A joint venture is important whenever there is a need for expansion, extension and enlargement of companies.
In this article, you will learn what a joint venture is, the types of it, what the requirements are for setting up a joint venture, and what the advantages and disadvantages of merging companies are.
Joint Venture meaning
In commercial law, a joint venture refers to a merger of two or more companies. The legally and economically independent companies cooperate to achieve a common goal.
Management tasks, as well as responsibility and economic risk, are shared, whereby the participating companies continue to be independent and shareholders of the joint venture.
Joint venture plays an important role in:
- Expansion of companies nationally and internationally;
- Balancing financial risks;
- Market position;
- Competitiveness;
- Expansion of resources.
A joint venture can have an impact on different areas of the combined companies. The main issue is the distribution of risks and dangers between two or more companies. At the same time, competencies and strengths can be combined and new or more power potential can be developed.
Joint venture can have an impact on:
- Use of local market knowledge;
- Use and expansion of competencies and resources;
- Competitiveness;
- Intensification and expansion of know-how;
- Sharing of entrepreneurial risks and dangers;
- Combining strengths;
- Reducing financial losses;
- Maintaining or strengthening market position;
- Expansion efforts;
- Overcoming global challenges;
- Investing in research and development.
Types of the joint venture
There are various types of joint ventures, whereby differentiation is possible based on several criteria. Typical differentiation criteria are the form of cooperation, the industry orientation and the spatial dimension.
Joint ventures according to form of cooperation
A joint venture can take these forms of cooperation:
- Equity Joint Venture;
- Contractual joint venture.
Equity Joint Venture
An equity joint venture involves the capital participation of several companies and the assumption of risk for a joint venture. An equity joint venture is the classic form of a joint venture in which at least two companies set up a joint enterprise that has its legal form.
Contractual Joint Venture
A contractual joint venture describes a purely contractual relationship. This means that the contractual joint venture is a mere merger of companies on a contractual basis so that no legally independent company is founded.
Joint ventures depending on the industry
When distinguishing joint ventures by industry, there are these four different variants:
- Horizontal joint ventures;
- Vertical joint ventures;
- Concentric joint ventures;
- Conglomerate joint venture.
Horizontal joint venture
The horizontal joint venture consists of at least two companies in the same industry, for example, two car manufacturers, two medical equipment manufacturers or two confectionery manufacturers.
Vertical joint venture
In a vertical joint venture, the companies are involved in the different stages of the value chain of a product, for example, a rubber producer and a car tyre manufacturer or a cocoa producer and a chocolate manufacturer.
Concentric joint venture
The concentric joint venture consists of companies in similar or related industries, for example, a car producer and a motorbike manufacturer.
Conglomerate joint venture
In a conglomerate joint venture, companies from other industries cooperate, for example, a car manufacturer and a manufacturer of child seats or a motorbike manufacturer and a manufacturer of motorbike helmets or motorbike clothing.
Joint ventures according to the spatial dimension
When distinguishing joint ventures according to the spatial dimension, there are two different variants:
- Domestic Joint venture;
- International Joint Venture.
Domestic Joint Venture
In a domestic joint venture, at least two companies based in the same country form a joint venture.
International Joint Venture
In an International Joint Venture, at least two companies that originate from different countries join forces.
It is possible to share only certain areas of a company, for example, production. Joint ventures can also be differentiated according to the number of cooperation partners, the area of cooperation and the choice of location. In addition, there can be differences in terms of capital participation and the duration of a joint venture.
Joint venture ventajas y desventajas
Mergers within the framework of a joint venture offer some advantages to the companies involved. Conversely, the companies also have to accept disadvantages.
Advantage
1. It provides a place where multiple levels of expertise can be shared
A joint venture allows several companies to pool their strengths without regard to possible weaknesses. It is an opportunity for each company to gain new insight into a market or specific areas of expertise. This makes it easier to understand future demographics, markets and competitors.
At the same time, you have the opportunity to generate profits from an opportunity that you would not be able to realise on your own.
2. It gives you access to better resources
When you pursue a lucrative opportunity on your own, you are tied to the resources available to you through in-house or third-party acquisition. When you enter into a joint venture, you can access skilled personnel, needed equipment and other shared resources that you may not currently have.
When these elements combine with the capital you bring to the joint venture, everyone can use the pooled resources to move the project forward.
3. It does not have to be a long-term solution
Many joint ventures are set up with the idea that it is a temporary arrangement. They join forces with other companies or individuals to achieve a specific outcome. This outcome may even be written into the joint venture agreement, creating a natural termination point for the relationship.
Some joint ventures can even become successful businesses in their own right, which you can spin-off with your partners into something completely new.
4. It reduces the risk you are exposed to
When you start a new venture, there are always certain risks associated with what you do. Consumers may not recognise or accept your new product or service. Your branding may not match your demographic targets. You may even run the risk of destroying the positive reputation your business has built up over time.
When you set up a joint venture, you spread the risks across everyone. If something happens and the project fails, you only bear part of the risk instead of all of it.
5. It reduces the required cost commitment
A joint venture does not only spread the risks. It also spreads the costs. Say you have an idea that will cost €10 million. If you were alone, you would bear the entire cost. If you have three other partners who are willing to form a joint venture with you, your total cost commitment is 25% or €2.5 million.
Although this means that your profit cut would probably also be 25%, this structure makes it easier to pursue ideas that would normally be too risky to explore because of the costs involved.
6. It creates opportunities for flexibility
A joint venture can operate as an independent business entity. It may operate as an informal partnership separate from other ventures. It may be a short-term or long-term commitment. It may cover most of what it already does or only a small part.
You can make a joint venture as flexible as you like. You also always know what your share of the joint venture is and can sell it as an asset if you need to.
7. It offers several exit strategies
One of the most common exit strategies for a joint venture is to sell the share you control in it. About 4 out of 5 exit strategies involve a sale from one partner to another. You can also sell your share to another outside investor who wants to get involved. You can have a termination point written into the contract, setting a deadline that applies to everyone.
This can ensure that long-term agreements do not happen unless you want them to happen.
8. It increases your network
Being involved in a joint venture gives you access to new markets, demographics and customers that you might not otherwise have reached. When you build relationships with your partners, your branding benefits from the positive value they have with their customer base.
This process makes it much easier to enter new markets if your business has something to offer, along with the natural opportunities that a joint venture provides in the first place.
9. It permits you to control the possibility of the partnership
In a joint venture, you get out as much as you put in. Although there are cases where some partners do not participate in the partnership as agreed, a joint venture is formed because several parties are striving for joint success.
You can create momentum that will take you across the finish line. You can even create more joint ventures because you build a reputation of success with the current one.
Disadvantages
1. It requires an agreement with clear objectives
One of the main reasons for the failure of a joint venture is the lack of clear objectives. The agreement outlining the rights and responsibilities of each party must be outlined with specifics.
If vague terms, responsibilities or outcomes are included, one partner could exploit them at the expense of all the others. You need to emphasise clear, honest and open communication from the outset to maximise the potential benefits of this partnership.
2. It is not always a flexible relationship
Your joint venture arrangement may require your company to be more involved in the day-to-day operations of the partnership than your company currently does daily agreeing. If you want to give the company more resources than your current client, the individual companies involved in the joint venture may fail.
If those companies fail, the joint venture almost always fails as well. Therefore, a balance must be struck and the individual business must always come first.
3. It is difficult to design an agreement with full equality
The strengths of each company within a joint venture often lead to unequal equity within the arrangement. One company may have manufacturing processes that can be used to develop a product. The second company might be responsible for the distribution network of the product so that it can reach target markets.
The third company might specialise in marketing. Which companies take the greatest risk? Those companies most involved in production and promotion tend to be exposed to the most risk in a joint venture.
4. It may expose an internal professional imbalance.
When you enter into a joint venture, the agreement may require your company to provide a certain level of expertise in certain areas. If a joint venture does one thing well, it is to expose the weaknesses of individual companies.
If there is not enough expertise, availability of assets or investment opportunities in all the participating companies, there will be an imbalance in the partnership. If the imbalance is too strong, the joint venture may never get past the planning stage.
5. It can lead to a clash of cultures
Every company has its own internal culture. When you combine the resources of several entities, you have to consider several internal cultures. Some of these cultures may clash with each other. One company might encourage casual dress, allow pets at work and have unstructured working hours.
Another may require a 9-5 schedule, formal business attire and no flexibility in how employees approach their work. Before setting up a joint venture, it is important to compare cultures to see if points of conflict can be resolved before they become problematic.
6. It may limit your future external activities while you are involved
Many joint ventures require participants to be involved in other new external activities while working on the project. If you are thinking about several different elements in your idea pipeline, taking the first joint venture proposal may not be the best way to go.
At the very least, try to remove this joint provision from the agreement. If your partners do not agree, it may be better to wait or look for other opportunities.
7. It can be difficult to leave some joint ventures
You may find in the early stages of a joint venture that the partnership you have agreed is not as beneficial as you thought it would be. Your partners may not have enough leadership. Their skills may have been overvalued in the agreement. They may refuse to provide their share of the resources.
Even though this agreement is usually for a fixed term, it may be difficult to exit early, even if you are willing to sell your share at a reduced price.
8. To be successful, you need partnership trust
You can only put so much trust into the contract or agreement that governs a joint venture. Your partners may decide to abandon the ship, forcing you into litigation to reclaim your share of the venture. If the cost of litigation exceeds the cost of your share, unreliable partners can be a costly experience.
For this reason, conducting your due diligence before entering into a partnership is imperative.
9. It can lead to inadequate lines of communication
This disadvantage tends to occur after the joint venture has matured. When targets are reached, different companies tend to respond in unique ways. Some decide to stop communicating altogether because they are satisfied with the results achieved.
If this happens early enough in the partnership, the lack of communication can lead to partner problems that could prevent a potentially successful company from reaching its full potential.
Joint Venture examples
There are many examples of joint ventures. Here are some of the better-known mergers:
- Insurance giant Allianz and VW subsidiary Volkswagen Financial Services formed a joint venture to gain a market-leading position in the motor insurance sector.
- Mobile phone manufacturer Nokia and electronics giant Siemens formed a joint venture in Helsinki to jointly push a major competitor out of the market.
- Energy companies RWE and E.ON joined forces for a joint venture in Great Britain to build new nuclear power plants there.
Conclusion
The advantages and disadvantages of a joint venture allow individual companies to join forces, share risks and reap rewards. Not every venture is successful. There are always risks that can drive some companies into bankruptcy, even if the risks are spread. As with any financial decision, a full look at each potential situation must be considered before agreeing. If you have any questions regarding this topic, please contact our tax advisors in Barcelona by phone or email.
