In part 1 of this article, we discussed the features of joint ventures, how they are different from other types of business arrangements, and some purposes for which they are used.
A joint venture can help two or more parties work together to accomplish a shared business goal, but as with other business transactions, a good working relationship can depend greatly on the clarity of the agreement that forms the venture. In this installment, we’ll discuss the steps that should be involved in forming a joint venture as well as different types of structures that can be employed for such ventures.
Forming a Joint Venture
Pooling resources to pursue an objective that separate parties would be unable to achieve individually is a powerful draw for creating a joint venture. To fulfill the potential of a joint venture, however, it should be formed with well-understood objectives, clear strategy, and comprehensive documentation. Some steps to follow in creating a joint venture are:
- Identifying the purpose: The purpose of the venture should be clearly identified, as well as what each party to the agreement hopes to gain from it.
- Choosing the right partner(s): Each partner should bring complementary resources, skills, and/or markets to round out the requirements for the endeavor. Due diligence is necessary to examine the financial standing, business practices, and reputation of each potential participant.
- Determining the structure: The structure of a joint venture should be guided by the nature of the venture as well as the tax and legal considerations of the parties involved. For example, the parties may wish to form a new business entity or they may prefer a contractual agreement.
- Drafting a joint venture agreement: The joint venture agreement should include all the details of how the venture will be run. All parties should have legal representation to help ensure that the agreement thoroughly covers all salient points. These include the purpose of the venture, the formation process, each party’s contributions and responsibilities, how profits and losses will be allocated, governance structure (such as when meetings will be held and the voting rights of each party), dispute resolution mechanisms, exit strategy, and more.
- Creating a management structure: A clear management and governance structure that defines who is responsible for daily operations, decision-making procedures, and how parties will participate in governance will help avoid confusion and conflict later.
- Financing the joint venture: This information should include not only the initial contributions of each party but also responsibilities for future financing needs.
- Preparing an exit strategy: The essence of a joint venture is the limit on its scope and duration. An exit strategy defines when the parties can leave the joint venture, procedures for dealing with a deadlock or disagreement, and the how the dissolution of the venture will be handled.
Possible Joint Venture Structures
What form any joint venture will take should depend on its purpose and circumstances. Some commonly used structures include:
- Contractual venture: Forming a joint venture by contract can be more flexible than creating a separate entity, since it can be quick to set up and to dissolve. Each party retains ownership of its own assets and is taxed directly on its share of profits and losses. However, because the venture does not have a separate legal identity, its operations may be hampered by a lack of clear structure.
- Business corporation (company limited by shares): This structure provides a clear corporate identity and established governance regime, as well as limiting the liability of parties involved to the amount each contributes in share capital. There is an increased administrative burden and public disclosure of information due to reporting and compliance requirements, as well as a potential for double taxation, as the joint venture company is taxed and the individual contributors may be taxed again when they take profits out or realize their investment.
- Limited liability corporation (LLC): An LLC is treated as a partnership for tax purposes; while each party is taxed directly on their share of profits and losses, the LLC itself is not taxed on its profits. It provides the benefit of a separate legal identity and limited liability for parties to the joint venture, but it does carry public filing requirements, and the roles and responsibilities of LLP members may not be as well defined as in other corporate structures.
- General or limited partnership: A partnership can provide flexibility because it is governed by the agreement between members, not by legislative requirements, and it can keep sensitive details private. A limited partnership, however, is not suitable for commercial joint ventures, as limited partners cannot be involved in managing the venture; these agreements are appropriate for circumstances in which most partners are passive investors. Among potential disadvantages are increased liability exposure, depending on the type of partnership and the partner’s role, and the fact that any change in joint venture partners requires a new partnership agreement.
In choosing the structure for a joint venture, professional legal and financial advice is strongly recommended to ensure that the structure chosen is suitable for the parties and their objectives.
Legal Expertise for Business Opportunities
How a joint venture is set up can profoundly affect on its prospects for success. The expert business law attorneys at Bridge Law LLP are your resource for creating domestic and cross-border joint ventures tailored to meet your needs and objectives. For more information, contact us here to schedule a consultation.