IMAGINE YOU HAVE been tasked with negotiating a joint venture agreement. Months of grueling negotiations have consumed significant resources and have led to agreement between your company and the counterparty on all but a couple of items. These items will require significant work to resolve and are critical to the JV’s financing and operations. But year-end is approaching, your target for signing up the JV, and the fatigued deal teams could use a win. The counterparty wants to sign a JV agreement with the terms agreed to date and decide on the open issues in ancillary agreements later.
What do you do?
Should you sign the agreement based on agreed on terms and defer the remaining issues, perhaps finding resolution between signing and close or even to after closing? Or should you hold out and not sign any agreement until all issues are resolved?
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COMPANIES ROUTINELY FIND themselves in painful joint venture negotiations, reaching “walk-away points” and failing to close deals because of hard-to-value contributions, differences in key assumptions, or valuations that do not support the desired ownership or control split. Relief lies in a paradox: While JVs often introduce more complex valuation challenges than other transactions, the flexibility inherent in JVs simultaneously offers dealmakers a range of techniques “to take valuation issues off the table” or otherwise help the counterparties get to yes.
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EARLY RESULTS OF OUR recent study on how companies perform across different aspects of the JV dealmaking process has revealed fairly pedestrian performance all around, with critical gaps across key functions within core JV transaction workstreams. With respect to financial modeling, for example, we find that companies struggle to create a dynamic model of what we call “Total Venture Economics.” And since a complete picture of Total Venture Economics is needed to dynamically and deeply inform negotiations regarding partner contributions, JV valuation, service pricing, and other economically driven deal terms, it is no surprise that the dealmakers we surveyed also reported dissatisfaction with their ability to structure those terms – especially those related to partner contributions to the JV (Exhibit 1).
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BECAUSE MANY JVs are closely related to – or even directly connected with – parent company businesses, opportunities often emerge for the JV to create value by working with the parents in new and uneven ways. This might mean developing new products, functionality, or technologies favored by one parent. It might mean allowing the JV to enter markets where one parent company already has a competitive presence. It might mean having the JV consolidate certain functions or
assets with one parent company in order to reduce costs or avoid future capital investments (Exhibit 1).
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.”
PSST. WANNA KNOW a seemingly innocuous joint venture deal term that packs a mighty punch? Consider this clause:
Unless otherwise and expressly agreed in a provision of this Agreement, or as otherwise required by applicable law, all decisions and actions shall require Majority Approval of the Shareholders.
Sounds harmless enough – especially when tucked at the end of the voting section of a joint venture agreement, following a list of several dozen matters explicitly labelled as unanimous, supermajority, or simple majority decisions. But that simple provision – in effect, a “default setting” for shareholder voting rights – can carry profound implications, both positive and negative, both today and in the future.Read More
