Running for the Exits: Getting Joint Venture Exit Right

  

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GettyImages-748567765_squareJOINT VENTURE (JV) EXIT is a key issue for dealmakers and corporate executives whose portfolios contain material JVs spanning the globe.

One way or another, companies eventually exit their JV investments – sometimes sooner than expected. Recent analysis of JV lifespan data shows that newer vintages of JVs are undergoing exits more quickly than in the past. For example, JVs formed from 1985 to 1989 tended to last about 15 years, while those formed from 2005 to 2009 lasted only 6 years (Exhibit 1). This contributes to a high volume of exits.


Exhibit 1: Joint Venture Lifespans and Recent Exits

Joint Venture Lifespans and Recent Exits_blue_png

Source: Water Street Partners JV Database; N=172 Large JVs that Terminated

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An exit, transfer, or termination event can involve significant value (Exhibit 2): Verizon paid $130 billion to buy Vodafone out of the Verizon Wireless JV; Rosneft paid $55 billion to take over TNK-BP; and GSK paid $13 billion to buy out Novartis’ 36.5% stake in the Consumer Healthcare JV. Exit deal terms are also tricky to define, let alone negotiate. There’s a huge variety of constructs to choose from, and a lot of mental chess that goes into it. Even the slightest misstep in deal structuring can “box in” executives that inherited the JV when they seek to exit down the road.

Yet exit terms are often the last topic of discussion for dealmakers when structuring new deals. And little attention has been paid to codifying the art and science of these terms – or how to implement the exit process, on the back end. This is a mistake, because JV exits can have big winners and losers. And they can be messy, sometimes with adverse press coverage.

Exhibit 2: Material Joint Venture Exits

Material Joint Venture Exits

Source: Water Street Partners JV Database
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The balance of this article addresses two issues:

What patterns are seen in JV contracts, and how should dealmakers shape JV terms relating to exit, transfer, and termination?

How should JV Board Directors or shareholder / parent executives approach exit, when they are already in a JV and the deal terms are cast?

SETTING UP NEW DEALS – ADVICE FOR DEALMAKERS

To craft JV exit terms, dealmakers must consider exit triggers (i.e., conditions under which one party can initiate an exit decision), disposition approaches (such as selling to a partner or taking the JV public), rights/restrictions on transfer (such as a “call option” or “buy-sell” agreement, etc.), and lastly, valuation mechanics.1

Based on an analysis of over 70 JV contracts, and prior experience with hundreds of JVs, we offer five best-practices for JV dealmakers contemplating exit provisions:

1. Include a robust list of exit triggers – more than the “basic four”. Our analysis indicates that there is a huge dispersion in the number of exit triggers, with 25% of JVs having four or fewer triggers (Exhibit 3).

We believe that all JVs should have four basic exit triggers: a) partner default/bankruptcy; b) uncured breach of contract (including failure to provide assets or resources that were committed to the JV); c) partner change of control to a competitor; and d) insolvency of the JV.

The vast majority of JVs should have more than these basic four exit triggers. Specifics will differ according to the deal context, but triggers to consider include (Exhibit 4):

  • At-will partner sale with a linked put/call option, potentially after a certain period of years. In some situations, it is useful to include an “at will” trigger to buy or sell the JV. Examples include when a partner has the intention to acquire the JV at a future date, to use the JV as a stepping stone to full sale of their part of the JV business, or to use the JV as a temporary vehicle to learn certain capabilities. Asking for a put or call may prompt your partner to do the same – and thereby increase the odds of the JV winding up at an inopportune time – so think carefully. Often JV partners do not want their counterparty to have at-will-related put or call because of the need to record this as contingent liability.
  • A “sunset clause” (aka, JV term period trigger) requiring renewal of the JV agreement after a certain period of years, e.g. 10,20, or 50 years. This can help facilitate beneficial restructuring of the JV, or exit, on a periodic basis.
  • Sustained underperformance of the JV. This is a good trigger to have when the JV is the exclusive vehicle for the parent companies to compete in a specific product market, otherwise parents can get locked into an underperforming JV while competitors take share in important markets.
  • Deadlock. More on this below.
  • Dilution of a partner below a certain threshold of ownership, e.g. 10-20%. When partner ownership levels get below 10%, the drag associated with JV governance often presents a major tax on JV performance, compared with the access to capital or other resources being provided by a small shareholder.
2. Tailor the approach depending on whether your company is the natural buyer or seller. This includes carefully selecting the triggers, disposition approaches, rights, and valuation mechanics.

In most JVs, there is a “natural buyer” and a “natural seller”. Few JVs are true partnerships of equals – or, if they start that way, a natural buyer/seller emerges over time. This happens because one of the partners has deeper pockets, stronger capabilities, or is winning the “race to learn” in the venture, and as a result becomes a more natural owner of the venture as time goes on. Similarly, it’s usually true that the moment of greatest negotiation power for one of the partners is the day they sign the JV agreement.

This dynamic has a huge implication for setting up exit provisions. In joint ventures where one of the partners isn’t able to operate the JV independently, a boilerplate buy-sell agreement in which one partner writes down a price at which the other can buy or sell, tremendously disadvantages the weaker partner. The buyer can offer an artificially low price, confident that the partner will have little choice other than to accept. Also, every company who thinks they might be a natural seller should adopt the approach of having an external valuation to determine the selling price, rather than relying on negotiation.

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1 Other related provisions may include post-exit obligations and liabilities (e.g., non-compete; transferability of assets/IP; post-exit services), voting matters, dispute, and deadlock procedures.