FEBRUARY 2022 – In the last year, many high-profile joint ventures have come to an end. Uber exited three JVs in Russia and restructured a fourth to provide local partner Yandex with a clear path to full control. John Deere and Hitachi ended their 30-year joint venture to distribute construction equipment in the Americas. And Renault ended its joint venture in China with Dongfeng due to poor sales.
Such terminations should not be surprising. The median joint venture lasts 10 years – a figure that has remained largely unchanged for decades. While JVs in relationship-driven geographies such as Asia and the Middle East, as well as asset-style JVs in slow-twitch industries like oil and gas, mining, and chemicals often last twice as long, the fact remains that all joint ventures come to an end, often earlier than partners anticipate.
EXHIBIT 1: HOW JVs END
Stock markets are also paying attention to JV exits. In looking at how exiting a material joint venture impacts the share price of parent companies, we found that 54% of JV exit announcements had abnormal returns for at least one parent, with a median positive return of 5.0%. “Buying” partners tend to have higher abnormal share price returns than “selling” partners.
Market Norms and Gaps
Getting exit right is essential to maximizing a company’s returns from a joint venture. In mountain climbing, more people are killed going down the mountain than going up. The same is true in joint venturing. Poorly structured exit provisions can cause significant time delays for companies to exit underperforming businesses, to monetize investments, or to execute broader strategic moves. Poorly structured exit provisions also can exacerbate partner animosity, trigger litigation, cause reputational damage, spawn high legal fees, and negatively impact exit valuations. All destroy shareholder value.
Given the importance of exit, we’ve been looking more closely at how companies structure exit terms in legal agreements. To do this, we’ve benchmarked the exit provisions of 81 joint venture agreements from around the world. Here’s a snapshot of what we found:
- At Will Exits: Some 60% of JVs provide one or more partners with the right to exit “at will” – i.e., the ability to freely transfer ownership interests without the occurrence of a defined event, such as partner breach or failure to secure a material government license. However, in 98% of instances, at-will exits come with strings attached, including the other partner’s right of first refusal, tag along rights, and restrictions on a potential buyer’s identity.
- Lockup Period: Less than 25% of JV agreements contain a lockup period – that is, a period where no partner is allowed to transfer its shares to a third party. Where lockups exist, the median period is five years. We think many JVs would benefit from a two to five-year lockup period during which the partners commit to provide early stability to the venture.
- Triggering Events: The median JV agreement contains seven events that trigger one or more partners’ right to exit. BMW’s joint venture in China with Brilliance Auto Group contains a chart-topping 22 exit triggers. The most common exit triggers relate to partner breach, insolvency, change of control, and deadlock. Interestingly, some 9% of agreements include performance-based exit triggers – both negative and positive. For instance, in a JV between Goodyear and Sumitomo, the agreements establish that if the venture did not achieve a 6% share of the tire market in Japan, such underperformance would provide either partner with the right to initiate exit. We think companies should include more performance-based exit triggers, especially when a JV is the company’s exclusive vehicle in a given market.
- Buy-Sell Provisions: Lawyers and game theorists love to comment on the incentives and negotiating dynamics associated with “buy-sell” provisions. In simple terms, a buy-sell structure works like this: One partner has the right to name a price for the venture and, once that price is on the table, the other partner must then decide whether to buy or sell at that price. Because the initiating partner does not know whether it will be the buyer or seller, it should have strong incentives to offer a fair price – assuming both sides see roughly the same value in the JV. But only 15% of JV agreements include a buy-sell provision, and when such terms exist, they are almost always linked to a negative event – such as deadlock or breach – and rarely associated with an at-will right to exit.
- Pre-Agreed Pricing Formula: Less than 5% of the agreements we reviewed contained a pre-agreed pricing formula for the price at which a partner may exit the venture. This is lower than we expected and suggests that many natural sellers may be missing an important protection. Under a buy-sell exit provision scenario, a natural seller would likely offer a lower price (putting aside game theory complexities) because it does not value the business as highly as the natural buyer partner and may not have the capital or desire to buy such partner’s interest. A natural seller is better off agreeing to a pre-agreed formula or an independent appraisal, rather than negotiating from a position of relative weakness or exposing itself to a buy-sell provision.
To read more about designing JV exit terms, please see our recent whitepaper on exit provisions:
Joint Venture Exits: Five Steps to Structuring Robust JV Exit Terms
To learn more about how Ankura advises clients on JV and partnership transactions, governance, restructurings, and exits, please contact James Bamford or Tracy Branding Pyle.