The
Business
Development Knowledge Network
Joint
Venture (JV) Deal Structures
Structuring Joint
Ventures
1. Preparing for Negotiations
"What is the economic rationale underlying the planned JV?" To
answer this question seriously is particularly important for the
"weaker partner" because he may have more to lose should the
JV go wrong. The "weakness" may result from owning the smaller
stake or holding fewer voting rights in the JV Company or from lacking
know-how, market access, or in less open countries, from the
"stigma" of being a foreign investor not familiar with the
"home rule".
Does the "weaker partner" want to prop up his local majority
partner with his know-how, or to get access to cheaper production or a
new market, or is he just looking for a profitable investment? Depending
on the answer he will be seen either as a "strategic partner"
or a "financial partner".
As a strategic partner, he will
· seek an assured level of influence over the corporate bodies of the
JV company and insist on the right to delegate nominees to them,
· allocate "strategic" responsibilities to such nominees,
· be interested in a long duration of the JV,
· stabilize the relationship with the majority partner by putting
restrictions on the transfer of the latter’s participation, and
· carefully draw up accompanying agreements of the JV company with
third parties (e.g., supply, procurement of know-how, intellectual
property).
As a financial partner he will rather focus on
· influence over financial matters (including minority rights relating
to financial control and audit),
· the right to nominate the Chief Financial Officer,
· a pre-defined lifetime of the JV and a pre-defined exit (e.g., an
Initial Public Offering).
In either case, the weaker partner would be well advised to retain
counsel familiar with the strengths of the majority partner.
2. Letter of Intent
The
Term Sheet or Letter of Intent (LOI), which precedes the Definitive Agreement, is a confidential document, usually prepared by
the buyer or investor, which outlines in general terms the purchase or
investment agreement between the parties. All of the following are
the same thing: term sheet, memorandum of understanding (MOU), letter of
intent (LOI), heads of agreement, deal points, etc.
Most of the time it is not a legally binding
commitment to buy, sell, or invest. However, certain provisions such as
confidentiality stand still and payment of consultants during the
diligence period should be and usually are binding. I refer to the LOI
as a “handshake in writing.
The main purpose is to assure that the parties agree on the general terms of the deal before starting due diligence. Without the terms written, the parties will expose themselves to crucial ambiguities and omissions.
| Term Sheet/Letter of Intent Template | Click Box For Free View of Each Document | Click Box to Buy Each Document - Annual Membership Not Required. Download link will be sent to your email. |
| Asset Purchase - M&A01 |
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| Asset Purchase - M&A02 |
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| Stock For Cash & Stock Purchase - M&A03 |
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| Stock For Cash Purchase - M&A04 |
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| Stock for Stock Purchase - M&A05 |
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| Earnout Purchase - M&A06 |
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| Joint Venture - M&A07 |
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| Product Distribution - M&A08 |
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| Product License - M&A09 |
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| Technology Development - M&A10 |
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| Series A Preferred - M&A11 |
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| Series B Preferred - M&A12 |
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As the weaker partner will be in the more vulnerable position;
confidentiality is essential, and exclusivity of negotiations with the
stronger partner for, at least, a certain time period. In order not to
lose face at a later stage, an understanding should be established to
value assets and what the price-relevant factors shall be.
In the interest of the weaker partner, the due diligence examination
should be both intense and expeditious. "Red files", if they
cannot be avoided, should be accessible for the minority partner as
early as possible, i.e., after the merger-control clearance is obtained.
3. Due Diligence Examination
The minority partner should insist on a well-organized and complete data
room. On the other hand, he should not formally acknowledge any
"completeness" of the information he has obtained, and
certainly not if it is demanded together with a waiver of any warranty
relating to "facts that could have been seen from the information
provided". More generally, the minority partner should not accept a
reduction of the representations and warranties to be granted by the
majority partner with the latter’s argument that "an extensive
due diligence examination of assets the majority partner is to
contribute to the joint venture vehicle was granted".
4. Shareholder agreement
a) In particular, the minority partner should insist upon a proper
definition of the purpose of the JV. This will help when the
interpretation of the JV agreements are at stake.
The minority partner should also insist that the majority partner shall
terminate its own (or its affiliates´) competing activities and to
completely transfer to the JV company the existing customers, suppliers,
key personnel, etc.
b) As far as the JV vehicle is concerned, the minority partner might
prefer a type of corporation where the directors are not subject to
direct instructions of the shareholder meeting.
The minority partner should aim to have as many minority rights as
possible established in the articles so that they work as statutory
rights (e.g., the right to delegate members of corporate bodies,
restrictions on the transfer of shares, preferred dividends). In
particular, he should secure his right of veto for resolutions on
specific, important matters by establishing a higher statutory quorum so
that no resolution would be valid without his presence at the meeting.
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c) It is essential for the minority partner to ensure his influence at
various levels:
Whereas the majority partner will, at least factually, have easy access
to information on the JV company, the minority partner will have to rely
on "watch dog" key personnel nominated by him and/or on
experts he may have the right to call in.
As already mentioned, the most important level to delegate such nominees
to, might be to that of director, which is where the day to day business
ensues. Depending on the purpose of the JV (see above), the weaker
partner should insist on the allocation of such tasks and
responsibilities to "his" directors and key personnel, which
are important to him.Apart from these "reserved tasks" other business decisions of
the directors should be subject to a majority, including the nominee of
the minority shareholder.
d) The minority shareholder should fix, in advance, the compensation of
the directors so that no excessive remuneration will be granted to the
nominees of the majority partner.
e) On the "upper level" (which, depending on the structure of
the JV company, will be a board or the shareholder meeting), the
minority shareholder should carefully negotiate a catalogue of business
matters (e.g., investments, loans) where his consenting vote is required
to pass a resolution; the same should apply to structural corporate
matters (capital increase, liquidation, merger, spin-off, etc.).
The minority shareholder should rather avoid a clause providing for
"dispute resolution in case of deadlocks" in order not to
dilute his veto.
f) Business plan, financing and at least the first
budget, should be
agreed in advance so that deadlocks in the initial phase of the JV can
be avoided.
g) Another deadlock to the detriment of the minority shareholder might
occur in relation to the distribution of profit. Here, a bottom line of
the profit to be distributed as a dividend should be agreed in the
shareholder agreement (e.g., as a minimum percentage of the annual net
profit, or a figure depending on the amount of equity shown in the
balance sheet).
h) When dealing with the transfer of shares, it should be the weaker
partner who insists on a minimum period during which no transfer of
shares shall be admissible at all (blocking period). Only then will he
be in a position to get a secured return on his investment.
Later on, there might be a well-defined circle of "permitted
transferees", accompanied by the right of first refusal (or a
pre-emption-right) of the non-transferring partner.
If the investment turns out to be negative for the minority partner, he
would be well protected if granted a put option (at a price in line with
a well established method of valuation).
If he sells only a part of his shares, it is important for the minority
partner to maintain his minority rights (at least, to an appropriate
extent).
i) Provisions for the exit from the JV are of paramount importance for
the minority partner: The duration of the JV, either for a definite or
an indefinite period of time, will very much depend on the nature of the
project. Yet it will be even more important for the minority partner to
have the right of exit in cases where events occur making it
unacceptable for him to continue. (Such an event might be the change of
control over the majority partner.)
There exist various ways of exit:
o The obvious variant is to liquidate the company.
Here, the minority partner should have the right to, at least, veto the
way the assets are sold or distributed. Another point is whether a block
sale of the whole business to the majority partner should be admissible?
It might be provided for that the minority partner gets back in kind
specific important assets he initially contributed.
o Another method of exit lies in the right to sell all the shares the JV
partner holds in the JV vehicle. Apart from the right of first refusal
(or a pre-emption right) the third party purchaser should be obliged to
continue the shareholder agreement so that the contractual rights of the
minority shareholder survive.
In that context, the option of the minority partner to simultaneously
sell to the third-party purchaser its minority share (tag-along option)
will be extremely valuable.
o Finally, the parties may have agreed in advance the details for an
exit through an Initial Public Offering. Again, if the JV partners
retain control of the company, they should in advance define their
continuing rights after such public offering.
5. Additional Agreements
a) Often, the weakness of a partner results from the fact that the JV
vehicle will be successful only if it enters into additional agreements
with the "stronger" JV partner or with one of its affiliates.
Such agreements typically relate to the supply of goods and services, to
intellectual property, to the use of information technology or the lease
of factory premises. The first question is whether the individual
agreement will have been entered into at arm’s length. This, however,
may not be the case at a later stage of the JV. From this viewpoint, it
would be in the interest of the "weaker" partner to provide
for a short term agreement (so that it must be re-negotiated at a later
time) or to allow the JV company to choose an additional third party or,
at least, to establish a mechanism of price adaptation, if possible.
b) The same applies to employment contracts with key personnel (in
particular, to pension agreements with senior staff).
Yet there is one essential thing, which cannot be put into any
contractual clause: Closing the "cultural gap" between the JV
partners so that the JV will be a continuing success for both the weak
and the strong partner.
