Joint ventures can help automotive companies expand their businesses. Sometimes forming a JV is the only way for a company to enter a foreign market. Although JVs can take multiple shapes, they generally involve pooling resources to accomplish a specific task. As an alternative to a more permanent arrangement, such as a merger or an acquisition, a JV allows each party to retain its independent identity, sometimes allowing for an easier exit. Many JVs end poorly within five years. Proactively addressing the key causes of failure and anticipating solutions or an exit plan can help.
As the old adage goes, if you fail to plan, you plan to fail. Many JV pitfalls can be avoided through diligence before the JV ever gets off the ground. First, you want to have a thorough understanding of your motivation for forming the JV. What is your ultimate goal, and how will the JV help you further that goal? Next, you need to make sure that your JV partner shares that same vision and is the proper “fit”—having the wrong partner can ruin a good plan. Together you can then determine what structure will best accomplish the JV’s goals. You should consider who is bringing what to the party—who brings the customers? The capital? The credit support? Intellectual property? The personnel? Expertise? You should also consider the tax implications of setting up, operating, and exiting the JV, and how and when the JV will pay distributions to its owners. There are pros and cons of using an LLC or a corporation, and you should consider which jurisdiction’s (domestic or foreign) laws and courts are most favorable. Alternatively, you may prefer to avoid creating a new entity, and instead opt to create a license agreement or some other contractual arrangement.
You will want to determine how the JV will be managed. Will each party have 50 percent voting rights? If so, how will you move forward in the case of a deadlock? Further, how will talent for the JV be recruited and retained? Will you use “phantom stock” or other incentives to align managements’ goals with the JV owners’ objectives? How will budgets be prepared and approved, and what metrics will be tracked and reported and how often? Is the industry cyclical? Have you run a stress test and cash flow projections to ensure sufficiency of working capital? What levers will be pulled, by who, and when, if things get tight operationally?
Exit strategies need formulation on the front end. Factors include whether a party that contributes unique property, such as a trademark, gets that property back, along with any enhancements, when they leave the JV. If you brought clients to the JV, will you get them back when the JV ends? Will there be a noncompete or nonsolicitation clause? Who will have the right to trigger a JV dissolution? On what conditions? Do you want to have the option to force your partner out of the JV? If you leave voluntarily, or if you are forced out, how much must your JV partner pay you? Over what period of time? If any JV debt has been guaranteed, how will the guarantor be indemnified/protected?
Each JV is different, but by addressing these key issues before the JV is up and running, you will increase your chances of success. Alternatively, exploring these issues may reveal that you and your JV partner are on different pages, and should not join forces. You will have avoided making a poor partnership, reserving your resources for the next, better-suited opportunity.
This article was co-written by Janelle Haggadone while Janelle was a summer associate at Varnum in 2016.