How to Evaluate a Joint Venture
Big companies enter into joint ventures—new business entities created through business agreements—all the time. In fact, many large companies now rely on partnering up with other companies, especially smaller ones, as a way to innovate by outsourcing their research and development efforts. "Companies can't do it on their own anymore," says Dr. Henry Chesbrough, the executive director of the Center for Open Innovation at UC Berkeley's Haas School of Business and author of the new book, Open Services Innovation. "There are too many good ideas and useful information out there for you to try and innovate on your own. The way you will win is to get to market fast and hit hard by collaborating with others."
In other words, it might be time for your small business to consider partnering up with one or more companies in a joint venture as a way to quickly gain access to new markets or technology, perhaps as an alternative to making an acquisition. Before you do, however, consider these tips on how to make sure a joint venture makes sense for your business.
Evaluating a Joint Venture: Define Your Terms
The term joint venture is often intermingled with a similar concept, called strategic alliance; however, they really are two different kinds of relationships, says Christopher D. McDemus, a corporate attorney with MCD Law Partners in Fort Washington, Pennsylvania, who also pens the blog, VC Deal Lawyer. McDemus likes to distinguish the two by defining a joint venture as a relationship where two or more parties work together to achieve some end where the sum of their efforts becomes greater than its parts. A strategic alliance, on the other hand, is a relationship where the parties aren't necessarily working in concert, but still benefit from each other's efforts.
An example of a classic joint venture, says McDemus, would be where one company builds a technology used by astronauts on the space shuttle, say an exo-skeleton that astronauts use to lift heavy items in space. As a way to expand the market for its suits, this company could form a joint venture with another company that might have significant experience selling items to the military, which might be interested in the exo-suit technology for its soldiers. "Is it possible that either one of these companies could have pursued this alone?" asks McDemus. "Sure, but it would have taken years to build the piece of the puzzle they were missing. Under a joint venture structure, these companies could be out selling their product in months."
Dig Deeper: What Is a Joint Venture?
Evaluating a Joint Venture: Evaluate Your Potential Partner(s)
Another of the first steps you should take in deciding on whether or not a joint venture makes sense for your company is to do some due diligence on your partner, says Chesbrough. "Find out if they have been in a joint venture before and how those arrangements worked out, ideally by interviewing the companies they partnered with," he says. You should also make sure that you and your potential partner have similar goals with the joint venture to ensure that a bigger company or one based overseas, for example, doesn't have a goal of becoming a competitor of your core business in the long run.
Dig Deeper: How to Build Business Alliances
Evaluating a Joint Venture: Evaluate the Business Potential
Just because some company wants to partner with you, and they have name recognition or customers, doesn't mean they are right for you, says Rebel Brown, a veteran business consultant and author of the book, Defy Gravity. "If you can't define a real immediate opportunity for both companies, then the joint venture may be for ego, not profit," she says. And there would be no real benefit to your business.
Brown also suggests asking yourself what things you might no longer be able to do because of the joint venture, since there is always an opportunity cost. "You'd be amazed at how often people give up solid revenue and profit opportunities in their business to partner with some flashy new kid on the block—and blow their whole business apart because they can't do it all," she says. So if the deal doesn't further your company's mission, passing on it may be the right move.
Dig Deeper: Deciding When a Joint Venture Agreement Makes Sense
Evaluating a Joint Venture: Choose Your Structure
If you decide that a joint venture will indeed be a net positive for your company, McDemus says there are two ways to structure it: Either by contract or by creating a separate entity. "The right structure for a joint venture relates mostly to the goals of the parties and the specific facts surrounding what the parties are trying to accomplish," he says. And the first step each company should take is to write down exactly what it hopes to get out of this relationship and what it plans on putting into it.
For example, if both parties are contributing assets to the joint venture and the hope is that the new entity is going to take those assets and develop a brand new technology, then it might be important to form the joint venture using a new entity that both companies own. "That way, all of the intellectual property and valuable assets are located in the new entity and are neatly packaged so that if the end goal is to sell the joint venture, then it's all right there," says McDemus. If, on the other hand, you and your partner just want to work together on, say, on a single project over the holidays, then a contract-based approach might work best.
Dig Deeper: Joint Venture Agreement Checklist
Evaluating a Joint Venture: Hire An Experienced Lawyer
Regardless of the kind of structure you choose for your joint venture, you'll want to hire an attorney experienced in putting together such deals. "This is an area where having done it before really helps," says Chesbrough. "If your own attorney has not done this before, get a referral to someone who has. You don't want your attorney to learn on your nickel. It might cost you more per hour, but it's well worth the investment." That goes double if your joint venture will be based outside the U.S., where you will need someone skilled in the laws of that country.
Dig Deeper: Sample Joint Venture Agreement Template
Evaluating a Joint Venture: Decide on an Operational Goal
Partners in a joint venture often see themselves as equals, where everything is divided 50-50, says McDemus. That creates problems, though, if the company needs to make a decision and both parties don't see eye-to-eye. "It will pay back tenfold if you work out ahead of time how these ties will be broken," he says, adding that the agreement should also specify a way to unwind or even exit the joint venture if deadlocks cannot be broken. Similarly, both parties should work out a clear capital contribution plan, which clarifies both who invested what and who is required to put additional cash into the venture moving forward.
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Evaluating a Joint Venture: Nail Down Intellectual Property Issues From the Get-Go
If the companies participating in the joint venture contribute assets or intellectual property, make sure these contributions are properly documented right out of the gate, says McDemus. This includes the development of any new technologies created by the joint venture itself. "That way, there are no arguments about who owns what down the road," he says. It's also another reason why you should hire an experienced lawyer who could foresee potential issues and advise you on the deal.
Dig Deeper: 10 Tips for Licensing Intellectual Property
Evaluating a Joint Venture: Plan for the End
The truth is, not all joint ventures are meant to last forever, says McDemus, whether due to design or for unexpected challenges—such as one of the partner companies going bankrupt. "That's why one of the most important things to consider when forming the joint venture—before anyone is in a position of self-interest—is how the parties can unwind the joint venture," he says. That means asking and answering questions, such as: If one party wants to sell its half, is it required to offer it to the other party first (called a Right of First Refusal)?
You might want to also make sure that both parties have agreed not to separately compete with the joint venture. "You don't want to find out that your disgruntled partner decided to start a separate business offering the same products or services as the joint venture and competing against it in the market," says McDemus.
Did we miss a key factor to consider when evaluating a joint venture? Share it with us in the comments below.
Darren Dahl is a contributing editor at Inc. magazine, which he has written for since 2004. He also works as a collaborative writer and editor and has partnered with several high-profile authors. Dahl lives in Asheville, North Carolina.