Key issues to watch out for in your joint venture

 

Introduction

When considering entering into a joint venture arrangement in New Zealand with another party it is important to be aware of potential issues before they even raise their head and become problems.  This article describes some of the key points to watch out for if you are considering a joint venture in New Zealand. It can also serve as a good reminder of a checklist of points to consider to review the health of your joint venture if you are already in one.

1.         Valuing different contributions

It can be hard to value what each party brings to the table.  Typically a joint venture will be entered into because each party has recognized that the other one is able to bring some unique skill or background to a proposed business.  Often for one party this may simply be the ability to provide capital such as finance or land while the other party has a certain expertise.   Alternatively, two companies who are generally competitors may decide that working together will help them to scale up and achieve more.

Either way the key point is not to undervalue what you bring to the joint venture.  If the other party has an ingenious idea but no financing and you can unlock capital for their idea to grow, then you hold significant bargaining power.  Equally if you are the one with the industry expertise and knowledge then you should not sell yourself short in negotiations with a financier.  We have seen this from both sides and often wondered why one party wasn’t more highly valuing what they bring to the table. Sometimes there is a tendency to value tangible contributions over the intangible ones, which may not always be appropriate.  So, in each case hold out for as much equity and participation in the joint venture as you can.

2.         Form of joint venture

Most commonly we would see a new company formed under the Companies Act 1993, which has two shareholders.  That way the new entity will be a standalone venture separate from each of them.  Typically it will have its own set of advisors and employ its own staff (although one party may second certain individuals in to assist).  Profits will be returned as dividends to the shareholders.

However, that is not the only option.  Alternatively there could simply be a joint venture agreement between two parties which sets out how they will work together.  This is called an unincorporated joint venture.  There is no separate legal personality of the joint venture so it cannot contract on its own with third parties.  This model may be used for financing, tax or accounting reasons.

Another possible structure is a Limited Partnership under the Limited Partnership Act 2008. This structure may be particularly attractive when one of the parties is an overseas entity because tax liability sits at the level of the partners rather than in the corporate structure. Also the details of the limited partners are less publicly available.

It pays to work through the possible structures well in advance so you know what you want to propose to the other side.

3.         Ownership shares and deadlock

You may think that an equal sharing in ownership is fair and that is usually correct.  However, the danger of an equal split is that decisions can get stalled if the parties cannot agree and so deadlock can result.  This can have a negative impact on the profits and reputation of the joint venture.    There are some ways to deal with a situation of deadlock though which are outlined in the next point.

4.         Overcoming deadlock

A deadlock situation can be fatal to a joint venture.  This is especially so when the shareholding is the same and there are also an equal number of directors appointed by each party.  One way to deal with this is to have a rotating chairman who has the casting vote.   Also, there can be a list of really key issues which are reserved as decisions for the shareholders rather than directors.  All joint venture arrangements should have clear disputes resolution procedures, including, where appropriate the ability to refer matters to independent experts or umpires.

5.         “Service” arrangements and extraction of value

Commonly we see that one party is the expert in the subject matter of the joint venture and so they often end up contracting to provide services to the joint venture.  That is fine, but the other party should closely look at those agreements and build in clauses that ensure these will be “arms’ length” arrangements.  If one party is an overseas entity they may be relying on their local partner to provide a lot of the “on the ground” work.  They may not realise that the same local partner is extracting a lot of value from the arrangement with the company through charging of high consultancy services, management fees or other arrangements.

6.         Exiting the joint venture

There should be a clear pathway for getting out of the joint venture.  For example, if one party wants to exit they may have to first offer their shares to the other party before they can they sell to a third party.  Such pre-emption rights can be included in the joint venture agreement.

What if one party wants to exit and the other party does as well?  This can be built in as “tag along” rights so that the party who is selling their shares to a third party may need to allow the other party to join in that sale.  Other typical rights could include “drag along” rights where a party is able to force their joint venture partner to also sell their shares to a third party.  All of these options need to be considered and worked through at the start of the joint venture.

7.         Other points to consider when setting up a joint venture

The following issues should also be considered at the beginning:

• capital and funding obligations going forward;
• scope of the JV company;
• will it be permissible for the shareholders to enter into other joint ventures or initiatives that may compete with this joint venture?;
• business plan and budgets;
• management and who will lead the joint venture;
• ownership of land;
• circumstances that may trigger termination;
• tax implications;
• minority protection rights;
• information flow to parent companies;
• marketing arrangements;
• powers of veto;
• will there be parent company guarantees;
• confirm no competition law issues; and
• if a foreign company is involved, whether Overseas Investment Office (OIO) approvals needed.

8.         No one situation …

… is like the other.  Many joint ventures can have more than two parties, with variable negotiating power, parties with different skills, land or finance available.  It is important to tailor the documentation to the situation.

We have experience in setting up joint ventures and providing advice about different situations and would be happy to discuss your circumstances.