Unique Challenges of JV Dealmaking: 29 Standards for JV Dealmaking Excellence
Part 2: Water Street Partners’ view of what “good” looks like when structuring key terms and provisions of a joint venture agreement
A FEW WEEKS AGO, we outlined some of the unique gaps in joint venture dealmaking and the consequences of failing to address them. To help companies tackle these gaps and improve venture performance, Water Street Partners developed a set of Standards for JV Dealmaking Excellence. These standards fall into different domains: some relate to specific deal terms (e.g., exit, governance, assumption of liabilities by a non-controlling partner), while others relate to the deal process and related analytics. While most are aimed at individual deals, some standards establish corporate-level processes and best practices, including putting in place a corporate stage-gate review process that reflects the unique needs and risks of JV transactions (and does not merely replicate the M&A stage-gate review).
In this second part, we illustrate three of the 29 standards where gaps are among the most widespread. An exhaustive checklist of the 29 Standards of Dealmaking Excellence proprietary to Water Street Partners can be downloaded at the end of this insight, if you would like to test how many of them your company has adopted.
STANDARD 1: MODELING TOTAL VENTURE ECONOMICS
Issue: Joint ventures are complex businesses to model. In many cases, this is largely due to the diverse financial flows occurring outside the venture P&L (e.g., parent company income from multiple licenses and service fees; parent company cost, revenue, or strategic synergies with other businesses and assets) that can be hard to map, but are critical to understanding the business.
Water Street Standard of Excellence: “The Company develops a financial model of the proposed JV that includes an integrated picture of total venture economics for the Company and the Counterparty.”
Example: To understand what it takes to meet this standard, consider a multi-billion dollar alternative energy venture between four partners formed to develop and commercialize a radical new technology. We helped the deal team of one party identify the financial flows of each partner, estimate the costs and revenues associated with each of these financial streams, and then evaluate how the integrated economics for each partner would play out over time (Exhibit 1).
Exhibit 1: Modeling Total Venture Economics
Illustration: Alternative energy JV — cumulative cash flow, by partner
This allowed the deal team to forecast the cumulative free cash flow of each partner over 15 years — analysis that showed that Partner 3 would likely fall into a severely negative cash flow position in years 6 to 8. Because Partner 3 was the main technology supplier to the venture, and did not have a strong balance sheet, this insight raised legitimate concerns about their willingness to remain in the venture over the long term — and, thus, the viability of the venture itself. This understanding of total venture economics led the company to fundamentally reset the proposed financial terms of the deal, including reducing future technology licensing and service fees paid to Partner 3 in exchange for co-funding of certain early-year technology development costs.
STANDARD 2: SCREENING PARTNERS FOR COMPATIBILITY
Issue: Among the main gaps in partner screening and due diligence is insufficient attention to the partner’s culture and compatibility. While cultural fit is important in acquisitions, it takes on even greater importance in joint ventures, where the counterparty will remain a separate entity — and its management style, decision-making approach, and organizational contours will have sustained influence over the venture and working relationship.