International Joint Ventures: How to Avoid the Pitfalls and Reap the Rewards
Having established a strong and vibrant brand in your home market, you’ve been exploring the possibility of international expansion. Although you lack the resources to enter a promising foreign market on your own, an opportunity to do a joint venture (JV) with a strong local company entices you to explore further. The local company is enthusiastic about your business model and brands, and your initial meetings are both positive and cordial. The potential joint venture appears to be a match made in heaven.
The attractions of an international joint venture are obvious:
- Ability to establish operations much more quickly than going greenfield
- Reduced financial risk because the local partner shares the setup costs
- Comfort from working with a strong local company adept at navigating the local marketplace
Given these advantages, why do so many international JVs end in fractious breakups? Extensive research shows that common pitfalls include lack of alignment on business plans, failure to commit adequate resources, and seemingly insurmountable cultural differences. However, perhaps the greatest pitfall of all is failing to appreciate that a joint venture is by its very nature a relationship and like any relationship it will change over time. Nearly every JV will at some point experience friction or outright conflict between the partners. Such problems arise for all sorts of reasons, but the most common source is one partner questioning the value the other partner brings to the table or both partners blaming each other for a failed project.
So given the above considerations and understanding that issues are going to arise, how can you give your JV the greatest likelihood of success?
The solution lies in meticulously thinking through all the potential issues before the JV commences business.. The first and most important step is to ensure that there is a viable business plan in place and that both parties are prepared to commit the physical and financial resources necessary to make the JV a success. The next step is to draft a Joint Venture Agreement (JVA) that will govern the relationship between the two partners. Each JV is unique, but below are some useful guidelines to follow in drafting a JVA:
- Pay scrupulous attention when drafting the JVA instead of delegating the task to a legal firm that lacks inside knowledge of what it takes to run your business. You need to have senior business ownership of this document, and it must include all the provisions that have been verbally agreed upon with the local partner. All too often, items that were verbally resolved suddenly become major issues when the partner sees them written down and is required to formally sign off on them.
- Understand that even with the best of intentions, verbal agreements count for very little. Over time the people who negotiated the original agreement will move on and the new team may be unaware of prior verbal agreements or may believe the context for these agreements no longer exists. Unless something has been specifically documented in the JVA, it will be next to impossible to enforce.
- Be careful to protect your intellectual property by avoiding conflicts with the local partner’s brands. The best way to handle potential conflicts of interest is to prevent them from happening in the first place. For example, if you are bringing the technology and brand to produce “Product A,” then the local partner simply can’t be allowed to produce any product that will compete with it. I use the word compete in the broadest possible sense, because you need to avoid a situation where you bifurcate the market and your brand is viewed as an expensive Western brand while the local partner’s brand caters to the lower end of the market. Although this type of bifurcation may seem viable in principle, it will invariably lead to major conflicts.
- Ensure that your JVA includes the following provisions:
- Dispute resolution and escalation provisions to handle various levels of conflict. Conflicts are certain to occur, so you will need a mechanism to resolve them. Ideally there should be some form of escalation provision where smaller issues are resolved at the local level and more serious issues work their way to the top of both organizations.
- Future funding and dilution provisions in the event that one partner fails to contribute. You want to incentivize people to contribute the necessary funds, but you also want to avoid being forced to fund projects that you don’t support, simply to avoid facing draconian dilution provisions.
- Depending on the shareholding structure, you will need to have effective veto rights over key decisions such as changing the nature of the business, selling key assets, or incurring capex above a certain dollar threshold. You don’t want to find out at a board meeting that a major change in direction is underway and you are powerless to prevent it.
- Termination provisions that clearly set forth the circumstances and procedures by which the JV may be terminated. At a minimum, these provisions must state how the business will be valued, who has a Put or Call option, and what will happen to the brands and intellectual property upon termination.
- If the JV is operating in a country with a questionably legal system then have disputes settled offshore or via arbitration in an internationally recognized location such as Hong Kong, Singapore or London.
- Make sure there is a senior presence in the JV operation who is unquestionably aligned with your company (e.g., CFO or Head of Operations). The best way to keep track of what is happening on the ground is to have your own person there.
- Attend all board meetings and appoint suitably qualified people to the JV’s board of directors. Board members must be senior enough to engage in meaningful discussions instead of merely rubber stamping proposals.
- Push for explanation of business performance issues and refuse to be fobbed off by a disgruntled local partner. Having your own contact in the JV will greatly facilitate your understanding of what items need to be discussed at the formal JV board meetings.
- Ensure your JVA contains provisions for payment of dividends and that excess cash is actually paid out via an annual dividend.
- Beware of unusual items that are described as “local business practices.” Such arrangements have the potential to run afoul of various Foreign Corrupt Practices Acts, placing the parent company in peril.
The preceding guidelines include some of the key items to consider when embarking on an international joint venture. For additional information, consult the excellent JVA checklist on the American Bar Association website http://apps.americanbar.org/buslaw/newsletter/0049/materials/book.pdf. Although the ABA list is so comprehensive that some of its terms will not apply to your JV, it can serve as a good reference point to ensure you are not overlooking something important.
If you would like more information on structuring successful joint ventures, please contact Donal by clicking here or call +662-6511-164