A strategic alliance, or joint venture, is often compared to a marriage in that, unlike a straightforward acquisition, there is an ongoing relationship between the parties. However, unlike a pre-nuptial agreement, a properly drawn up joint venture agreement should address all issues arising during the alliance, from its establishment, through its operation, to any ultimate unwinding.
The joint venture agreement is usually a lengthy and complex document. However, underpinning the contractual arrangements for strategic alliances are four basic questions:
- What is the purpose of the alliance?
- What will each party contribute?
- How will the venture be managed?
- What happens if the alliance doesn’t go as planned?
This article considers each of those questions in turn and highlights the key issues and problems that arise in relation to each.
What is the purpose of the alliance?
It is critical that the parties agree what the alliance is intended to achieve. The usual clause in the joint venture agreement setting out the objective and scope of the joint venture is, sometimes, the subject of a surprising degree of negotiation. Alongside the contractual provisions, drawing up a detailed business plan and budget for the venture will focus the participants’ minds on the purpose of the venture and its feasibility, and help to identify any areas of potential conflict.
Each party will also have its own interests to protect and will need to consider how, and in what timeframe, it expects to benefit from the venture. Such benefits may not arise just from the dividend income and capital growth from the joint venture as a party may also derive revenue from commercial arrangements entered into between it and the joint venture. Devising a structure to enable a party to receive such returns in a tax-efficient manner should start as early as possible in the negotiations.
What will each party contribute?
A party’s contribution to an alliance will depend on the circumstances; most commonly the participants will contribute cash (by way of debt, equity or both), but a party may also provide physical assets, know-how, services, or people to the venture.
Where a party’s contribution is not in cash, it is important both for the contributor and the recipient that the value of such assets and the terms on which they are to be provided are clearly identified. The other parties may wish to conduct due diligence into the relevant assets, and the contract under which the asset is provided will need to address matters such as whether the joint venture is to own the asset or is to have the benefit under a licensing or secondment arrangement. Even when ownership of the relevant asset is transferred, the contributing party may want the right to demand its return if the joint venture terminates.
The parties will also need to consider whether they are to be obliged to provide future funding to the joint venture, and what should happen, if the venture needs more cash, what happens if one of the parties is unwilling or unable to provide that finding. Should that party’s interest be diluted? Should external financing be sought? Should the venture be unwound?
How will the alliance be managed?
It is common for the parties to retain some level of influence in the venture’s decision-making process, either through representation on the board of directors, or through requiring certain key decisions to be referred to shareholders. The extent of a party’s influence will usually be determined by the size of that party’s shareholding. Where one shareholder holds a minority of the shares, it may accept that it can be outvoted at the board level, but may negotiate a list of material decisions over which it should have a right of veto as shareholder.
In order for the parties to manage the alliance effectively, it is important that they are able to monitor it. The joint venture agreement should set out the management information that the parties expect to receive, and the timetable within which it is to be provided.
What happens if the alliance doesn’t go as planned?
Over the life of the joint venture there may be a number of reasons why it does not follow the parties’ intended path: parties’ views about the future direction of the joint venture may change and they may be unable to reach agreement on a proposed course of action; a party may decide that the joint venture is not achieving the aims for which it was established and wish to exit; or one of the parties may take or suffer some action (such as a change of control) which the parties’ had previously agreed should give rise to a right of termination.
The joint venture agreement will usually contain a mechanism for trying to resolve a dispute between the parties. If the dispute cannot be resolved, the joint venture may need to be terminated.
The parties will usually agree at the outset, and record in the joint venture agreement, how the arrangement is to be terminated. If the joint venture arrangement is a purely contractual one it may be possible simply to terminate the underlying agreement. Usually, where the joint venture is structured as a company or partnership, it will either need to be liquidated, or one party will need to buy out the interests of the other.
The disadvantage with liquidating the joint venture is that the return to shareholders is usually less than the value of the venture as a going concern. The alternative is that one party buys the other out – this will require the joint venture agreement to specify some method of determining the price at which the interest is sold. Two approaches which are frequently adopted are an expert valuation or one of various auction mechanisms (including those known as “Russian Roulette” or “Texas Shoot-out”), but whichever method is adopted it will always favour the party with the deepest pockets.
For richer, for poorer
Terminating a strategic alliance, like divorce, can be painful and expensive. It is therefore understandable that the parties spend a considerable amount of time when negotiating the terms of a joint venture in legislating for its termination. As discussed, there are, however, a number of other issues that the parties should consider carefully before embarking upon the alliance which may make the difference between its success or failure.