What’s the Best Way to Structure a Joint Venture?

FIVE ESSENTIAL ELEMENTS OF JV DEALMAKING

FEBRUARY 2023 – Overall, JVs offer many potential benefits. Depending on context, they may allow companies to access capabilities, enter new or restricted markets, share risk, pool capital, and capture revenue, cost, or accounting synergies. But these advantages come with challenges that can make JVs more difficult to negotiate than, say, acquisitions or licensing agreements. At its essence, running a successful JV transaction process is about getting to a “good yes” or a “quick no.” In our experience advising on more than 400 JV transactions over the last three decades, we believe that success is built on five essential elements.

Five Essential Elements
Each of the following elements introduces critical questions in the design, structuring, and negotiations of a new joint venture.

1. Deal Rationale: Is a JV really needed, and how will it support strategic and financial objectives? Consider whether a JV is the best vehicle to meet the company’s goals, or whether an alternative structure, such as a licensing agreement, non-equity partnership, or acquisition would be easier, more flexible, provide greater control, or better optimize tax and accounting benefits. Answering this question starts with being very clear about the company’s and counterparty’s financial and strategic goals, including capability building, market flexibility, and need for consolidation.
   
2. Partner Fit: Do the partners bring needed capabilities, compatibility, and commitment? Examine whether potential partners bring needed capabilities, assess whether they are compatible with your organization’s values and culture, and determine whether they are committed to the JV. All of this demands conducting a different type of due diligence – what we call strategic partner due diligence – that goes beyond the typical commercial and legal due diligence of ordinary deals to look more deeply at the counterparty’s strategy, market pressures, track-record and behaviors in prior partnerships, and internal culture.
   
3. Deal Options: Has the deal team considered several transaction concepts? Deal teams too often rush into negotiating a specific deal structure (often one that mirrors a prior deal done by a company CEO or senior business sponsor), but don’t take sufficient time to frame a range of viable alternative deal concepts to determine which is best. In our experience, there are often 3-5 viable alternative deal concepts that contain different answers on deal dimensions like venture scope, exclusivity, ownership, control, and financing. These transaction concepts are worth framing out and evaluating prior to negotiating around the preferred concept.
   
4. Financial Arrangements: Have the economic terms been structured in a way that fairly reflects initial contributions and that will align the partners post-close? Assess whether there is fair value for initial contributions and whether value-sharing terms align partner interests. When it comes to creating strong and aligned financial interests, companies might consider using a range of contractual mechanisms, which include shared revenue pools, variable ownership interests linked to the performance of parent contributions, earn-ins, milestone payments, rights to expand the venture’s scope or structure when performance milestones are achieved, earn-outs, or negative rights and disincentives (such termination of exclusivity) if performance fails to meet certain thresholds.
   
5. Governance and Evolution: Has a workable decision-making and oversight structure been developed, and will it be robust as the JV evolves? Have you determined which governance elements need to be addressed – not just “standard” contract terms? Are you limiting the number of termination issues? It will be essential to put an effective dispute resolution process in place, with rapid escalation.
   
   Our research suggests that JVs that are restructured and materially change their ownership, scope, or operating model are more than twice as successful as those that remain essentially unchanged. Yet virtually every JV gets “stuck” at critical inflection points – when the external market or the parent-company ambitions have changed, or after the JV accomplishes its initial objectives. Building in the capacity and flexibility to evolve at these points should be on the must-do list for dealmakers. 

To learn more, read the full White Paper.