What Are the Primary Disadvantages of Forming a Joint Venture?
A joint venture is 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.
In most cases, a joint venture is a temporary arrangement between two or more businesses, and a contract is formed under which the terms of the joint venture project are detailed for each participant.
Once the joint venture is completed, all parties receive their share of the profit or loss and the agreement that established the joint venture is dissolved. Although there are advantages to forming a joint venture, companies entering into this type of arrangement face some disadvantages as well.
Understanding the Primary Disadvantages of Forming a Joint Venture
Limited Outside Opportunities
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.
- A joint venture is a common method to combine the business prowess, industry expertise, and personnel of two otherwise unrelated companies, usually to complete a specific project or goal while reducing cost and spreading risk inherent to the task.
- Joint ventures are usually temporary arrangements between businesses.
- The contract under which joint ventures are created exposes each company to liability inherent to a partnership unless a separate business entity is established for the joint venture.
- While companies participating in a joint venture share control, work activities and use of resources are not always divided equally.
These arrangements are meant to reduce the potential for conflicts of interest between participant companies and outside businesses and keep the focus on the success of the new joint venture.
Although contractual limitations expire once the joint venture is complete, having them in place during the project has the potential to impede on a partner's core business operations.
Most companies that enter into joint ventures are established as a partnership or a limited liability company and operate with an understanding of the risks of liability associated with their chosen business types.
The contract under which a joint venture is created exposes each participating company to the liability inherent to a partnership, unless a separate business entity is established for the purpose of pursuing the joint venture. This means each company is responsible for claims against the joint venture on an equal basis despite its level of involvement in the activities that prompted the claim.
Uneven Division of Work and Resources
Participating companies in a joint venture share control over the project, but work activities and use of resources relating to the completion of the joint venture are not always divided equally.
It is common for one participant business to be expected or required to contribute technology, access to a distribution channel, or production facilities throughout the duration of the joint venture, while another partner company is only tasked with providing personnel to complete the project.
Placing a heavier weight on one business creates a disparity in the amount of time, effort, and capital contributed to the joint venture, but it may not mean an increase in the share of profit for the overburdened partner. Instead, unequal distribution of work and resources can lead to conflicts among participating companies and result in a lower success rate for the joint venture.
Although forming a joint venture is a viable business strategy for some companies focused on a common objective, it has its caveats. Companies considering entering into a joint venture should compare the advantages of cost savings through pooling resources to the disadvantages innate to this type of business arrangement.