Unique Challenges of JV Dealmaking: JV Dealmaking Gap Assessment
The low success rates of joint ventures — and high level of post-close misalignment and exit issues — suggest that failing to think deeply about the future may not always be the best way to approach joint venture dealmaking.
JOINT VENTURES ACCOUNT for 15 to 25% of the typical global company’s annual income, asset base, and market value. The world’s largest public, private, and state-owned companies enter into thousands of serious joint venture negotiations each year. But successfully consummating a joint venture transaction is not easy. JV dealmaking has the potential to seriously stretch a company, especially when its JV experience is limited, or when pure M&A approaches dominate.
This note summarizes unique gaps in joint venture dealmaking and outlines the consequences of failing to address them. The low success rates of joint ventures — and high level of post-close misalignment and exit issues — suggest that failing to think deeply about the future may not always be the best way to approach joint venture dealmaking.
GAPS IN JOINT VENTURE DEALMAKING
Water Street Partners recently conducted a broad-based research study on how companies perform across different aspects of JV dealmaking, which included a close review of 50 JV transactions and direct input from dozens of dealmakers. We came to a much fuller appreciation of the unique challenges of joint venture dealmaking, and how the work of dealmakers can have a profound influence on the ultimate success of the entity created.
The results revealed middling performance. For example, when evaluated by core deal workstream, companies delivered fairly pedestrian results (Exhibit 1). With the exception of Regulatory Approvals and Management, no dealmaking workstream had more than 40% of companies performing at strong levels by our standards. And each workstream had notable gaps.
Exhibit 1: JV Dealmaking Gap Assessment — By Core Workstream
Overall assement of strengths and gaps in JV transaction process
For example, within the Deal Strategy and Financial Modeling workstream, companies struggled to adequately model “total venture economics.” In a recent technology services JV transaction we advised on, the initial financial model developed by the team was focused on the JV’s P&L, and did not account for the counterparty’s off-P&L financial flows, including charge backs, and service and license fees for supporting the venture’s customers and systems. Once the model was expanded, it revealed that 85% of the total venture returns would be derived by the counterparty by Year 5, despite it only contributing 50% of the capital and assuming 50% of the risk.
Even when a prospective venture has few interdependencies with the parent companies, financial modeling can be challenging. A key gap: Failure to agree on underlying assumptions and second-level numbers within the model. In our experience, the parties in a joint venture negotiation will each build their own financial model, and then engage in a strained kabuki dance to agree on annual revenue or aggregate cost projections. Below that, however, there is no agreement — and from there, the thread of misalignment starts to be spun. For example, in a China market entry venture we advised on last year, the parties agreed on the JV’s annual revenue projections, but held completely different views on growth rates and profitability for different product lines, and capital investment requirements. Getting to the needed agreement on the next level of the model took months, and challenged each of the parties’ strategic rationale for entering the business (since each placed different importance on different product lines within their broader corporate strategies). But this agreement was absolutely necessary to get to a venture that had a chance of surviving for more than a few years.
Stories of similar gaps can be told for each of the main workstreams.
