How to Structure a Joint Venture: The Five Essential Elements of JV Dealmaking
Deal flexibility is both a blessing and a curse for JVs. Structuring a durable JV with a strong chance of success. Getting to a “quick no” or a “good yes”.
RARELY A DAY PASSES without a new joint venture being announced in the world’s leading financial publications. In the last year, Apple, Bank of China, Google, ExxonMobil, IBM, Microsoft, Nestlé, Novartis, Samsung, Sinopec, Tesla, Toyota, and many other leading companies entered into at least one new joint venture — and in some cases several. The continued volume of deal activity is not surprising, as joint ventures allow companies to access capabilities, enter new or restricted markets, share risk, pool capital, and secure scale- and scope-related synergies.
But the great advantage of joint ventures — the freedom to combine contributions of two or more players in creative ways — also makes these deals inherently challenging to negotiate and structure compared to, say, acquisitions or licensing agreements. The inherent flexibility of joint ventures requires dealmakers to make design choices on multiple dimensions, including asset and value chain scope, operating model, exclusivity, contributions, ownership, branding, IP rights, governance, financial arrangements, management and staffing, and exit.
It can be a demanding task.
Below, we offer a five-part checklist that can be used to to pressure-test new joint venture deal concepts and to negotiate and structure JV legal agreements. We also offer some advice on how to ensure that the JV negotiation process leads to either a “quick no” or a “good yes.”
FIVE CORE ELEMENTS OF SUCCESS
Over the years, we have advised on more than 600 joint venture transactions and conducted dozens of research studies on what makes for succesful deals.
At the most fundamental level, we’ve found that joint venture dealmaking success hinges on five critical elements (Exhibit 1) — each of which introduces questions that need to be addressed in the design, structuring, and negotiations of a new joint venture.
- Deal Rationale: Is a JV really needed, and how will it support strategic and financial objectives? The deal rationale should be tested on two dimensions: the choice of JV vs. other structures and the strategic and economic case for the JV. A JV should only be pursued if it is a better vehicle than other strategic options — or is the only viable way to pursue an attractive business opportunity. There are many simpler business arrangements — including supply, distribution, marketing, and licensing agreements — that involve substantially less shared control and complexity. If any of these deal options will accomplish the objectives with similar results, it should be preferred, since a JV will consume a significant amount of management time and expense in its setup and ongoing governance.
Similarly, a straight acquisition is preferable when it’s possible to acquire a target company or asset and synergies are large enough to recapture the expected control premium. Often, a JV is a compelling “second best” to an acquisition if the desired target can’t be acquired — for example, when a family-owned business won’t sell but is willing to JV, or when an emerging-market is a great growth opportunity but regulations require that a local partner own 50+% of a business. Conversely, a company might be better off entering into a joint venture as a “staged exit”, if for instance, it cannot reach agreement with the counterparty on an acceptable valuation of the assets or business. In these cases, a JV should be structured with evolution toward a full acquisition in mind.
The rationale for a joint venture — strategic and economic success metrics — should be sharply stated in ways that can be tested with the partner (e.g., market share of 15% in 5 years, combined parent cost savings of $150 million over 2 years).
The JV economic case needs to be quantified to complete the assessment of the deal rationale. A few points are worth keeping in mind. First: the fact that a partner may be putting up 50% of the capital doesn’t mean that there is any less burden of proof on the investment analysis. (Indeed, for consolidation type JVs, our rule of thumb is that most JVs should create at least 20% in incremental value above the standalone value of the assets contributed, in order to more than cover the added governance burden.) Second: beware of the potential JV built on achieving strategic goals but with a weak financial case. We have found this to be especially prevalent in JVs formed to satisfy regulatory restrictions on foreign ownership. While it may be wise to enter a JV for strategic reasons, sponsors and dealmakers need to present a clear articulation of the strategic (non-financial) drivers, have an eyes-wide-open discussion that these strategic drivers (and not an inflated financial case) provide sufficient benefits to proceed, and describe how success against these strategic drivers will be measured and tracked.
2. Partner Fit: Do the partners bring capabilities, compatibility, and commitment? Partner screening should begin with partner capabilities — the geographic, product, or functional strengths that the potential partner will contribute — which are core to the reason for selecting them as JV partners. The assessment of capabilities should also include reviewing the financial performance of potential partners since JVs between partners that are strong financial performers are more than twice as likely to succeed compared to those that involve less-than-average performers in their industry.
JVs between partners with different product markets and functional capabilities perform better than JVs between partners with similar capabilities, except for consolidation JVs, where the parents are fully merging assets into the JV. In fact, JVs between companies that have similar product markets and functional strengths — which are often competitors — are more likely to lead to tensions after the JV is formed because the partners are natural competitors and may seek to play similar roles in the venture.
Assuming the partner has the needed capabilities, compatibility should be judged based on the dimensions of culture and values. A systematic assessment of the key attributes of a partner’s company culture can quickly reveal if there are likely to be major issues. For example, an organization that is heavily process-oriented will not be a good match for a highly entrepreneurial company.
The fit of values is essential, and should be tested with an assessment of the partner’s most important corporate values as well as their reputation with business partners, customers, and suppliers. As negotiations progress, the policies of the partner with respect to environment, safety, health, and corporate social responsibility should be reviewed for consistency with the company’s own policies and beliefs.
Partners should also have a compatible long-term vision and strategy (i.e., whether the JV is intended as a growth business vs. a narrow-purpose entity). Many JVs between emerging-market and global partners have been stressed as the emerging-market partners wanted to expand the scope or their role in management of the JV. Some of these, like GS Caltex and Alcatel China, have been very successfully restructured and expanded over time; others have been unwound or bought out by one of the partners to resolve the friction.
The third “C” in partner screening is commitment, which is crucial to ensure follow-through after the deal is struck. Two good indicators of commitment are: the level of involvement of senior people in the deal process, and the partner’s willingness to name high-performing senior executives who will go into the JV after the deal is done.
3. Deal Structure, Scope and Contributions: Has the deal team considered several options and tailored the JV to fit the business and parent company needs? The greatest benefit of the JV structure is that it can be tailored across many dimensions. A look at the table of contents of a joint venture agreement shows more than a dozen major deal clauses (Exhibit 2), each of which introduces a series of important questions. However, there is rarely a single best answer for how to structure a JV. Usually, there are several viable options, each of which has different pros/cons. For example, it is common to have a choice between a “lighter” structure (fewer value-chain activities in the JV), and a “heavier” structure (a more self-standing JV with its own assets, people, systems, and with a full value-chain). More often than not, the lighter option creates less value but is easier to govern; the heavier option brings more potential value, but is harder to set up and to govern.
We recommend that deal teams: a) gain agreement on the criteria that will be used to evaluate deal options (e.g., value, feasibility, post-close manageability), b) identify key inputs (e.g., partner wants, needs, and constraints, tax, accounting and regulatory considerations; analogous transaction structures within and outside the industry), then c) develop alternative JV options creatively blending major deal terms, d) test these against a set of evaluation criteria and with the ultimate sponsors of the JV, and finally e) adapt and combine the options to create a best-of-breed hybrid. The initial options are usually characterized by differing scope and contributions (i.e., value- chain, product, geography, technology), and/or by different governance models (i.e., independent JV; interdependent JV; JV that is operated by one of the partners). For example, in an emerging market hotel JV, we developed transaction structure options based on value chain scope — which parts would be in the JV versus which would be done by the parent companies. These competing options were then compared in terms of fit with parent strategy, value, and feasibility (Exhibit 3).
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