JOINT VENTURE NEGOTIATIONS pose many unique challenges to dealmakers. One common challenge is how to achieve an equal ownership split when the parties’ contributions are inherently unequal. In many two-party deals, such as Royal Dutch Shell-Cosan, Bosch-Siemens, GE-Mubadala, TNK-BP, and Samsung-Corning, creating a 50:50 joint venture is a core requirement for one or both parties. But initial valuations don’t always support such a split due to differences in the scope and scale of contributed assets or businesses, disagreements on the valuation of hard-to-value intangible contributions (e.g., local regulatory contacts, brand reputation, trademarks, etc.), or inability to share information about black boxed intellectual property contributions. When valuations diverge, three things can happen:
- Both parties can accept an asymmetric ownership model (e.g., 50.1:49.9, 51:49, 52:48; 55:45; 60:40), according to the initial valuation;
- The disadvantaged party can fight for a higher valuation (e.g., where intangibles or IP is involved), while the advantaged party demands a majority interest, according to the as-is initial valuation. This often results in prolonged negotiations, deadlock, and termination;
- Or, both parties can mutually seek to re-balance contributions in a way that supports equal ownership. This is often underscored by a belief that equal ownership helps to create goodwill, alignment, economic parity, and a natural incentive to cooperate over the long-term.
Typically, parties opt for choice three. And this leaves dealmakers searching for ways to reach 50:50 ownership while providing fair consideration for unequal contributions. The purpose of this note is to introduce 10 potential pathways to do just this (Exhibit 1).
To illustrate, consider the true-up mechanism – the first of three common pathways. Prospective JV partners can negotiate a true-up mechanism, either as an upfront true-up payment (i.e., a direct cash equalizing payment or disproportionate initial capex contribution) or a post-deal payment (i.e., an asymmetric dividend, distribution, or future capex requirement). This is what Merck and Sanofi-Aventis negotiated in a deal to consolidate their respective animal healthcare businesses into a JV equally-owned by the two companies. The enterprise value of the Merck business was $8.5 billion versus $8 billion for the Sanofi-Aventis business. To address the gap, Sanofi-Aventis made a true-up payment of $250 million plus other contributions to reach a 50:50 ownership split. The JV would have been the largest company of its kind in the world had regulatory and other challenges not blocked the deal from moving forward.
Liberty Global-Vodafone also used a true-up mechanism, in their JV deal to create a national unified communications provider in the Netherlands (i.e., video, broadband, mobile, and B2B services). These partners anticipated this deal would realize synergies with estimated NPV of €3.5 billion after integration costs, or a run-rate savings of €280 million per annum by the fifth full year of operations. While the partners negotiated a 50:50 ownership split, the valuation of their contributed assets did not support such a split. Based upon the enterprise value of each business, and after deducting €7.3 billion of net debt from Liberty Global, Vodafone was still short €1 billion. To true-up this valuation gap, Vodafone made a one-time payment of €1 billion to equalize its ownership stake in the JV.
The second pathway is staged funding or earn-ins. This is where one partner funds their share over time, rather than upfront, based on the venture achieving certain milestones or incurring certain expenses. Cyberkinetics-Neurometrix was a 50:50 JV to develop products for treating nerve injuries. Not only did Cyberkinetics contribute intellectual property and know-how, it also agreed to license a key piece of technology to the venture that resulted in a higher initial valuation than its partner. To compensate, Neurometrix agreed to fund the first $2 million of program costs, and any required funding beyond the initial $2 million was to be shared equally, according to the 50:50 ownership split. However, dealmakers should consider one caveat to staged funding and earn-ins: Whether the partner holds their full 50 percent ownership stake to begin or accretes that ownership stake over time, in line with their capital contributions, is a matter for negotiation.
The third pathway – contingent payments or earn-outs ...