Joint ventures: Weighing up the pros and cons of collaboration

Is a collaboration with another business the right move for you? We examine the benefits and the risks


You might have a killer idea, but lack the resources, finance or knowledge of a particular market to deliver it. Sometimes, collaborating with another business that is able to plug the gap can be the way forward, giving you credibility as you move into a new area.

What’s more, when the economy is shaky and access to capital is scarce, sharing the risk and pooling your resources with a partner can be a great way of strengthening your proposition.

“Given that we’re in the thick of a credit crunch, I think businesses will look harder at joint ventures,” says Peter McHugh, a partner at law firm Pinsent Masons. “There will be great opportunities, and the ability to combine with another like-minded entity with complementary strengths will offer a competitive advantage.”

However, joint ventures (JVs) are complex relationships and take many different forms. They also need careful planning to make them work. We spoke to entrepreneurs who have been there to find out the secret behind a successful JV.

Is it right for you?

If you’re stepping out of your comfort zone, whether it’s away from your core business area or into a new territory, acquisitions become riskier because you have less knowledge of what you’re buying into. “In that case, a classic way of seeking to grow the business is to buddy up with an expert in that field,” says McHugh. “Say you’re thinking of expanding into China. If you know nothing about the country, starting up, or buying a business there are risky strategies. The logical route is to collaborate with a third party to deliver a mutually beneficial outcome.”

Sometimes, JVs are simply a contractual relationship, where a business wants a partner to embark on a project, from developing a new product to researching a new market or tendering for a large contract. Depending on what the objectives are, you may want to take your collaboration beyond this to form a company that each partner owns shares in.

Whatever type of collaboration you’re thinking about, there have to be strong commercial drivers. “The first step is to ask why you need to do this as a JV’?” says McHugh. “Both parties have to be able to understand how they can derive significant commercial benefit.”

Rosaleen Blair concurs. She set up her recruitment outsourcing business, Alexander Mann Solutions, as a JV with its namesake, the recruiting giant Alexander Mann Group. She joined the company 13 years ago as an employee, and after six months had the idea for the business.

“I’d written the business plan, found my first client and decided to do it myself,” she recalls. “But the chief executive encouraged me to do a JV with the group.”

The business now turns over £340m, and following a £100m management buyout (MBO) in December 2007, Blair and her management team own 35% of the company. However, she admits that before the MBO, while she had total control in terms of running the business, ownership and value creation were “disproportionate” between the two parties, and not in her favour. “I’d think very carefully about what you are gaining from it,” she advises. “I would be certain that you had worked out what it would take for you to do it yourself with the right support before you give away too much of the company or your ideas.”

So does Blair regret her decision? “I think hindsight’s a wonderful thing,” she says, adding that, at the time, her options were limited, with non-compete clauses restricting her for at least six months. However, she stresses that there are often circumstances where a JV is absolutely the right move – when there is a window of opportunity and you need accelerated geographic expansion or to take a product to market quickly, for instance.

Finding a partner

If you decide that a JV makes commercial sense, the next step is to form an ‘identikit picture’ of your ideal partner in your head, says McHugh. Typically, JVs come about when two (or more) partners have complementary skills and their combined strength is far greater than the sum of the parts. “They may not be equal in size, but they must be equally matched in what they are bringing to the venture,” says McHugh. “Large and small can get together, but strong and weak can’t.”

Blair recommends spending a lot of time researching your prospective partner, speaking to as many people as you can who have had different types of experiences with them. Of course, you want an alliance that will lead to a lucrative outcome, but knowing you can work with someone is the most important thing. People buy into people in business, and if the chemistry’s wrong it won’t work.

“There has to be an engagement of personality, and mutual trust and respect,” says Jonathan Metliss, a partner at law firm Davenport Lyons. “No document is going to hide any cracks in the relationship.”

Indeed, one of the biggest threats to a JV is an initial deal that is significantly more favourable to one partner than the other. The disgruntled party will dwell on the deal rather than focusing on growing the venture. “You want to have a situation where the contract is something that sits in the drawer and gathers dust,” says Len Dunne, managing director of Galleon Entertainment, a division of AIM-listed Galleon Holdings. “If it’s going to work, both parties have to see it as a good deal from the start.”

There must also be a strong cultural fit, with shared values, visions and commitment to the venture. Investigate the corporate nature of the other business. How aggressive or collaborative is it and how will this work alongside yours?

Key to success 

Galleon develops multi-platform entertainment properties, and then finds partners to help deliver them. One of its biggest hits is Super Soccer Star, a reality TV show looking for the next teen football star in China. It is a strategic alliance with Chelsea Football Club, generating revenues through various channels and activities, including online participation, advertising and merchandise.

“We identified the English Premier League as a hot theme and emerging market in China, but felt there were probably only four teams that have real draw,” says Dunne, who admits there was “a bit of serendipity” involved when deciding which of them to approach. Galleon had already secured interest from a broadcaster in Guangdong, where Chelsea were planning a tour. It quickly became the number one entertainment show on the Guangdong TV Sports Channel, and Galleon and Chelsea have since extended the relationship into other territories.

Dunne attributes the success to the fact that each party had much to gain from the deal, both commercially if the show was a hit and through an increased global reach. So both partners have been committed to making it work.

“One of the fundamental elements in any form of JV is that you’ve got active investors – people who aren’t just looking for a financial return, but want to be part of the project operationally,” he says.

While Galleon is responsible for finding format partners and doing the “heavy lifting”, Chelsea provides guidance in terms of skills testing and the use of its facilities in London. “If both partners are willing to invest time and energy in its success, whenever you approach roadblocks, each party will be trying to find solutions to get around them,” explains Dunne.

Oli Norman, founder of marketing agency DADA, agrees, saying: “You must be equally committed to the objective from the outset.” DADA has a number of alliances on the go, including co-owning a three-storey bar and restaurant in Glasgow with a client that owns around 25 venues in the city. “We can clearly make it very busy, but we don’t have the expertise to carry out the day-to-day operations,” he says. So a JV does not necessarily mean both parties work equally as hard, but it has to be in everyone’s interest.

Norman also uses JVs to offer his clients marketing projects that are sustainable. “Rather than try to pitch for their advertising account, we approach them with a strong idea, such as a festival or large event and say let’s run it as a JV and share in the profits,” he explains. “Or, we might minimise the exposure by taking the bulk of the risk and owning the property, with them co-funding it.”

It’s an approach he feels is particularly good in a downturn. “It’s marketing that’s revenue generating,” he says. “Instead of getting a fee, we have a new business that can be a profit centre in its own right.”

Protection

There are a number of ways a JV can be structured and managed, which is dictated by how the relationship will work operationally and financially. This requires extensive upfront planning, and once decided, needs to be enshrined in a watertight shareholders’ agreement.

You must consider what could go wrong and the ‘what ifs’. This can involve some difficult conversations, which you may fear will jeopardise the deal. But tiptoeing around each other’s sensibilities won’t do anyone any favours.

“The best JVs are usually 50:50. Then what’s good for one is good for the other and vica versa, in terms of the way it can be structured,” says McHugh. “There is a commonality of interest to talk about these issues hypothetically, and to make sure the contract accurately addresses them.”

Disagreement on policy is one of the most common reasons JVs break down, and your agreement must put in place mechanisms for resolving disputes early, to avoid deadlock. Other important issues include what capital each party will introduce, how any value created will be recognised and apportioned, and how future growth will be funded.

“Don’t underestimate the importance of having a vision of what your business is going to look like in the future and think about all the eventualities,” says Blair.

You also need to have good exit provision. “Going into a JV is very easy; getting out is very difficult,” says Metliss.

If things go wrong for whatever reason, such as a takeover or bankruptcy, there must be appropriate exit routes. These can include a ‘put’ option, where you can put all your shares onto the other party who’s then obliged to sell at valuation, or a ‘call’ option, where you buy the shares of the other party, subject to valuation.

In any JV, you have the risk of one partner being unable to fulfil its ongoing financial commitments. So you have to devise mechanisms to deal with this eventuality. “If the other party defaults, basically breaching any term of the agreement, then the innocent party should have power of attorney,” says Metliss. This gives the latter the power to take on the shares of the other party, which they may have to pay for, depending on the terms.

Most JV agreements will include negative pledges, Metliss adds, which dictate that certain events, such as buying a property, selling the business, raising capital or hiring staff over a certain wage, can’t take place without unanimity.

You should always carry out legal and financial due diligence on your JV partner and try and have as much ‘face’ time with them as possible, to ensure you’ve got a shared vision, attitude and that they have a good reputation. Dunne advocates transparency in financial accounting too, including the right to audit the other party.

Getting advice

Given the intricacies of a JV, it’s extremely important to seek legal advice before taking the plunge. Lawyers will help determine the best structure, to ensure it delivers the value the partners are seeking. “JVs often fail because the agreement doesn’t really address the issues,” says McHugh. “I think lawyers can be great facilitators of having those difficult conversations upfront.”

He strongly advises engaging with lawyers early, and says some will even share in the risk and reward of the JV happening or not in terms of the cost of their advice. “Because lawyers feel they can really add value at the outset, they want to give their clients every incentive to make use of them,” says McHugh. “Ask if they are prepared to invest a couple of hours while you talk about a venture you’re thinking of.” 

Asking the experts is also something Blair strongly recommends. “I was very naïve going into it,” she admits. “No matter how much it appears to be costly at the time, I would get expert legal advice. If it looks too good to be true, it probably is.”

With all collaborations, there is an element of danger. What’s important is to make sure everyone’s aware of the risk each party is taking, and is comfortable with that. One of the biggest threats is someone “moving the goalpost”, says Norman. But again, it all comes down to finding a partner you feel you can trust and work well with.

“You can have all sorts of deadlock provisions,” he says, “such as ones that relate to voting rights and other things. But if you’re going into a JV on the basis that you may have to use them at some stage, don’t do it.”

Joint venture agreements: an initial checklist

  • How will the joint venture be managed?
  • What capital will partners introduce at the outset?
  • What obligations are there to introduce more capital at a later date?
  • How will decisions be taken?
  • What key performance indicators will the relationship depend on?
  • Will certain decisions be reserved for shareholders (not management)?
  • What happens if ownership of one partner changes?
  • What issues might cause shareholders to require a right of veto?
  • What happens to any intellectual property that’s created?
  • How is value created going to be recognised and apportioned?
  • How will future growth be funded?
  • How will you deal with disagreements or disputes?
  • What is the exit strategy?

 

Comments

(will not be published)