IT IS NOT UNCOMMON FOR JOINT VENTURES to bring in new owners to gain scale, access needed capabilities, support future funding needs, or allow existing owners to monetize their investments. Star Alliance, the global airline joint venture led by United Airlines and Lufthansa, has grown from its original 5 owners to its current 27, increasing its scale, global footprint, and the attractiveness of its customer offering in the process. Hulu, the content streaming service that started life as a 50:50 JV between NBCUniversal and Fox, has since added Disney and Time Warner to its ownership cast, accessing a wider and richer content menu. And Syncrude, the granddaddy of Canadian oil sands operations, has added more than 20 new owners over its 50-year life.
But adding new owners to a joint venture when it is not a simple transfer of interests from an existing owner to a third party introduces a series of questions related to ownership and governance rights.
The purpose of this note is to outline three of the five different ownership and governance models for adding such owners into JVs, and to discuss the rationale and key considerations in selecting each model.
MODELS OF OWNERSHIP AND GOVERNANCE RIGHTS
Based on our review of major joint venture transactions, we have identified five common models of ownership and governance rights when existing JVs add new owners (Exhibit 1). Each of the alternative models has its merits and pitfalls. Ultimately, the deal logic, acceptability to new and existing owners, regulatory and accounting constraints, and existing venture agreements will determine which model is more viable than others. The remainder of this note illustrates each model, and indicates typical situations when each should be considered.
Model 1: Standard ownership interests and rights, and dilution of existing owners
Under this model, new owners enter the JV on the same terms as existing owners (Exhibit 1a) . A new owner purchases an equity stake in the venture from one or more existing owners at a price linked to the venture’s valuation, receiving proportionate governance control through Board representation and decision-making rights. The selling owners are proportionately diluted. The addition is formalized through amendments to the venture’s formation agreements, inserting, for example, the financial and non-financial contributions of the new owners, and revised ownership stakes and voting thresholds. The addition appears either as transfer of equity from existing owners, or as a capital increase on the JV’s books.
Standard ownership interests and rights is the default model through which ventures add new owners. It is simplest to execute, and creates a perception of fairness (for example, by avoiding competing or cross-subsidized profit pools with different owner groups, which is a concern across many other models). Syncrude used this model in effecting the numerous modifications to its ownership base. Masdar and La Caisse entered the offshore wind farm venture London Array as part owners under this model, respectively diluting existing owners E.ON and DONG.
This model is particularly apt in situations when the ownership base is – and will remain – small and relatively homogenous, and the risk of governance inefficiencies or strategic misalignments is limited. In situations where this is not the case, the other four models should be considered.
Click to Enlarge
Model 2: Non-standard (i.e., non-preferred) ownership interests and rights, with dilution of existing owners
Under this model, new owners enter the JV as part of a junior ownership tier. This junior tier has lower commitments relative to the founding owners, and may, for example be required to make a smaller investment, or a smaller contribution to the venture. The junior tier correspondingly receives lower governance rights than the founding owners. The founding owners, could, for example, retain special reserved rights, disproportionate voting control, and other non-voting rights (like the right to senior JV management appointments and JV pricing policy amendments). JVs structured as LLCs and using this model create a separate class of shares, with one class receiving a profits interest, which entitles them to a dividend but not a vote on decisions. This model can also be executed without creating a separate ownership class by specifying the governance rights of the new owners relative to the existing owners in relevant legal documents (for example, the right to collectively appoint only one Board representative / collectively have 1 vote on the Board).
The non-standard ownership interests and rights model is used in ventures where the founding owners want to be able to continue controlling the venture’s strategic direction and key decisions, or where giving the new owner equivalent decision-making rights is likely to provoke regulatory and anti-competitive concerns. Such was the case in Hulu, the Internet streaming JV equally owned by Walt Disney, Comcast’s NBCUniversal, and Fox . Time Warner was willing to acquire an equal 25% stake in the venture. Instead, Time Warner settled for a 10% stake without a Board seat or a voice in the venture’s management, in part to avoid making the governance unwieldy, and in part to avoid any regulatory pushback from having 4 media giants coming together to influence the video streaming market. But Time Warner withheld certain content – like the current seasons of its shows – from Hulu’s on demand service, which receives rights to all current season programs from the other owners. Time Warner also seems to have been given a haircut on the purchase price – where the company was willing to pay as much as $2 BN for 25%, it paid $583 MN for its 10% stake.
We’ve also seen this model used in multi-owner ventures with a large owner base, where additions to the Board size would further clog governance systems already prone to sluggishness. The Clearing House, a shared utility in automated clearing, funds transfers, and check-image payments, with 20-plus owners, has a two-tiered ownership model. Its Class A owners – mostly large financial institutions – make a higher one-time capital contribution than its Class AA owners, mostly smaller banks. The Class A owners appoint one representative each to the venture’s Supervisory Board, and one representative each to a lower governance body, the Managing Board, that reports up to the Supervisory Board and works under direction from the Supervisory Board. Class AA members are not represented on the Supervisory Board, but collectively appoint 1 representative to the Managing Board.
Model 3: Phased ownership interests and rights
Under this model, new owners are allowed a token entry into the venture in the form of a small equity stake, or enhanced user rights without an immediate equity stake. In return, the new owner is expected to start transferring some volumes through the venture, initiate the process of meeting the venture’s IT and customer service standards, or make other minimal funding or capability commitments to the venture. The new owner is progressively inducted as a full owner if pre-established trigger conditions are met. The triggers could be linked to time, the JV’s phase of operations (for example, at FID), or contributions (i.e., after increasing its commitments to the same level as the other owners and for example, processing larger volumes through the venture, or achieving full compliance with the venture’s IT and customer service standards, or making larger funding and capability contributions). The venture gives the new owner some incentive to make the transition to full ownership – in the form of operational support, the requirement to pay part of the joining consideration in advance, or a voice on critical decisions during the token ownership phase.
Multi-owner shared utilities are typical users of this model. In these ventures, a phased entry allows existing owners to test the fit and commitment of the new owner before a full induction. It also allows the new owner a period to get comfortable with the workings of the venture, and to decide whether it truly wants to commit to the venture (versus consider other alternatives). Multi-owner utilities like Star Alliance, SkyTeam, SWIFT, and others using this model have well-defined procedures through which they phase the screening, selection, and induction of new owners. SWIFT, the financial messaging consortium for example, has a staged process under which prospective owners are first admitted as users, and then as shareholders. Prospective owners initiate the process of becoming a new owner by providing evidence of being compliant with SWIFT’s eligibility and admission criteria. SWIFT then coordinates a validation process, involving the analysis of the applicant’s corporate and financial documents, information from local regulators and public sources, and consultations with existing owners. If the validation is satisfactory, the applicant is admitted as a user. The applicant then proceeds to fulfill, or provide evidence that it has met, a set of documented shareholding criteria. If the Board approves the applicant’s admission as a shareholder, the applicant purchases one share (at a price determined by the Board that reflects the current valuation of SWIFT) and is admitted as an owner .
This model can also be used to incentivize future contributions from a new owner in situations where it might not be possible to lock-in the contribution upfront. Consider Sovello, a bilateral JV between Evergreen and Q-Cells to manufacture solar modules, which added REC as a third owner. Evergreen’s primary contribution was its low-cost wafer manufacturing technology, and Q-Cells, its solar cells. REC was a key supplier of granular form factor silicon, a critical feedstock that complemented Evergreen’s wafer manufacturing technology. Accordingly, the JV entered into a long-term agreement with REC to source solar-grade silicon, and receive an initial 15% ownership stake on a cost-of-capital basis. REC also received the option to increase its stake to 33.33% if it offered the JV a second long-term supply agreement. The venture’s contractual agreements were modified to pre-empt governance concerns if REC did increase its stake to 33.33%. For example, allowing for the joint nomination of a seventh Director, if all three owners ended-up with equal stakes and the right to nominate two Directors each .
This article is an excerpt of a full article only available to our members through the Joint Venture Advisory Group. An explanation of Model 4 and Model 5 are available in the full version of this article. Please contact us for more information.