Joint Venture (JV)
Broadly speaking, a joint venture is a co-operation between two or more companies for a mutual purpose. This purpose could be commercial or charitable, short-term or long-term. If used in the right circumstances, a joint-venture could be a beneficial opportunity to combine both the knowledge and the resources of the members. In this article I will outline the key features of JVCs and answer the most frequently asked questions.
What are the key features of Joint venture companies (JVCs)?
One of the most important decisions the participants in a JVC should make is which business medium to use to carry on the joint venture. The most common type of business medium for a commercial Joint venture is private company limited by shares (LTD). There are certain advantages to using a private limited company over other business entities. These advantages include:
• Limited liability from the claims of third parties in case that the JVC fails
• A separate legal personality so that the business can develop in its own name and in its own goodwill. Thus, if the JVC fails, the participants may find it easier to distance themselves both commercially and legally
When a Joint venture is conducted through a private company limited by shares, the participants become shareholders of the JVC. They face two choices – to either incorporate a new company or to use an existing wholly owned subsidiary of one of the participants.
Should I incorporate a new company to act as the JVC?
The most common type of JVC is a newly incorporated company. In this case each of the participants is issued shares in the new company in exchange of cash, assets or both. The main advantages of using a new company to act as the JVC are that:
• The new company has no trading history or potential liabilities which may affect the JVC
• The share structure can be easily set up in order to meet the participants’ needs
However, note that there are some disadvantages as well. The main drawbacks are that:
• Any assets which need to be owned by the JVC will have to be transferred to the new company, which could result in unpredicted tax liabilities
• Any bank lending may have to be guaranteed by the participants as the company has no trading history
Usually one of the participants in the JVC incorporates the new company and is expected to warrant that the company has been properly incorporated, has never traded and has no liabilities.
What are the benefits of using an existing subsidiary to act as the JVC?
In some cases it is more appropriate to use an existing wholly owned subsidiary to act as the JVC. For example, it will be more beneficial to use an existing subsidiary if it already owns a large number of assets which are to be used in the Joint venture company. Consequently, the other participants in the JVC will need to become shareholders of the existing subsidiary. This could be achieved through an issue of new shares in return for the transfer of assets or cash. As an alternative, shares could be transferred to the others by the holding company of the proposed JVC.
However, before opting for an existing subsidiary to act as the JVC, you should take into consideration a range of issues. Some of the issues that may arise are outlined below.
• It is important to know that any assets held by the proposed JVC which are not required for the joint venture will have to be transferred to another company in the participant’s group
• The usual tax considerations when transferring assets within a group will need to be taken into account
• The share structure of the proposed JVC will have to be altered in order to meet the requirements of the Joint venture. This may include an alteration of share capital or the adoption of new articles of association
How many shares should each participant in a JVC hold?
One of the essential features of a Joint venture company is each participant’s shareholding. The proportion of shares held by each individual is a matter of negotiation between them and usually depends on their contribution to the company. However, this is hard to define, especially when one of the participants is bringing something intangible such as management skills or intellectual property.
Often financially stronger participants will be able to negotiate a higher proportion of shares. In some cases, the participants will have equal ordinary shareholdings and, if necessary, any extra contribution by one of them will be compensated in other ways such as licence fees for the use of assets or through the issue of non-voting redeemable shares.
It is common for each participant to hold a different class of ordinary share. This is the case when the participants are to have rights particular to their shares. In this way each participant will constitute a separate class of shareholders. Class rights can only be altered with the consent of the shareholders in that class. Thus, the rights of the participants will be better protected.
How can I make my assets available to the JVC?
In general, the participants agree to form a Joint venture company because each has assets which are better exploited when combined with the assets of the others. For example, one individual may own the intellectual property rights to a new product while another individual may own the manufacturing plant capable of building it. Therefore, it is essential for the participants to identify which assets they will be contributing and to agree how to make them available to the JVC.
The participants will face two choices:
• The asset is retained by the participant and is leased or licensed to the JVC. The terms of the lease or the licence should be considered very carefully. The other participants will need to ensure that they do not give the person granting it the ability to prevent the asset from being used by the JVC
• The asset is transferred to the JVC in return for an allotment of shares .However, there may be tax liabilities on the asset transfer. The taxation will generally depend upon whether or not the JVC is part of the transferring participant’s group
How can I fund a JVC?
The participants will need to consider how the JVC will be financed. There are two ways of financing the JVC.
• From the participants:
The initial funding is usually made by the participants and is often sufficient to start with. The JVC may receive some cash from the participants in exchange for a share allotment. They should ensure that their capital contributions are sufficient for the foreseeable future.
It is advisable for the participants to agree on the amount of loan or capital each will provide and the circumstances in which further funding will be provided.
• From third parties:
The JVC may also obtain loans from third parties such as banks. Banks usually require the participants to provide a comfort letter. If the bank is not comfortable with the commercial standing of the participants or with the track record, it may require the participants to guarantee its loans.
How is a Joint venture company managed?
The participants are usually able to exert control over the commercial decisions and management of the Joint venture company. Their share rights give them the ability to appoint at least one director to the board of the JVC. The duties of the JVC’s directors are the same as that of any other company. The directors must promote the success of the JVC for the benefit of its shareholders instead of promoting the person or company that nominated them.
What is a deadlock provision?
At the start of any Joint venture, the participants are usually very co-operative and firmly believe in the success of their collaboration. However, it is important to take precautions in case that the collaboration fails. A worst-case scenario, for example, will be when the participants are unable or unwilling to make decisions, leaving the JVC in a state of paralysis. This is known as “deadlock”.
Deadlock provisions are used in cases when the relationships between the participants have irreversibly broken down. Before they are put into effect, the participants usually try to negotiate a compromise. If they cannot reach an agreement, deadlock can be resolved in a number of ways.
If the participants want to carry on the JVC, for example, a so called “Russian roulette” solution may be a suitable option. A “Russian roulette” solution means that one participant offers either to buy the shares of the other participants or to sell its shares to them at a specified price. Thus, this decision will most likely be in favour of the financially strongest participant. Other solutions are that the JVC is put into voluntary liquidation or the participants are required to co-operate in a sale of the JVC to a third party.
If you have any questions or queries related to Joint ventures companies (JVCs) or company formations in general, we are available for a live chat or you can leave a message on our Support & Contact web page and we will get back to you.