Joint Venture – Key Concepts

Financial Modeling and Analysis

A Joint Venture is the most common method for companies to enter into new markets. Two or more businesses come together and combine their commercial resources. Most businesses across the world are using this strategy to combine their diverse expertise and resources, minimize business costs, and share the risks involved. This partnership is a driving force of the modern business strategy. Many businesses use this strategy to expand beyond their core business. The article elaborates below an overview of joint ventures, their significance in the business world, different types of ventures, their advantages, and the challenges/risks involved in them.

 

joint venture

Source: Pinterest

 

Definition

  • A Joint Venture is a partnership of two or more businesses where they combine their resources to complete a particular task. This task can be either a business activity or a project. Each player of the JV is responsible for the costs, profit, and loss associated with the venture. However, the venture is seen as an entity of its own and is a separate form from the interest of the parties involved. 
  • The main purpose of joint ventures is to combine with local businesses to enter into the new market. These ventures can be made up of any form of legal structure. It can employ any structure like partnerships, limited liability companies (LLC), corporations, or any other type of business entity. 
  • Ventures of this type will make agreements among the members to cover the business’s operational activities like the board of directors, management structures, capital and equity management, legality, and financial rights. They even decide upon the market rights of each partner in different regions of the business structure and resolution of disputes. 
  • One of the main advantages incurred by the formation of combined ventures is the share of expertise, resources, and investment returns and even the risk factors and loss in the business. Companies can expand their business beyond their main operational activities, explore new markets, and expand their portfolio/brand.
  • Established companies can make use of these partnerships to enhance their market presence, credibility, and trust in the newly formed venture. It will also help in attracting investors, customers, and other stakeholders into the venture.

 

Types Of Joint Ventures

  • Function-Based Ventures
  • As the name indicates, the businesses join together as a venture to perform a particular function. These business-related functions can be like sales, distribution, or marketing. This combination of businesses will empower the utilization of each other’s resources, networks, and expertise in particular business areas. This will in turn result in the improvement of efficiency and market penetration.
  • These ventures might be ongoing as per the continuous business functions. The individual companies can also choose to create a separate business legal entity and can operate with a formal agreement based on their objectives and requirements.
  • An example of a function-based venture is the North American Coffee Partnership (NACP), which was formed by the combination of multinational companies PepsiCo and Starbucks. It has resulted in their improved brand awareness, profits, and market reach. 

 

  • Project-Based Ventures
  • This type of JV is formed for performing a specific business project. It is time-bound and will have an agreement between the companies to finish the project in a specific amount of time. Like other venture types, they also pool their expertise, abilities, and resources to reach the project objectives and goals. It will help them finish the project or reach the goal much faster and more efficiently than they will be able to finish if done independently.
  • After the completion of the specific project, this venture can be terminated and each company can get back to their businesses. If the project is completed successfully, then there will be a scope for future collaborations for some other projects. 
  • While partnering they will form a contractual agreement, legal entity, or informal collaboration between them.
  • The partnership of British Petroleum (BP) and Reliance Industries was made for the specific purpose of developing offshore gas and oil reserves in India. They combined the Reliance industry’s market expertise and BP’s technical/operational expertise to achieve their specific goal. 

 

  • Vertical Venture
  • This venture is established mainly between the suppliers and buyers. Some companies form a strategic collaboration during the various stages of their supply chain. This collaboration can be between distributors, retailers, or manufacturers. It will enhance the economic scalability, optimize the supply chain, better control over the production/distribution process, increase efficiency, and reduce the inhibited costs for both of them.
  • It required proper coordination between the companies to identify their flaws and improve operations and information flows. This venture will also improve the quality of products by ensuring that they meet the regulatory standards, specifications, and customer requirements. If a company can work along with the supply chain companies, then they can enhance their delivery timings and inventory levels.
  • A venture named Raizen was formed by the companies Royal Dutch Shell and Cosan to focus on competitive and sustainable fuels. Raizen has become a well-established bioenergy producer in Brazil. 
  • Another vertical joint venture is the combination of Honda and LG Energy Solutions, which was formed to established to build a battery plant in Ohio. Their work is that the plant will use the LG Energy Solution’s battery modules to create batteries for Honda’s electric vehicles.

 

  • Horizontal Venture
  • Horizontal ventures are formed between companies working in the same line of business that are often each other’s competitors. The purpose of combining is to pool the resources and gain competitive advantages. They will also work together to achieve a shared objective, create innovative products, or expand into new markets.
  • This type of venture will also manage the mitigation of risks related to competition, industry-specific challenges, and market fluctuations/downturns.
  • A famous horizontal venture is Hulu, which is a combined venture by several media companies like News Corporation, Providence Equity Partners, NBC Universal, and The Walt Disney Company. By pooling their resources like media libraries, they were able to develop a streaming platform for online video content. This venture gave them advantages for monetizing their content libraries, sharing costs and risks, better positioning in the market, adapting to the new media landscape, cross-promotion of their brands, and opportunities for future growth. 

 

You may also like to read about:

 

The Advantages Of A Joint Venture

There are significant advantages to forming a JV. Some of the major advantages are explained below:

  • Resource Pooling

These types of ventures enjoy the advantage of pooling their resources to achieve a combined goal. For example, one company might have advanced and better distribution channels, while the other may have the best manufacturing process and technology in hand. Both of these companies can combine their valued resources and achieve a specialized objective very easily. 

  • Cost Reduction

Each company in the combined venture will share its initial capital investment in the particular project. They can also share the expenses and reduce the operational costs. This is most useful for those companies who share the advanced technologies that may be costly to own and implement independently. The reduction of cost can be enhanced if they share costs for advertising, labor costs, and business supply. 

  • Combining Expertise

Each company and its professionals will have different levels of expertise, skill sets, backgrounds, and knowledge. Both companies can take advantage of each other’s expertise and benefit from each other to move towards the specific venture objective.

  • Entering into New Markets

Another main benefit of combining businesses to form a venture is the easy penetration into the new market/industry. Companies can expand their product/service portfolio and increase their market share. Companies can partner with local businesses to enter a new market area and expand their presence over there.

In this scenario, all the legal regulations and channels will be taken care of by the existing local company. For example, a company that wants to enter into a new market is sharing a venture with a local business, can benefit from the already existing distribution and logistics channels of the local company and thereby supply their products in the new market.

  • Reduced Risks

Since there will be a mutual agreement between the joined companies to share the business-related losses, their financial loss or financial risks will be minimized. Each other’s expertise in the new market, knowledge, and connection networks in the industry will also help to mitigate the potential risks in the venture.

  • Credibility Enhancement

This venture is very beneficial for small companies that find it difficult and take a long time to create enhanced credibility among potential investors, customers, and other stakeholders. By combining into a partnership with well-established, well-known branded, larger, and reputed companies, they will also enjoy the credibility and integrity associated with them. It will also help them to enhance their market visibility more effectively and quickly.

 

Risks And Challenges Included In JV

    • Even though they enjoy lots of benefits and advantages, there are several risks and challenges associated with the formation of a joint venture. The formation itself is very complex since a lot of time and effort needs to be put in. 
  • Cultural Mismatches – Different companies follow different cultures and diversified management practices. Combining these differences may pose a problem. This can also lead to misunderstandings, conflicts, miscommunications, poor cooperation, and integration which will affect the venture’s objective and its success rate. Some advanced solutions to mitigate this potential challenge are encouraging cultural training, open communications, mediators (cultural advisors), or even forming a venture by combining businesses from the same culture.
  • Different Objectives – Companies entering into these types of ventures may have different objectives and goals to achieve. Also, pursuing different objectives will threaten the success of the venture. It is very important to work together towards a common goal to reach success. To face this challenge, the venture together can prepare an arrangement where the objectives are clearly defined and communicated to all the participants involved.
  • Imbalanced Contributions – The expertise, assets, resources, and investments put by the companies involved in the venture may differ. These differences might lead to future disputes and inequality tensions among them and will in turn affect the success ratio of the venture. Some of the better-off solutions to mitigate this challenge are creating a transparent agreement, mutual agreement on fair compensation, and performing regular audits of the functioning of the venture.
  • Issues on Exit Strategies – Disagreements on the exit strategies are common risks in these types of ventures. It may cause severe disputes and legal matters between the companies, particularly when the venture is unsuccessful. Some solutions are the preparation and agreement of a predefined exit strategy, implementation of valuation methods (for assets and revenue), continuous performance monitoring, and revisiting of the exit strategy.

 

 

FAQs-

1. How Can You Differentiate Join Ventures And Partnerships?

  • A joint venture is a type of partnership in simple words. It is a well-structured establishment to pool resources, share profits, and risks involved. Its main formation purpose is to operate on a specific project or task temporarily which will be limited till the project’s completion. The risk incurred is equally shared. Every business aspect like profits and decision-making charges. 
  • A partnership is an arrangement with mutual agreements like the chosen relationship between supplier and customer. Partnership is formed for the long-term operation of business activities and it is ongoing indefinitely. The distribution of business risk/loss will be based on the agreement only. 

 

2. Do The Joint Ventures Require An Exit Strategy?

  • Normally this type of venture is established to achieve specific goals or projects and it will end with the completion of that particular project. An exit strategy is created in most of these ventures to easily dissolve them, and avoid future legal disputes, extended discussions, unfair business practices, control of possible financial losses, and negative impact on the customers of either business. 
  • Three forms of exit strategies are commonly implemented by the ventures – employee ownership, sale of the newly formed business, or a derivative continuity of the operations. The businesses can choose the right exit strategy option and end their partnerships in a friendly and fair manner. 

 

3. How To Set up A Venture Jointly?

  • Whatever the structure or type of venture you are planning to build, the major step to consider is the agreement to set apart the obligations, rights, financial returns, contributions, and responsibilities of each party in the venture. The objectives, investments, daily business operations, right-to-profit returns, responsibility for potential business loss, etc. must be drafted and agreed upon by both parties to avoid any potential risks ahead.
  • The steps to be followed for forming a JV by two or more companies are as follows:
  1. Define the objectives of the venture
  2. Select the right partner for the venture
  3. Draft an agreement jointly
  4. Decide the legal structure according to laws and regulations
  5. Analyze and agree upon resource allocation
  6. Establish a management structure and set roles and responsibilities
  7. Plan to integrate business operations, culture, communication channels, and systems
  8. Schedule for regular performance reviews and key performance indicators (KPI) for the valuation of the venture
  9. Must have a mutually agreed exit strategy on the agreement paperwork
  10. Ensure compliance with legal and regulatory requirements
  11. Prepare a regular communication plan between the partners
  12. Officially launch the venture, start operations, and implement continuous monitoring of its performance

 

4. Who Controls A Joint Venture?

  • Typically these types of venture control are shared between the joining companies. A governance structure will be established in the agreement of the venture and duly agreed by both of them. It includes a management committee or board of directors with representatives from each company of the venture. This is where the decision-making controls lie according to the agreement laid during the formation of the venture.
  • Most prominent strategic decisions are taken by the mutual consent of both companies. Daily business operations may be overseen by the mutually agreed partner or the person appointed by the board or management team. Control is required on business mechanisms and resolution of business problems/conflicts to ensure mutual governance and smooth functioning of the venture. It is also crucial to have effective control and proper distribution of powers among the companies to ensure the success of the venture.

 

5. What Are The Key Components Of A JV?

  • JV Agreement – This is the major component of the venture formation. All the operations of the venture will be dependent on this agreement. It will include the venture scope and objectives, contributions of each company, profit and loss sharing mechanisms, exit strategy of the venture, control of the venture, and duration of the venture.
  • Resources – Allocating resources proportionally to the venture is essential for its success. Both companies can contribute resources like capital investment, personnel expertise, technology, industry knowledge, business networks, or intellectual property.
  • Management – A JV will have a well-structured management team to oversee the venture’s daily operations and functions. Usually, this management team will have representatives from each company included in the venture.
  • Profit / Loss Sharing – The return on investments, generated revenue from the venture, and losses incurred from the venture, all these are shared among the companies within the venture itself. This is usually done according to the mutually agreed terms during the formation of the venture.

Conclusion

The process of combining two or more businesses to form a joint venture is a powerful strategic tool for the types of businesses that are looking forward to expanding their activities into new horizons. They can also combine their business resources and even share the risks inhibited in the venture. The key point is to have a clear understanding, planning, agreements, and efficient management strategies to attain success with this venture. With an appropriate understanding of the key aspects and benefits of these ventures, businesses can formulate diverse strategies to achieve their business goals and objectives and maintain sustainable growth. 

 

One response

Leave a Reply

Your email address will not be published. Required fields are marked *

Contact Us!