.
A big area to consider is procurement. If the JV is in the manufacturing sector, where will it procure raw material from? Imagine that you enter into a JV with say, a Japanese or Korean company that is bringing in engineering expertise. But what they might do is ask you to buy all your raw material from their group companies because they manufacture key raw material required by the JV. Areas in this arrangement could be a source of conflict that you’d need to be prepared to handle unless proper policies and procedures are in place in the JV.
The mirror image of procurement is sales. If the JV conducts B2B sales, for example, who are you selling to and what how does your pricing structure work? Do you have favoured customers? When the business isn’t doing well, your partner might turn around and question why costs are high and whether you’re selling at the right price to the right people. So the JV needs to have a sound customer policy and procedures. If not handled effectively, these issues create difficult long term problems.
All of the above points back to values. Let’s say one of your partners is interested in choosing ‘sustainable sources’ of raw material, even if costs are higher. If that’s not clearly established from the onset, you could end up dealing with conflict later on. Or if one JV partner doesn’t want to invest in a particular stock because that company deploys legal but aggressive tax avoidance strategies, while another partner feels it’s a promising stock, this could cause friction. Similarly, one partner might want to invest in a particular country but another may not. You should therefore work on understanding and recognising your partners’ values during the due diligence stage to reduce the risk of disagreements and sour relationships.
Now, extend this thinking to consumer goods and you have the question of brand reputation. What kind of products are you selling? What is your brand architecture? What is your brand and pricing policy? How do you position your brand? Do you focus on premium margins or on volume? As part of the marketing strategy, it is important to establish agreement or, have full control on this matter. Make sure all your JV partners are on the same page.
Ultimately, it boils down to knowing who you are doing business with. Once you know that, you’d be able to develop a fair idea of what could potentially cause friction in the relationship. You would then be able to decide on how you manage such situations of disagreements using yours and the JV’s existing toolkit. In very complex situations, you might even decide to get external help to manage the disagreement.
When you come together, it is very important that all partners have clarity on who has control of the JV. This is primarily driven by provisions related to decision-making rights in the Shareholders’ Agreement. But for managing relationships, think about operating management procedures such as meetings, or the composition of the Board of Directors.
How is the decision-making split between Shareholders and the Board? Is there a delegation system in the JV and if so, does it allow for a few layers of decision-making, or discussion forums? It is these layers that allow you to escalate matters. For example, if you’re faced with a routine operating issue, you should solve it at the operating management level, while strategic issues can be handled by the Board of Directors, and if a disagreement should arise, you’d escalate it to the Shareholders.
Think about your Shareholders Agreement as a marriage document. While a husband and wife may argue about things everyday they usually resolve their issues and move on. The moment they reach for the Agreement, it is a sign that things could take a turn for the worse.
Along with Shareholders Agreement you should have a separate document that outlines ways of working at the operating management level. The ways of working document would determine how meetings are conducted, how many times, or what types of meetings are held. For example, meetings conducted for performance management or performance reviews may be scheduled once a quarter. Then you have other business decisions such as pricing, marketing campaigns, capital investment decisions, buying equipment, and appointing people. Establish which forums make each of these decisions.
If the JV is quite large, consider hiring a JV Manager. This could be an employee of the JV company but who is independent of the partner companies. Their job would be to manage shareholders and address risks. While not every joint venture can afford this role, it is a useful role.
If the JV is small or an unincorporated entity, each partner should have a nominated JV representative. Make it clear who the spokespersons for each company are, so that everyone knows that they are expressing the Shareholders’ views. If you’re a small JV, you can consider having someone take this on as part of their role in addition to their regular responsibilities. If you have a senior person in the joint venture with gravitas, experience, and bandwidth, that person could potentially make a good JV Manager.
What if a disagreement occurs?
If you sense that there is a problem, instead of letting things fester, address tit with the partners immediately. If you’re a shareholder, you should ideally leave it to your representatives who should be working to resolve the matter. Whether it is ways of working or relationships, don’t think of any issue as being “too small” to address.
Your lawyers will tell you that you should have a mechanism built to handle “reserved matters”, where any decision needs consensus or unanimous agreement to move forward. Big decisions such as selling the business, buying another business, or entering into partnership with a third party, or big procurement decisions could be examples of reserved matters. However, be sure not to go overboard and add too many issues to the reserved matters list. Reserved matters should cover a handful – say four or five – of matters that will require one hundred percent consensus.
How often Shareholders come together should be predetermined in the Shareholders’ Agreement. An ideal frequency is once a quarter. If it is a large JV, you should appoint a legal representative who has the power of attorney and the right to make decisions on behalf of the Shareholder. This could even be someone like your appointee to the JV Board of Directors.
In some JVs, the CEO may have been appointed by one partner, but the CFO appointed by another. These people may have come from different backgrounds or different companies, and as a result they may have very different mindsets. In addition to running the business effectively, the C-suite management needs to make sure they have good alignment. Meeting once a month will help establish that. Make sure you have someone organising these meetings, running them, and documenting meeting minutes.
Instead of waiting for things to go south, keep an eye out for signs that the relationship isn’t working. For example, what is being said during performance reviews? If the business isn’t doing well and people are saying “I told you the price point wasn’t right” or pointing fingers instead of working on resolving the situation, that is a red flag and calls for a proper conversation. Or, if the partner wants to pursue projects that are not of interest to you or have not been discussed at the Shareholder level, you should be concerned. Keep your finger on the pulse of the Company. If there are departments that are getting restless, or your management team isn’t performing, reach out to discuss how you could work better.
From a Finance and Operations management perspective, you need to have your Management Information System (MIS) well designed to have a view of what is actually happening in the JV Company. If there’s a breakdown of controls or fraud occurs, then things have clearly gone wrong. Of course, it could be simply due to bad management but perhaps it could be that your partner isn’t supporting you and the JV effectively.
In the JV, if there are clearly established roles of an Operating Partner and a Passive Partner, you’ll have to be even more careful. Usually, the Operating Partner will have to explain and manage if things go wrong in business operations but the outcomes affect all partners. It is possible that the Passive Partner might be pulling the strings behind the scenes, especially if the JV is in a different country and managed by a JV Board. You shouldn’t doubt your partner, but should be cautiously aware of what might be at play.
While it might seem counter-intuitive to think about exit and termination clauses when you’re embarking on a JV, it is vital that you have an exit strategy. You may love your business, or even your partners, but you need to establish an exit route from the beginning. If things go wrong or turn out worse off from your expectations you need to move on amicably, legally, efficiently and smoothly.
It is said that seven out of ten JVs end up failing. The reality of the matter is that when you’re working with various entities, disagreements are bound to happen. But how you approach these differences will determine the success or failure of the Joint Venture.
You can manage a disagreement between partners in a JV either formally or informally. The Shareholders Agreement will usually include the definition of a deadlock situation. This is when the partners cannot reach a resolution on an issue. Suppose the agreement states that you can only proceed with consensus. However, you’re unable to reach that consensus, there is no escalation left, and the Shareholders have agreed to disagree. In this case, the solution would be to part ways. There are many different ways of doing this, for example either one shareholder buys out the other, or you value the business and sell it. Each shareholder will look at how any shareholder’s exit or their own exit impacts them economically. For these reasons, the procedure of parting ways has to be detailed and objective.
As you can see, the Shareholders Agreement is a crucial document and the language on exit mechanisms needs to be very clear. For example, suppose one party wants to buy out the other, they could say “Here’s my offer, and if you accept the offer we have a deal.” But if they can’t afford it, you might be presented with a counter-offer and so on. In order to hold a fair negotiation the Shareholders can also consider appointing a third party or an expert to value the business and use that value as a starting point for a bidding process.
The outcome of a negotiation really depends on how badly you want to stay or exit. If you have one partner who wants to exit because they need money or are fed up with the way things are being run, the negotiation could potentially be straightforward because their objective is to leave the JV.
In summary, exit mechanisms should be clearly addressed in the Shareholders’ Agreement, which should be designed by experienced commercial persons with language crafted by capable lawyers. Now if the JV is going to continue, you should be able to replace a partner with another one that meets the JV’s and your needs (back to where we started!).
Once an exit happens, the exiting partner typically would be released of all obligations. Sometimes this isn’t as straightforward as it sounds. Let’s say the partner had brought some intellectual property to the JV and it is core to the JV’s business. If the partner takes away the IP, there’s really nothing left in the JV. In such a situation, one way forward is to have an “IP survivor bridge clause”, another way is to look for another partner who can bring a similar substitute intellectual property. This could easily get very technical in terms of feasibility. If so, enlist expert technical help to figure out the mechanism to move forward.
Keep in mind that replacing one IP with another might change the value of the venture. This might even be followed by a period where your business is disrupted. You should try to minimise this period of instability as much as possible. You’ll find that lawyers usually insist on setting clear time frames on exit situations - say six months, such that it doesn’t drag on for too long. Not only will dragging out the exit process negatively impact your business, it will also impact your partners, employees, your reputation in the market and your shareholders.
Steps to Take in 24 Hours
- Schedule Monthly Meetings
Make it a point to schedule recurring meetings where expectations and concerns are communicated between partners. In the long run, open communication will help build trust and strengthen your relationship.
- Make a Checklist of What You Haven’t Discussed
Based on the points mentioned in this book, write a checklist and start planning for areas that haven’t been considered. Don’t dismiss “small” issues that come up in your joint venture. Make sure every potential point of concern is discussed and resolved by appropriate management.
- Start Collaborating
Take a collaborative approach to your business operations. While you should not be blindly trusting, you should believe in your partner’s ability and provide breathing room to your partners. After all, their valuable expertise is helping you elevate your business and that is why you brought them into the JV!