DEALMAKERS LOVE using simple analogies to explain complex transactions. A favorite we hear is that joint ventures are like marriages. True, a strong marriage has shared decision- making and a common bank account (though we suspect modern marriages lack service agreements). But where this analogy falls flat is that while marriages are covenants intended to last forever – only 5% have prenuptial agreements – joint venture legal agreements have the terms of exit defined at the outset in 95% of the deals we see.
Unfortunately, these terms are often problematic, with critical flaws that go unaddressed by dealmakers concerned that over-engineering the exit is inviting it to happen. As one dealmaker recently told us, “I want to signal that this is a long-term partnership, not something with 10 different ways to declare it a failure and get out – which, by the way, also sounds like we don’t trust them.”
The sentiment is understandable, but also highly problematic.
First, the simple truth is that all joint ventures come to an end. While some, like Dow Corning, Fuji Xerox, or Bosch Siemens may last for a half-century or more, the median lifespan of joint ventures is now ten years (higher for asset JVs, lower for business JVs), according to our ongoing analysis.
Second, joint venture termination is not synonymous with joint venture failure. If you think back 10 years, the BlackBerry was ubiquitous in business and half of phones globally ran on Symbian, American automakers were circling bankruptcy and miles away from products like the Volt, consumers still rented DVDs at Blockbuster, and major names like DuPont, Kraft, Aetna, and Monsanto were independent companies. As corporate strategies evolve, it is inevitable that joint ventures designed to support an old strategy may no longer make sense, leading a company to exit an otherwise outdated venture. But only 24% of JVs in our data are dissolved or unwound at termination – a truer sign of failure.
And third, many exits are ugly – but especially so when the legal agreements are vague on when and how to pull the plug.
So, what’s a dealmaker to do?
BEST PRACTICES FOR DEVELOPING YOUR EXIT STRATEGY
After putting together and pulling apart hundreds of JVs across our collective careers, we have identified five best practices for dealmakers trying to structure a JV exit clause:
1. Always have an exit clause you can use or a path to control: As a matter of boilerplate legal language, almost every joint venture agreement covers mutual agreement to terminate, liquidate, windup, etc. via Board or Shareholder decision. It is also true that one-sided exit is almost always possible via mutual consent (i.e., if the parties can agree to terms for buying / selling shares). The problem is that “mutual” decision is often hard to reach, even more so when an acrimonious relationship is the backdrop for the discussion.
We firmly believe that dealmakers need to consider all the ways a potential joint venture could go badly and try to protect themselves from the worst outcomes with levers the company can unilaterally pull. And if the other side refuses to budge beyond the boilerplate referenced above, you need at least one reasonable path to get control in the future, so you can unilaterally resolve whatever painful dispute arises that will have you wishing you had a way to get out.
2. Tailor the components of the exit clauses to the industry, partners, and operating conditions: Every potential partnership has its own up- and down-side scenarios, and the exit should be designed to reflect these scenarios – not boilerplate approaches from a legal template. This means carefully considering all the elements of exit (Exhibit 1): The different potential triggers for termination, disposition paths for each trigger, valuation methods for each disposition, key post-termination rights and conditions, and potential restrictions on 3rd party transfers.
A helpful exercise we often do with clients is to collectively identify all of the good, bad, and ugly things that could occur in the JV– regulations kill the market; the partner is caught committing bribery in another country; the venture starts to compete with parts of your own business – and ask “what kind of exit rights do we need to protect ourselves in this case?”
Exhibit 1: Components of an Exit Clause (only one shown below)
Source: Water Street Partners. © All rights reserved
Click to Enlarge
3. Go beyond the minimums – but not too far: Bad situations like uncured material breach, partner insolvency, and illicit partner behavior ought to be reasons for an aggrieved party to untangle themselves from any joint venture – but not the only reasons. On the other hand, it’s possible to go too far when looking for reasons to exit. One joint venture agreement we reviewed had an exit trigger linked to deadlock on over 30 different Board decisions, large and small. Situations like that introduce moral hazard; the partner need only invent the flimsiest of excuses for pulling out via deadlock. Success lies somewhere in the middle.
4. Pay close attention to current and anticipated future asymmetries between the partners: Even (or perhaps especially) when an exit term is written neutrally, the partner with greater resources, capabilities, and operational linkages with the venture usually has a built-in advantage in the process. Sometimes, the geographical or regulatory context dictates the sole buyer in an exit. If your company is not the “natural buyer,” the exit terms should be designed to level the playing field (for example, by pre-agreeing on the specific valuation methodology, rather than relying on a standard buy/sell provision, which naturally advantages the natural owner).
Imagine being the dealmaker for a JV that is located inside a partner facility, supplied solely by utilities from the partner, and staffed via partner secondees and service providers. That dealmaker – our client – was only willing to agree to a buy/sell clause that forced the partner to pay 125% of fair market value if forcing a sale, or to accept 75% of fair market value if forcing a buyout, in order to balance out the natural asymmetries.
5. Consider whether the JV is really a phased exit, and if so, structure accordingly: If the JV is really a thinly-disguised sale, make sure that the sale will actually happen by inserting automatic triggers – and make sure the pricing reflects the acquisition premium the buyer would have paid if it took over the entire business at the beginning. This also calls for carefully thinking through how to untangle any dependencies between the company and the JV before it becomes wholly owned by the partner.
Thinking through all the scenarios that might lead to exit is never a fun exercise, and we understand the psychological hesitation behind investing deeply in a tailored set of exit clauses. But this much is clear: Dealmakers who fail to plan for exit are planning to fail when – not if – an exit occurs.