Your business is ready to embark on a new project. You have tested the market, performed the necessary due diligence and, after reviewing your overall business strategy and aims, you have decided to partner with another company or companies to turn your vision into a reality.
Forming a joint venture holds many advantages including:
- Access to larger and/or different markets
- The ability to share and spread risk
- Access to greater knowledge and resources
- A greater capacity to produce more goods and services
However, if a joint venture is not planned and structured correctly, professional misery can descend on all interested parties. Aspects such as cultural differences, poorly drafted contracts and misunderstandings between the organisations’ leaders as to the objectives of the joint venture can all lead to conflicts and disputes jeopardising the entire project.
To ensure your joint venture is a success the joint venture agreement which governs the entire operation needs to be clear and concise. All parties to the project must be 100% certain of their rights, responsibilities and obligations.
There are key features of a joint venture agreement and points you need to consider and/or include to ensure your agreement leads to success and prosperity.
The Structure of the Joint Venture
The initial question that must be asked by the parties before drafting a joint venture agreement is “How do we want the joint venture to be structured”?
The three main ways joint ventures are designed are:
- By forming a limited liability company;
- By forming a limited liability partnership; By setting out the details of the joint venture in a contract;
and there are advantages and disadvantages to each.
Limited Liability Company
- A separate legal personality is created in the form of a company. The newly formed joint venture company can enter into contacts in its own name and the owners of the company can easily transfer their interests to a third party at the end of the venture
- The shareholders liability for the company’s debts is limited
- A limited liability company provides a greater range of options for gaining finance, for example, it can grant security over a loan in the form of a floating charge
- Limited liability companies are required to file annual accounts every year which will be available to the public
Limited Liability Partnership (LLP)
- LLP’s offer greater flexibility than a limited liability company in both the sharing of profits and allowing additional partners to join the venture at a later date
- Although annual accounts must be filed, an LLP can diminish its disclosure allowing much of its business to remain confidential
- All members of an LLP have limited liability
- Creditors may sometimes require personal guarantees from individual partners
- Obtaining external investment may prove easier under a limited liability company
Contractual Joint Venture or Partnership
- Because there is no statutory framework, parties can take advantage of greater flexibility by simply detailing the terms of the agreed venture into the contract or partnership agreement
- There is no need to file accounts with Companies House
- There are less expenses involved in setting up a joint venture of this kind
- Excellent structures for short-term ventures such as the launch of a new product
- There is no limitation on liability for any of the parties
- As there is no statutory framework surrounding these types of structures, if a crucial term is omitted from the contract or partnership agreement, there are no statutory regulations to fall back on
When deciding on the structure, one of the key considerations is tax. Particular structures call for different tax obligations. For example, if you choose to structure your joint venture as a LLP, each partner is taxed individually. However, if you form a limited liability company, both the company and the shareholders are liable to pay tax on any profits and dividends.
It is important to obtain advice from a professional advisor to ensure your joint venture is set up in the best way possible to avoid tax and maximise profits.
Key Matters to be Covered in the Joint Venture Agreement
Once all parties to the joint venture have agreed on the organisational structure of the venture a joint venture agreement needs to be drafted to give the parties clarity as to their rights and obligations.
Head of Terms
Head of Terms, properly drafted at the beginning of the process, will prove invaluable at this stage. Heads of Terms are usually not legally binding, rather, they create a roadmap that parties can use when later drafting a formal agreement. Matters that should be covered in a good Head of Terms document include:
- The name of the company/partnership
- The parties to the joint venture
- The exact nature of the joint venture, i.e.: why it was formed and what goals it plans to achieve
- The structure of the venture
- Any conditions the proposed venture is subject to, e.g.: planning permission being obtained or software developed
- Dispute resolution mechanisms
- Governing law and jurisdiction of the agreement
Having a detailed head of terms will save a lot of time and money when it comes to the negotiation and drafting of the final joint venture agreement as many of the issues will have already been decided upon.
A well-drafted joint venture agreement should contain details of the following matters:
Contributions of Each Shareholder/Partner
Each party’s contribution (both financial and non-financial) needs to be set out in the agreement. It should state clearly how the individual investments will be valued and what rights and obligations they will produce. This will do much to avert the possibility of disputes developing at a later date as the venture progresses.
The Rights of Each Shareholder or Partner
The joint venture agreement will set out the rights of each stakeholders. Majority stakeholders or investors will generally enjoy greater voting rights than minority sakeholders. However, minority stakeholders will usually seek to negotiate veto rights or insist that some decisions must have the written approval of all parties before they can be actioned, in order to protect their rights on important issues such as the payment of profits and bonuses, or the creation of new shares / rights / interests.
A joint venture is usually set up to make the partners or shareholders money. Therefore, it goes without saying that one of the key terms in the joint venture agreement needs to state with complete clarity how the profits of the venture and/or any eventual sale of the company will be distributed between the parties.
Structure of the Board
With two or more commercial entities forming a joint venture in order to achieve a common goal, it is vital that the joint venture agreement sets out how the board will be appointed and both the boards, and each members responsibilities in a clear and concise way.
Most agreements will state that all stakeholders must be given adequate notice of any matters to be heard before the board and state that there must be at least one representative from the minority stakeholders present at each meeting.
Aside from simple capacity warranties, it should be stated in the joint venture agreement whether the individual companies who formed the venture will provide a guarantee as to its shareholders/partners obligations.
Sometimes, despite the most water-tight agreement and the best of intentions, disputes happen. A breakdown of communication, time delays, ineffectual board performance; these are just a few examples of the many ways disputes can arise within a joint venture.
To avoid conflicts spiralling out of control and threatening the whole project, a well-drafted dispute resolution process within your joint venture agreement is essential. There should be clear guidance as to the initial steps to take if a dispute develops, as well as clauses covering arbitration and mediation and whether or not compensation can be claimed if the dispute causes one of the party’s damage.
Termination of the Agreement
A number of factors can cause the termination of a joint venture agreement including:
- One of the parties committing a serious breach of the joint venture agreement
- The project coming to an end
- One party choosing to exit the joint venture company or partnership
- The parties being unable to agree on a disputed issue
The joint venture agreement needs to provide clear steps to manage the termination of the joint venture. For example, if the venture is terminated because one party defaults, the joint venture agreement should allow an opportunity for the defaulting party to remedy the situation.
If the issue cannot be resolved the standard procedure usually involves the compulsory transfer of one party’s interest in the joint venture. The simplest compulsory transfer procedures that can be used are put and call options. A put option entitles the exiting shareholder to require the other party or parties to buy its entire shareholding and a call option entitles the holder to require the other party or parties to sell its or their entire shareholding to it. Although put and call options work well in a joint venture which only involves two parties, the procedure becomes complicated the more shareholders or partners involved in the enterprise.
Joint ventures offer businesses a solid vehicle for coming together and pooling finances and resources in order to develop a specific project. If the individual parties involved are governed by a well-drafted joint venture agreement, there is no reason why the venture should not be a success.
To find out more about joint ventures click here.
We welcome any comments. If you would like to express a thought on this article then please write it in the comments section below.