Executing Successful Joint Ventures (Part 2): Frequently Asked Questions
How do you structure your cross-border joint venture?
Although a flexible approach is needed when structuring a joint venture in order to properly negotiate and accommodate the diverse interests of the parties, there are certain required key conceptual elements of all joint ventures. The rights and obligations of the parties typically are set forth in a contract, which depending upon the organizational structure may be a joint venture agreement, stockholders’ agreement, limited partnership agreement, voting agreement or the like. In most cases, the parties will choose to form a local entity (rather than simply establishing a non-entity foreign branch of the U.S. parent) in order: (i) to isolate the legal risk of the venture to the assets contributed to that entity; (ii) to properly tailor country-specific issues with your joint venture partner; (iii) to more easily sell the joint venture; (iv) to qualify for local subsidies, permits or the like; and (v) to more effectively deal with local parties. The choice of entity often is a function of the amount of flexibility needed in governance and ownership, the effects of local taxation and, in some cases, restrictions on foreign ownership of certain entities or certain industries.
What other key elements must be addressed by the parties?
Elements that often are key to cross-border joint ventures, and therefore merit early discussion,
- The scope of the joint venture in terms of target markets and product and service lines;
- The licensing of trademarks or technology;
- The supply of raw materials, parts or components;
- The manufacturing of products;
- Day-to-day management and technical assistance services;
- The marketing, sales and distribution activities;
- The impact of income, property, value added (VAT) and import taxes and duties; and
- Required government permits and approvals.
One reason to exclude a function from a joint venture, and instead to have the joint-venture entity contract with you, would be to protect a trade secret. Also, before contributing any key element to the venture, you should ensure that the value of those elements to the enterprise is properly reflected in the profit-sharing and governance arrangements. You also should receive advice on the extent to which the laws of the host country impact these functions, for example by reserving certain activities to host country nationals.
Where one partner will be providing a particular element, e.g. supply of raw materials, it is better to be clear in the contracts regarding availability, price and quality. Creating a strong joint venture means building trust over time. It therefore is critical to set expectations from the outset and avoid conflict.
When should the parties begin drafting legal documents?
Because it is important to approach negotiations of cross-border joint ventures with patience and a commitment to clear and layered communication, it is important to not begin drafting legal documents until it is clear that the parties have clear expectations for the business and their role in the business. For that reason, it frequently makes sense to perform thorough business and legal due diligence and to prepare a business plan and set of financial models that identify drivers of value and sensitivities. The parties then can better understand the relative importance of the set of activities they will undertake, who is best positioned to undertake them, and the associated risks that must be addressed in the documentation.
Once the expectations of the business, and each party’s interests and priorities for it, are better understood, the parties can begin memorializing them. The first set of communications should not be in legal terms. In most cases, the best approach is to meet with your counterpart in person and communicate your interests and priorities orally. In that way, you can learn from the responsive body language of your counterparts and adapt to the dynamics of the meeting. You should use the meeting as a way to gather information about the interests and priorities of your future partner as well. Rather than focus on the positions being taken, you should attempt to understand the reasons behind the position. By understanding those interests, you will be better positioned to find trade-offs that offer greater value to each party.
It is recommended that the first written expression of any proposal be in bullet form and again not be in legal terms. However, it is important that you visit with legal counsel in order to identify material legal terms that should be included at an early stage in order to avoid misunderstanding. After the parties have reached a sufficient degree of understanding of the basis upon which they can agree to move forward, then the lawyers can begin crafting a complex set of agreements that expresses that understanding.