How To Structure A Joint Venture | Harper James Solicitors (2024)

What makes a joint venture successful? The answer depends on a number of factors, not just how aligned the parties to the joint venture are on a common goal. Successful joint ventures are reliant on communication and effective problem-solving. This article describes some of the ways in which parties to a joint venture can structure their arrangements so that they are better placed to achieve their goals.

Joint venture structures: what are your options?

The type of joint venture structure you choose will depend a lot on the facts and circ*mstances and not least the purpose of your joint venture. Even if the parties broadly want the same end result, each party will always have desired outcomes and interests specific to them, independently of the joint collaboration and there may be other reasons a party has for entering into the joint venture aside from the main collaboration.

There are a variety of ways to structure a joint venture:

Collaboration agreement or contractual jointventure

This is a legally binding commercial agreement that the partiesvoluntarily put in place to formally document:

• How the joint venture will run
• The project that the parties are consideringcollaborating on
• How the responsibilities and obligations of eachparty are to be shared
• To set out who owns what
• To make sure that all parties know what to do ifthings go wrong and a party wants to raise a dispute or to stop being part ofthe venture

This type of structure does not usually require the parties to a jointventure to combine resources or investments in a separate entity. Each partywill usually maintain control throughout the project of its assets andresources that are to be used in the venture.

Joint venture by way of legal entity

In some circ*mstances (for example where the parties want to establishan ongoing business venture) the parties may want to establish a separate legalentity to operate and run the venture. In this instance, the parties will contributemoney or assets on a percentage basis to the entity to facilitate the project. Ifa separate entity is established the parties must then decide on the legal formit will take -whether it is a company, a limited liability partnership or apartnership will depend on the requirements of the project.

There may be tax consequences from establishing a new entity, forexample, if the entity is established in a particular jurisdiction or has beenset up to hold real property assets. It is important to get professional legaland tax advice before setting up a new entity, particularly if you haveexisting business arrangements in place, to ensure that the establishment ofthe new entity will not adversely affect you, your current commercial structureor your tax status.

What arethe most common legal structures used in joint venture?

Common legal structures used in joint ventures are:

A limited company

This is a company whose members have limitedliability. Liability can be limited by shares or limited by guarantee. In thecase of a company limited by shares, liability is limited to the amount, ifany, unpaid on the shares held by the company’s members. In the case of acompany limited by guarantee, liability is limited to the amount that themembers say they will contribute to the company if it goes into liquidation.

What are the benefits of choosing a limitedcompany?

Benefits of choosing a limited company to be the joint venture entity is that this is a well-known structure underpinned by well-established principles for financing and investment, governance and accountability. Plus, there are clearly trodden paths to go down in the event of disputes or insolvency, all of which investors might think are positives when considering any investment into a joint venture entity that is independent from the joint venture partners. This type of structure also provides the parties to a joint venture with the tools to limit their risk as the joint venture company will most likely enter into its own contracts, invest and borrow by itself and incur liabilities and rights by itself without the joint venture partners being directly involved.

Having said this, a limited company and its board of directors will have to comply with obligations under the Companies Act 2006 which can be time consuming (and costly if they are not undertaken correctly or on time). The directors of a company will have personal liability to act in the interests of the company and its shareholders as a whole. So the joint venture parties should be clear on directors’ responsibilities and what is expected from a governance perspective before setting up a company. Setting up and maintaining a company can be a big commitment and so this type of structure is more suitable to high value projects, or projects that are ongoing in time, or projects that require some other form of significant investment from the joint venture parties.

A limited liability partnership

This is a form of partnership that must comply with the Limited Liability Partnerships Act 2000. A limited liability partnership is legally separate from its members and so in most circ*mstances the entity will be liable and not its members. It can enter into contracts and hold property.

This type of structure is useful where there are multiple individuals involvedin the project. This form of legal structure is often used by individuals inprofessional services such as accounting and law as it provides the tax regimeof a traditional partnership while at the same time limiting the liability ofits members. One factor to consider however is that in a partnership, profitswill go directly to the partners, whereas in a company, the parties can receivedividends – this distinction may have tax consequences for a party and is oneof the reasons why it is important to get tax advice before a legal structureis chosen.

A legal partnership

This is a form of partnership that must comply with the Partnership Act 1890. It is not a separate legal entity and will often be governed by a partnership agreement between the joint venture participants. The creation of a legal partnership means that the partners will have some legal obligations that they will have to comply with. But compared to the well-established procedure for establishing a company, establishing what counts as a ‘legal partnership’ can depend on the facts of the specific project. There may be certain tax advantages for being recognised as a legal partnership and the parties should investigate this further.

The potential risks of using a partnership include the fact thatpartners will be jointly liable for the other partners’ actions on behalf ofthe partnership without any limit on that liability. This in itself may be arisk that joint venture partners do not want to take. Assets that arecontributed or transferred to the partnership will be committed to thepartnership but are often dealt with in accordance with the partnershipagreement and so it is advisable to take legal guidance on the drafting of thepartnership agreement to ensure that your interests are protected.

How to tailor the joint venture structure toyour business objectives

Joint venture arrangements are used by parties who want to create a legally binding commitment to a common project or venture. The extent of the commitment that parties give often depends on the nature of the project and how much investment or ongoing work each party is prepared to offer.

Typically, the more a party is investing, the more commitment it wants fromthe other party or parties, and the more control it wants over the project as awhole. If for example a project involves the contribution of assets, who ownsthose assets can determine the structure of the joint venture. If the existingowner is to remain the owner of the assets, a contractual arrangement may work.However, if both parties intend for the assets to be fully contributed to orheld by the project, often an independent legal entity will be set up by theparties and the assets will be transferred into that entity. The taximplications of any asset transfers can play a big part in deciding on anappropriate structure.

The joint venture structure you choose will depend on the risks that youare taking as part of the project and how much time, money and resources youare giving to the project - not to mention what you are hoping to gain from theproject.

Establishing a joint venture using an independent legal entity requiresa higher level of commitment, on top of the commercial project commitments. Thisis because the parties are usually to some extent jointly responsible for meetingthe legal and regulatory obligations required for the management and operationof the separate entity.

If the joint venture parties do not want to form a separate legalentity, they can still protect their interests by putting a written legallybinding commercial agreement in place as a way to ensure that risks are managedand the parties have some recourse (for example, to bring a claim for damagesor specific performance under English law against the other party or parties)if the collaboration goes wrong.

How to structure your management team ina joint venture

In a joint venture that is operating through a separate legal entity, thestructure of the management team will be broadly set out in statute throughdefault provisions.

(Either in the model articles of association or otherwise as set out in the Companies Act 2006 in the case of a limited company, or as set out in the Limited Liability Partnerships Regulations 2001 (SI 2001/1090) (as amended) in the case of a limited liability partnership.)

In both these regimes, however, parties are able in large part to agree theirown arrangements for the management and control of the entity on a day-to-daybasis. The size and complexity of the management team will depend on the scale andindependence of the joint venture (for example, whether it has any employees andcustomers of its own).

How a management team will be structured will depend on how equal theparties’ bargaining power is. For example, a party that is contributing most ofthe funds to a venture or whose commitment or presence in the project isimportant for its success, may expect to have more control and rights over howthe venture is run.

This can take the form of a majority shareholding in the case of acompany limited by shares or provisions for additional or superior votingrights or veto rights when decisions relating to the project have to be made(sometimes called ‘reserved matters’) being included in the joint ventureagreement or shareholders’ agreement.

Who the partiesnominate to the venture’s management team can also depend on whether each partyis allowed to nominate candidates they already employ or are familiar with orwhether the nominations are independent appointments? Usually joint ventureparties are allowed to have their own representation on the management team butthe joint venture may also have independent representatives too, to assist withany disputes between the parties and to make sure that the interests of theproject as a whole are being considered.

How to minimise risk when selecting yourpartners/management team

You should do research before selecting potential joint venture partnersor members of a management team – including reference checking, analysis ofexperience and face to face meetings. This is not only to gauge the candidate’sfinancial viability and credentials but also to see whether you trust them andsee yourself working with them.

The likelihood is that in a joint venture, there will be some managementrepresenting each party to the joint venture. The risks can come in determininghow the joint venture is controlled - how the management representatives of theparties work together and make decisions, particularly if one party is makingmore investment or has a stronger bargaining power than the other parties.

A management agreement (or partnership agreement) can be put in place to direct how the management are expected to perform and to state the processes required to keep the investing parties informed of the progress of the venture. It is worth seeking employment law and tax advice before setting up complicated management structures, particularly if they involve pensions or other benefits like share schemes.

In some cases where there is a party in the minority, the joint ventureagreement, shareholders’ agreement or collaboration agreement may set out someprotections such as veto rights for the minority party to ensure that the otherparties/party cannot make decisions without its approval. These documents also usuallyset out what happens if a decision cannot be made, as may be the case when aventure has two parties committing on a 50/50 basis and the parties havesimilar bargaining power.

Joint venture governance bestpractices

One issue withsetting up an independent legal entity controlled by two or more parties isthat there may be potential conflicts of interests between what an investorwants (and therefore what its representative in that entity wants) compared towhat is best for the entity itself. This will be particularly relevant in thecase of public entities which can be subject to a lot of public scrutiny overgovernance compliance. There is an ongoing trend toward transparency ofmanagement and better governance compliance particularly in public listedcompanies and so it is important to make sure that any joint venture entity isaware of and complies with its duties on a stand-alone basis.

There are manyways to effectively comply with legal and regulatory governance compliance andthere are regulatory guidelines and codes for companies and limited liabilitypartnerships that will specify in detail what constitutes best practice.

Common ways todemonstrate good governance practices include:

• Appointing independent directors on boards in addition to thosedirectors that have been nominated by each party.
• Establishing audit committees and remuneration committees (this may onlybe relevant if the size of the joint venture warrants it and the joint ventureemploys people).
• Establishing a code of conduct, a mission statement and policiesrelating to anti-bribery and anti-corruption.
• Putting in place a rotation system for the managing partner or chiefexecutive officer between the joint venture partners.

Another consideration is that a party will usually want to protect anyinformation that it provides to the other parties that contains confidential orcommercially sensitive content. So obligations to protect such informationshould be drafted into the joint venture agreement.

They will however need to be subject to any disclosure requirements that the joint venture entity itself may have legally or to a regulator. A joint venture agreement should also be clear on whether the joint venture can carry on activities that may compete or be of a similar nature to the parties. Any restrictive provisions will need to be carefully drafted to ensure that they are in accordance with competition law requirements.

Joint venture finance best practices

Much like with governancerequirements, joint venture finance best practices will be put in place toensure transparency and to stop undue influence over the finances andaccounting of the independent legal entity being exerted by the joint venturepartners.

Scrutiny byfinancial regulators or the entity’s auditors may be heightened if assets ofjoint venture partners are pooled or profits are frequently taken out of thejoint venture entity. One way to manage the process is to have in place robustaudit policies and committees that oversee how the finances are managed. Thisis particularly important if a joint venture entity is established and theentity runs out of money or takes on more debt than it can handle as the actionor inaction of the joint venture entity’s directors or partners could beinvestigated for misconduct or negligence.

If the jointventure is established as a separate entity, it will be obliged to prepareannual accounts and make filings with the Registrar of Companies and so bestpractice is to make sure that any accounts and related filings are prepared andregistered on time.

Another area thatwill have best practices is compliance with tax obligations, including filings.If the joint venture is operated through a company, it will pay corporationtax, whereas for a partnership each individual person will pay income tax. Itis important to get tax advice before setting up your joint venture to makesure that you are aware of all of the relevant obligations (including any valueadded tax obligations) and possible tax exemptions that the joint venture maybe eligible for.

Do you have plans in place as the joint venture evolves?

Nobody has a crystal ball and it is likely that not all of the detailsand issues that arise in the project will be known at the start of the jointventure. A sensible way to manage the development of the project is to set outin the joint venture agreement the known details of the project (this is oftenincluded in the agreement in the form of a specification annexed to theagreement or provided in a schedule to the agreement). This could include such thingsas the intended contribution and resources required by each party at the startof the project and what is expected of the parties throughout its duration. Themore detail that is provided, the clearer the parameters of the project will beand may save any renegotiations or clarifications on terms at a later stageonce the project has begun. This approach can work both ways. It may bebeneficial if the negotiations are difficult or the outcome is in your favour,but it may also be useful to keep flexibility to further discuss how parts ofthe project will work once the parties have a better idea of how the project isgoing.

Another mechanism is to include a schedule of milestones or projectdeliverables and set out what happens if those milestones are not met.

Throughout the project there should be clear reporting obligations onboth parties or the joint management team (or board of directors in the case ofa joint venture company) to ensure that all plans are known to the investors ofthe project as the collaboration unfolds.

The key to any good collaboration is arguably strong communication. Usuallya joint venture will set out formal reporting (and if necessary, inspection) requirementsof each party and at a high level, meeting schedules for the management boardor team. The nature and extent of the reporting requirements will depend on theproject specific circ*mstances.

Do you need to have an exit strategy in place?

The simple answer is yes.

No matter how well intentioned theparties to a joint venture start out, no one can predict the future. It’ssensible to manage risk by including detailed provisions in the joint ventureagreement or collaboration agreement that allow you to suspend, transfer or endyour obligations and commitments under the joint venture in certaincirc*mstances.

Parties should be clear on the process that theyneed to follow if a dispute arises between the project or management team, inparticular in which forum the disputes should be heard and resolved (this couldbe between the senior management of the parties, by votes of the managementteam, board of directors or shareholders or ultimately in court or through formalarbitration proceedings). If all parties have an equal say into projectarrangements or control a legal structure on a 50/50 basis, the parties mightwant to think about how to progress the project if there is a deadlock indecision making and whether if unresolved, this could trigger to a right forthe parties to terminate the venture.

Each party should think carefully about whathappens if the project fails, stalls or goes wrong and what that means forthem. Parties may want to be able to terminate the agreement early before theproject has finished, or to tie all parties into a ‘lock-in’ period where theyhave to commit to a certain amount of time (and possibly investment) in theproject before they can opt to terminate.

There may be provisions for termination in thecollaboration agreement or joint venture agreement if a project milestone isnot reached, if one party undergoes a change of control, or if the otherparties breach a major obligation under the agreement. And usually an agreementwill allow a party to terminate the agreement if the other party goesinsolvent. The list of reasons that allow parties to terminate thecollaboration agreement or the joint venture will vary depending on the project.

In reality however, termination may result in a numberof issues other than simply ending the collaboration agreement or joint ventureagreement. What happens to the legal entity that has been set up and anyexisting value or liability held by it? Any shared resources, existing supplieror customer relationships or agreements or shared confidential information willalso need to be dealt with. The parties also need to think about whether anycontinuing collaboration is necessary after termination and for how long (forexample, any continuing statutory commitments or contractual obligations thatstill need to be complied with).

If the venture is run through a limited company,decisions will need to be made as to whether one or both parties’ shares can besold or transferred and to whom.

For example:

• Whether party B can make party A sell its shares to a third-party purchaserthat it is planning to sell its own shares to.
• Or whether Party A can oblige Party B to make a third-party purchaseracquire the shares of all of the parties to the joint venture, so called ‘dragalong and tag along rights’).
• Or whether the company will be wound up and struck off the register inthe event of termination (for example, if it has been agreed that neither partycan continue doing business through the joint venture entity).

Some joint venture agreements will includerights for a party to buy or sell the other party’s shares in the event oftermination, called ‘put and call options’. This may include pre-emption rightsor a first right of refusal to the other party’s shares before they can be soldto a third party. Usually a party will want to sell all of its shares or buyall of the other party’s shares so that it is not tied into commitments withanother party that it did not choose. With any separate legal entity, anotherthing to think about is how assets contributed to the venture will be redistributedwhen the venture ends, for example they could be returned to the party that acquired or funded the asset or sold to a third party.