What Is a Joint Venture (JV)?
A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity.
In a JV, each of the participants is responsible for profits, losses, and costs associated with it. However, the venture is its own entity, separate from the participants’ other business interests.
- A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task.
- They are a partnership in the colloquial sense of the word but can take on any legal structure.
- A common use of JVs is to partner up with a local business to enter a foreign market.
Understanding Joint Ventures
Joint ventures, although they are a partnership in the colloquial sense of the word, can be formed between any legal structure. Corporations, partnerships, limited liability companies (LLCs), and other business entities can all be used to form a JV. Despite the fact that the purpose of JVs is typically for production or for research, they can also be formed for a continuing purpose. Joint ventures can combine large and smaller companies to take on one or several big, or little, projects and deals.
There are four main reasons why companies form joint ventures:
A joint venture can take advantage of the combined resources of both companies to achieve the goal of the venture. One company might have a well-established manufacturing process, while the other company might have superior distribution channels.
By using economies of scale, both companies in the JV can leverage their production at a lower per-unit cost than they would separately. This is particularly appropriate with technology advances that are costly to implement. Other cost savings as a result of a JV can include sharing advertising or labor costs.
Two companies or parties forming a joint venture might each have unique backgrounds, skillsets, and expertise. When combined through a JV, each company can benefit from the other’s expertise and talent within their company.
Regardless of the legal structure used for the JV, the most important document will be the JV agreement that sets out all of the partners’ rights and obligations. The objectives of the JV, the initial contributions of the partners, the day-to-day operations, and the right to the profits, and the responsibility for losses of the JV are all set out in this document. It is important to draft it with care, to avoid litigation down the road.
Enter Foreign Markets
Another common use of JVs is to partner up with a local business to enter a foreign market. A company that wants to expand its distribution network to new countries can usefully enter into a JV agreement to supply products to a local business, thus benefiting from an already existing distribution network. Some countries also have restrictions on foreigners entering their market, making a JV with a local entity almost the only way to do business in the country.
Paying Taxes on a Joint Venture
When forming a JV, the most common thing the two parties can do is to set up a new entity. But because the JV itself isn’t recognized by the Internal Revenue Service (IRS), the business form between the two parties helps determine how taxes are paid. If the JV is a separate entity, it will pay taxes like any other business or corporation does. So if it operates as an LLC, then the profits and losses would pass through to the owners’ personal tax returns just like any other LLC.
The JV agreement will spell out how profits or losses are taxed. But if the agreement is merely a contractual relationship between the two parties, then their agreement will determine how the tax is divided up between them.
Joint Ventures vs. Partnerships and Consortiums
A joint venture (JV) is not a partnership. That term is reserved for a single business entity that is formed by two or more people. Joint ventures join two or more different entities into a new one, which may or may not be a partnership.
The term “consortium” may be used to describe a joint venture. However, a consortium is a more informal agreement between a bunch of different businesses, rather than creating a new one. A consortium of travel agencies can negotiate and give members special rates on hotels and airfares, but it does not create a whole new entity.
Examples of Joint Ventures
Once the joint venture (JV) has reached its goal, it can be liquidated like any other business or sold. For example, in 2016, Microsoft Corporation (NASDAQ: MSFT) sold its 50% stake in Caradigm, a JV it had created in 2011 with General Electric Company (NYSE: GE). The JV was established to integrate Microsoft’s Amalga enterprise healthcare data and intelligence system, along with a variety of technologies from GE Healthcare. Microsoft has now sold its stake to GE, effectively ending the JV. GE is now the sole owner of the company and is free to carry on the business as it pleases.
Sony Ericsson is another famous example of a JV between two large companies. In this case, they partnered in the early 2000s with the aim of being a world leader in mobile phones. After several years of operating as a JV, the venture eventually became solely owned by Sony.
Why Do Firms Enter into Joint Ventures?
There are many reasons to join forces with another company on a temporary basis, including for purposes of expansion, development of new products, or entering new markets (particularly overseas). JVs are a common method to combine the business prowess, industry expertise, and personnel of two otherwise unrelated companies. This type of partnership allows each participating company an opportunity to scale its resources to complete a specific project or goal while reducing total cost and spreading out the risk and liabilities inherent to the task.
What Are the Primary Advantages of Forming a Joint Venture?
A joint venture affords each party access to the resources of the other participant(s) without having to spend excessive amounts of capital. Each company is able to maintain its own identity and can easily return to normal business operations once the joint venture is complete. Joint ventures also provide the benefit of shared risk.
What Are Some Disadvantages of Forming a Joint Venture?
Joint venture contracts commonly limit the outside activities of participant companies while the project is in progress. Each company involved in a joint venture may be required to sign exclusivity agreements or a non-compete agreement that affects current relationships with vendors or other business contacts. The contract under which joint ventures are created may also expose each company to liability inherent to a partnership unless a separate business entity is established for the joint venture. Furthermore, while companies participating in a joint venture share control, work activities, and use of resources are not always divided equally.
Do Joint Ventures Need an Exit Strategy?
A joint venture is intended to meet a particular project with specific goals, so the venture ends when the project is complete. An exit strategy is important as it provides a clear path on how to dissolve the joint business, avoiding any drawn-out discussions, costly legal battles, unfair practices, negative impacts on customers, and any possible financial loss. In most joint ventures, an exit strategy can come in three different forms: sale of the new business, a spinoff of operations, or employee ownership. Each exit strategy offers different advantages to partners in the joint venture, as well as the potential for conflict.
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