What makes a joint venture successful? The answer depends on a number of factors, not just how aligned the parties to the joint venture are on a common goal. Successful joint ventures are reliant on communication and effective problem-solving. This article describes some of the ways in which parties to a joint venture can structure their arrangements so that they are better placed to achieve their goals.
- Joint venture structures: what are your options?
- What are the most common legal structures used in joint venture?
- How to tailor the joint venture structure to your business objectives
- How to structure your management team in a joint venture
- How to minimise risk when selecting your partners/management team
- Joint venture governance best practices
- Joint venture finance best practices
- Do you have plans in place as the joint venture evolves?
- Do you need to have an exit strategy in place?
Joint venture structures: what are your options?
The type of joint venture structure you choose will depend a lot on the facts and circumstances and not least the purpose of your joint venture. Even if the parties broadly want the same end result, each party will always have desired outcomes and interests specific to them, independently of the joint collaboration and there may be other reasons a party has for entering into the joint venture aside from the main collaboration.
There are a variety of ways to structure a joint venture:
Collaboration agreement or contractual joint venture
This is a legally binding commercial agreement that the parties voluntarily put in place to formally document:
- How the joint venture will run
- The project that the parties are considering collaborating on
- How the responsibilities and obligations of each party are to be shared
- To set out who owns what
- To make sure that all parties know what to do if things go wrong and a party wants to raise a dispute or to stop being part of the venture
This type of structure does not usually require the parties to a joint venture to combine resources or investments in a separate entity. Each party will usually maintain control throughout the project of its assets and resources that are to be used in the venture.
Joint venture by way of legal entity
In some circumstances (for example where the parties want to establish an ongoing business venture) the parties may want to establish a separate legal entity to operate and run the venture. In this instance, the parties will contribute money or assets on a percentage basis to the entity to facilitate the project. If a separate entity is established the parties must then decide on the legal form it will take -whether it is a company, a limited liability partnership or a partnership will depend on the requirements of the project.
There may be tax consequences from establishing a new entity, for example, if the entity is established in a particular jurisdiction or has been set up to hold real property assets. It is important to get professional legal and tax advice before setting up a new entity, particularly if you have existing business arrangements in place, to ensure that the establishment of the new entity will not adversely affect you, your current commercial structure or your tax status.
What are the most common legal structures used in joint venture?
Common legal structures used in joint ventures are:
A limited company
This is a company whose members have limited liability. Liability can be limited by shares or limited by guarantee. In the case of a company limited by shares, liability is limited to the amount, if any, unpaid on the shares held by the company’s members. In the case of a company limited by guarantee, liability is limited to the amount that the members say they will contribute to the company if it goes into liquidation.
What are the benefits of choosing a limited company?
Benefits of choosing a limited company to be the joint venture entity is that this is a well-known structure underpinned by well-established principles for financing and investment, governance and accountability. Plus, there are clearly trodden paths to go down in the event of disputes or insolvency, all of which investors might think are positives when considering any investment into a joint venture entity that is independent from the joint venture partners. This type of structure also provides the parties to a joint venture with the tools to limit their risk as the joint venture company will most likely enter into its own contracts, invest and borrow by itself and incur liabilities and rights by itself without the joint venture partners being directly involved.
Having said this, a limited company and its board of directors will have to comply with obligations under the Companies Act 2006 which can be time consuming (and costly if they are not undertaken correctly or on time). The directors of a company will have personal liability to act in the interests of the company and its shareholders as a whole. So the joint venture parties should be clear on directors’ responsibilities and what is expected from a governance perspective before setting up a company. Setting up and maintaining a company can be a big commitment and so this type of structure is more suitable to high value projects, or projects that are ongoing in time, or projects that require some other form of significant investment from the joint venture parties.
A limited liability partnership
This is a form of partnership that must comply with the Limited Liability Partnerships Act 2000. A limited liability partnership is legally separate from its members and so in most circumstances the entity will be liable and not its members. It can enter into contracts and hold property.
This type of structure is useful where there are multiple individuals involved in the project. This form of legal structure is often used by individuals in professional services such as accounting and law as it provides the tax regime of a traditional partnership while at the same time limiting the liability of its members. One factor to consider however is that in a partnership, profits will go directly to the partners, whereas in a company, the parties can receive dividends – this distinction may have tax consequences for a party and is one of the reasons why it is important to get tax advice before a legal structure is chosen.
A legal partnership
This is a form of partnership that must comply with the Partnership Act 1890. It is not a separate legal entity and will often be governed by a partnership agreement between the joint venture participants. The creation of a legal partnership means that the partners will have some legal obligations that they will have to comply with. But compared to the well-established procedure for establishing a company, establishing what counts as a ‘legal partnership’ can depend on the facts of the specific project. There may be certain tax advantages for being recognised as a legal partnership and the parties should investigate this further.
The potential risks of using a partnership include the fact that partners will be jointly liable for the other partners’ actions on behalf of the partnership without any limit on that liability. This in itself may be a risk that joint venture partners do not want to take. Assets that are contributed or transferred to the partnership will be committed to the partnership but are often dealt with in accordance with the partnership agreement and so it is advisable to take legal guidance on the drafting of the partnership agreement to ensure that your interests are protected.
How to tailor the joint venture structure to your business objectives
Joint venture arrangements are used by parties who want to create a legally binding commitment to a common project or venture. The extent of the commitment that parties give often depends on the nature of the project and how much investment or ongoing work each party is prepared to offer.
Typically, the more a party is investing, the more commitment it wants from the other party or parties, and the more control it wants over the project as a whole. If for example a project involves the contribution of assets, who owns those assets can determine the structure of the joint venture. If the existing owner is to remain the owner of the assets, a contractual arrangement may work. However, if both parties intend for the assets to be fully contributed to or held by the project, often an independent legal entity will be set up by the parties and the assets will be transferred into that entity. The tax implications of any asset transfers can play a big part in deciding on an appropriate structure.
The joint venture structure you choose will depend on the risks that you are taking as part of the project and how much time, money and resources you are giving to the project - not to mention what you are hoping to gain from the project.
Establishing a joint venture using an independent legal entity requires a higher level of commitment, on top of the commercial project commitments. This is because the parties are usually to some extent jointly responsible for meeting the legal and regulatory obligations required for the management and operation of the separate entity.
If the joint venture parties do not want to form a separate legal entity, they can still protect their interests by putting a written legally binding commercial agreement in place as a way to ensure that risks are managed and the parties have some recourse (for example, to bring a claim for damages or specific performance under English law against the other party or parties) if the collaboration goes wrong.
How to structure your management team in a joint venture
In a joint venture that is operating through a separate legal entity, the structure of the management team will be broadly set out in statute through default provisions.
(Either in the model articles of association or otherwise as set out in the Companies Act 2006 in the case of a limited company, or as set out in the Limited Liability Partnerships Regulations 2001 (SI 2001/1090) (as amended) in the case of a limited liability partnership.)
In both these regimes, however, parties are able in large part to agree their own arrangements for the management and control of the entity on a day-to-day basis. The size and complexity of the management team will depend on the scale and independence of the joint venture (for example, whether it has any employees and customers of its own).
How a management team will be structured will depend on how equal the parties’ bargaining power is. For example, a party that is contributing most of the funds to a venture or whose commitment or presence in the project is important for its success, may expect to have more control and rights over how the venture is run.
This can take the form of a majority shareholding in the case of a company limited by shares or provisions for additional or superior voting rights or veto rights when decisions relating to the project have to be made (sometimes called ‘reserved matters’) being included in the joint venture agreement or shareholders’ agreement.
Who the parties nominate to the venture’s management team can also depend on whether each party is allowed to nominate candidates they already employ or are familiar with or whether the nominations are independent appointments? Usually joint venture parties are allowed to have their own representation on the management team but the joint venture may also have independent representatives too, to assist with any disputes between the parties and to make sure that the interests of the project as a whole are being considered.
How to minimise risk when selecting your partners/management team
You should do research before selecting potential joint venture partners or members of a management team – including reference checking, analysis of experience and face to face meetings. This is not only to gauge the candidate’s financial viability and credentials but also to see whether you trust them and see yourself working with them.
The likelihood is that in a joint venture, there will be some management representing each party to the joint venture. The risks can come in determining how the joint venture is controlled - how the management representatives of the parties work together and make decisions, particularly if one party is making more investment or has a stronger bargaining power than the other parties.
A management agreement (or partnership agreement) can be put in place to direct how the management are expected to perform and to state the processes required to keep the investing parties informed of the progress of the venture. It is worth seeking employment law and tax advice before setting up complicated management structures, particularly if they involve pensions or other benefits like share schemes.
In some cases where there is a party in the minority, the joint venture agreement, shareholders’ agreement or collaboration agreement may set out some protections such as veto rights for the minority party to ensure that the other parties/party cannot make decisions without its approval. These documents also usually set out what happens if a decision cannot be made, as may be the case when a venture has two parties committing on a 50/50 basis and the parties have similar bargaining power.
Joint venture governance best practices
One issue with setting up an independent legal entity controlled by two or more parties is that there may be potential conflicts of interests between what an investor wants (and therefore what its representative in that entity wants) compared to what is best for the entity itself. This will be particularly relevant in the case of public entities which can be subject to a lot of public scrutiny over governance compliance. There is an ongoing trend toward transparency of management and better governance compliance particularly in public listed companies and so it is important to make sure that any joint venture entity is aware of and complies with its duties on a stand-alone basis.
There are many ways to effectively comply with legal and regulatory governance compliance and there are regulatory guidelines and codes for companies and limited liability partnerships that will specify in detail what constitutes best practice.
Common ways to demonstrate good governance practices include:
- Appointing independent directors on boards in addition to those directors that have been nominated by each party.
- Establishing audit committees and remuneration committees (this may only be relevant if the size of the joint venture warrants it and the joint venture employs people).
- Establishing a code of conduct, a mission statement and policies relating to anti-bribery and anti-corruption.
- Putting in place a rotation system for the managing partner or chief executive officer between the joint venture partners.
Another consideration is that a party will usually want to protect any information that it provides to the other parties that contains confidential or commercially sensitive content. So obligations to protect such information should be drafted into the joint venture agreement.
They will however need to be subject to any disclosure requirements that the joint venture entity itself may have legally or to a regulator. A joint venture agreement should also be clear on whether the joint venture can carry on activities that may compete or be of a similar nature to the parties. Any restrictive provisions will need to be carefully drafted to ensure that they are in accordance with competition law requirements.
Joint venture finance best practices
Much like with governance requirements, joint venture finance best practices will be put in place to ensure transparency and to stop undue influence over the finances and accounting of the independent legal entity being exerted by the joint venture partners.
Scrutiny by financial regulators or the entity’s auditors may be heightened if assets of joint venture partners are pooled or profits are frequently taken out of the joint venture entity. One way to manage the process is to have in place robust audit policies and committees that oversee how the finances are managed. This is particularly important if a joint venture entity is established and the entity runs out of money or takes on more debt than it can handle as the action or inaction of the joint venture entity’s directors or partners could be investigated for misconduct or negligence.
If the joint venture is established as a separate entity, it will be obliged to prepare annual accounts and make filings with the Registrar of Companies and so best practice is to make sure that any accounts and related filings are prepared and registered on time.
Another area that will have best practices is compliance with tax obligations, including filings. If the joint venture is operated through a company, it will pay corporation tax, whereas for a partnership each individual person will pay income tax. It is important to get tax advice before setting up your joint venture to make sure that you are aware of all of the relevant obligations (including any value added tax obligations) and possible tax exemptions that the joint venture may be eligible for.
Do you have plans in place as the joint venture evolves?
Nobody has a crystal ball and it is likely that not all of the details and issues that arise in the project will be known at the start of the joint venture. A sensible way to manage the development of the project is to set out in the joint venture agreement the known details of the project (this is often included in the agreement in the form of a specification annexed to the agreement or provided in a schedule to the agreement). This could include such things as the intended contribution and resources required by each party at the start of the project and what is expected of the parties throughout its duration. The more detail that is provided, the clearer the parameters of the project will be and may save any renegotiations or clarifications on terms at a later stage once the project has begun. This approach can work both ways. It may be beneficial if the negotiations are difficult or the outcome is in your favour, but it may also be useful to keep flexibility to further discuss how parts of the project will work once the parties have a better idea of how the project is going.
Another mechanism is to include a schedule of milestones or project deliverables and set out what happens if those milestones are not met.
Throughout the project there should be clear reporting obligations on both parties or the joint management team (or board of directors in the case of a joint venture company) to ensure that all plans are known to the investors of the project as the collaboration unfolds.
The key to any good collaboration is arguably strong communication. Usually a joint venture will set out formal reporting (and if necessary, inspection) requirements of each party and at a high level, meeting schedules for the management board or team. The nature and extent of the reporting requirements will depend on the project specific circumstances.
Do you need to have an exit strategy in place?
The simple answer is yes.
No matter how well intentioned the parties to a joint venture start out, no one can predict the future. It’s sensible to manage risk by including detailed provisions in the joint venture agreement or collaboration agreement that allow you to suspend, transfer or end your obligations and commitments under the joint venture in certain circumstances.
Parties should be clear on the process that they need to follow if a dispute arises between the project or management team, in particular in which forum the disputes should be heard and resolved (this could be between the senior management of the parties, by votes of the management team, board of directors or shareholders or ultimately in court or through formal arbitration proceedings). If all parties have an equal say into project arrangements or control a legal structure on a 50/50 basis, the parties might want to think about how to progress the project if there is a deadlock in decision making and whether if unresolved, this could trigger to a right for the parties to terminate the venture.
Each party should think carefully about what happens if the project fails, stalls or goes wrong and what that means for them. Parties may want to be able to terminate the agreement early before the project has finished, or to tie all parties into a ‘lock-in’ period where they have to commit to a certain amount of time (and possibly investment) in the project before they can opt to terminate.
There may be provisions for termination in the collaboration agreement or joint venture agreement if a project milestone is not reached, if one party undergoes a change of control, or if the other parties breach a major obligation under the agreement. And usually an agreement will allow a party to terminate the agreement if the other party goes insolvent. The list of reasons that allow parties to terminate the collaboration agreement or the joint venture will vary depending on the project.
In reality however, termination may result in a number of issues other than simply ending the collaboration agreement or joint venture agreement. What happens to the legal entity that has been set up and any existing value or liability held by it? Any shared resources, existing supplier or customer relationships or agreements or shared confidential information will also need to be dealt with. The parties also need to think about whether any continuing collaboration is necessary after termination and for how long (for example, any continuing statutory commitments or contractual obligations that still need to be complied with).
If the venture is run through a limited company, decisions will need to be made as to whether one or both parties’ shares can be sold or transferred and to whom.
- Whether party B can make party A sell its shares to a third-party purchaser that it is planning to sell its own shares to.
- Or whether Party A can oblige Party B to make a third-party purchaser acquire the shares of all of the parties to the joint venture, so called ‘drag along and tag along rights’).
- Or whether the company will be wound up and struck off the register in the event of termination (for example, if it has been agreed that neither party can continue doing business through the joint venture entity).
Some joint venture agreements will include rights for a party to buy or sell the other party’s shares in the event of termination, called ‘put and call options’. This may include pre-emption rights or a first right of refusal to the other party’s shares before they can be sold to a third party. Usually a party will want to sell all of its shares or buy all of the other party’s shares so that it is not tied into commitments with another party that it did not choose. With any separate legal entity, another thing to think about is how assets contributed to the venture will be redistributed when the venture ends, for example they could be returned to the party that acquired or funded the asset or sold to a third party.