A profitable way to minimize the risk of expanding your company is to pool resources with your competitor and create a joint venture. It may only last for one project or a series of projects, but a joint venture can bring you a greater return for your investment, let you achieve goals more quickly and allow you to take on larger projects.
Entrepreneurs at the expansion stage typically face a dilemma: To distinguish themselves from their competitors, they must add a new product or service, a new market, or a contract twice the size of anything they’ve done before. But they need a whopping investment for that kind of expansion, and there is no guarantee the investment will pay off.
Joint ventures are a popular way to share the costs of expanding into new territory. A joint venture (JV) is an incorporated entity, in which each participating company is responsible for the entity’s actions and debts. Unlike a merger, however, a JV is temporary and is often dissolved or sold on completion of the project that brought the partners together.
Your best friend at a time like this may actually be a competitor — or at least, a company in a related line of business, such as a supplier. Many expanding businesses have found that pooling resources with one or more partners to create a JV is an excellent way to minimize risk while helping each partner boost both expertise and revenues. According to Thomson Financial Securities Data, “The 31,528 worldwide joint ventures in 1999 were valued at $3.4 trillion. In the fourth quarter alone, joint ventures across the globe realized a combined value of $779 billion.” (“M&As Reach New Heights,” Internal Auditor, April 2000, p. 12.)
As with any partnership — whether temporary or long-term — such factors as compatibility and mutual trust can make or break the deal.
In this Quick-Read you will find:
- Advantages and disadvantages of JVs
- How to evaluate potential partners.
- Factors to consider as you define your role.
Advantages of JVs:
- The return on both venture partners’ investments is expected to be greater than the return they would get independently.
- Joint ventures make it possible for independent small companies to participate in large projects.
- Resources from multiple companies can accomplish goals and objectives more quickly and effectively than resources from one.
- Venture partners can learn about and adopt each other’s best practices.
- JV partners get access to each other’s technology and resources.
Disadvantages of JVs:
- JV partners get access to each other’s technology and resources.
- Entering a JV requires the diversion of resources from one’s present business.
- There are risks of failure because of compatibility problems and liability for partners’ mistakes.
- If both JV partners are not deeply committed to the joint operation, it is unlikely to succeed.
Which comes first: the opportunity to expand, or the JV that will make it possible? The situation varies. You might have a prototype for a product already but can’t afford to hire the technical experts needed to refine it. Or you might form a JV to conduct research and development to reach the prototype stage. Companies involved in infrastructure projects often set up a JV before bidding on a contract, so they can market the venture’s collective strengths. In the event the partners fail to win the contract, they might still pursue other projects together.
Some emerging market countries require that foreign companies set up JVs as a way of creating employment, training and technology transfers. While the World Trade Organization may eventually forbid mandatory JVs, many companies new to a foreign market find they need partners who know the cultural and political terrain.
JV partners should complement each other’s skills. For example, one partner might have more technical expertise, while the other knows the market or is closely connected to the clientele.
Finding a partner is mostly a matter of plugging into the right network. Many small business development centers have consultants who can make introductions. A JV depends so much on personal chemistry that searching for a partner is not unlike looking for a mate. Attend social functions, Chamber of Commerce meetings and local chapter meetings of professional organizations. Once you find a likely candidate, spend time "dating," e.g., meeting for lunches, dinners and golf games to get acquainted.
Plan on performing the same due diligence that you would for a merger or acquisition. Before you sign a formal contract, you and your partner(s) should prepare the ground for it by drafting a letter of agreement that can later be formalized into a legal contract. The letter of agreement should spell out certain details:
- The equity stake that each partner will take. In some JVs, each partner takes a fee based on the amount of work she or he has put into the project; but this arrangement can lead to misunderstandings. Generally it is preferable to agree on the split up-front. Often the partners agree to take equal shares, but a more experienced party could instead be considered the lead partner and contribute 60% or 70%. Your share of the initial investment will also be your share of the profits, as well as the liabilities. The JV also may seek its own third-party financing, e.g., a bank loan.
- The specific duties of each partner in the day-to-day operations. Who will be the lead manager? Who will provide what personnel, equipment and financial resources?
- The type of entity the JV will be. Choices include a limited liability company (LLC), a corporation, an S corporation, or a limited partnership. The most popular form is the LLC, which is taxed as a partnership. When it comes to establishing ownership and management relationships, an LLC offers more freedom than a corporation, while limiting your personal liability for the JV’s debts.
- An exit strategy. In most arrangements, when the project is finished, one partner buys out the others or an outside party buys the whole entity. Other possibilities include taking the JV public or recapitalizing it through private investors.
Be aware that JVs among competitors (also called "horizontal relationships") are subject to antitrust regulations. (For more antitrust information, see the Resources section.)
Don Todd Associates Inc., a San Francisco-based construction management company with revenues around $12 million, often seeks JV partners for its larger projects. The partners in one venture could be competitors in other projects, but Gwen Powell-Todd, the company’s senior vice president of corporate development, says it’s just the way business works.
"We might bid head-to-head against another company for Project B," she says. "But then Project C comes up, and we realize the same company has a better connection to the client than we do, so we approach the other company about a joint venture."
Recently Don Todd Associates set up a JV with Bovis Land Leasing and a local civil engineering company. Called the JTB Airport Alliance, it will work on a $600 million construction facility for the Oakland Airport. Thi
s venture was arranged through the Port of Oakland, which is actively matching local businesses with larger companies bidding on airport contracts. Even so, Powell-Todd feels it was important to become a known entity to the port management, so the company worked on a smaller project with the port first.
Powell-Todd says JVs present a great opportunity to learn from a partner. "You want to always come out of a joint venture having increased your skills, not just having been there," she says.
- If you have identified an ambitious project that would expand your business and you think collaboration might be the best way to approach it, start looking for a potential partner. Look for one with expertise that will complement yours and a company culture compatible with your own.
- Once you have candidates, do your due diligence. Be wary of potential partners with financial, leadership or labor-relations problems.
- Work out the division of responsibilities, the composition of a board of directors, equity split, type of company, exit strategy, and what rights each venture partner has to use of JV resources, such as facilities, personnel and technology.
- Sit down with your lawyers to iron out the final details, including the tax obligations of each partner. Only then, sign a letter of agreement or JV contract.
- Use the experience to add value to your own company. Take advantage of opportunities to learn new skills from your partners.
- Create the JV for a specific project, and dissolve it through a predetermined exit strategy when the project is finished. Even if you start another project with the same partner, do it through a new arrangement tailored for that purpose.
Books
Creating Successful Acquisition and Joint Venture Projects: A Process and Team Approach by John E. Triantis (Quorum, 1999). Chapter 10: "Steps of the Joint Venture Formation Process."
Intellectual Property: Licensing and Joint Venture Profit Strategies, 2nd edition, edited by Gordon V. Smith and Russell L. Parr (Wiley, 1998).
Joint Ventures: Business Strategies for Accountants, 2nd edition, edited by Joseph M. Morris (Wiley, 1998). Chapter and verse on financial aspects of joint ventures.
Teaming Up: The Small-Business Guide to Collaborating With Others to Boost Your Earnings and Expand Your Horizons by Paul and Sarah Edwards and Rick Benzel (Tarcher/Putnam, 1997).
Internet Sites
Global Trade and Technology Network. U.S. Agency for International Development, (800) 872-4348, is an Internet-based matchmaking service that promotes partnerships between small and medium-sized companies in developing countries and the United States.
How Do I Make a Joint Venture Work?
Technology Licensing and Joint Ventures
Antitrust Issues in Joint Ventures
Article Contributors
Writer: Jan Alexander
