Do Joint Ventures Need an Exit Strategy?

When two or more businesses come together for the purpose of achieving a specific goal, they form a joint venture. This type of business partnership allows each business to benefit from what its partners have to offer, including resources such as capital and highly skilled personnel, or an expanded capacity in marketing or advertising intended to reach a larger or previously untapped market.

Most joint ventures are established under a partnership agreement that details the specific business objective the companies are trying to reach collectively, the responsibilities of each partner, and how profits and losses will be distributed. A partnership agreement establishing a joint venture should also contain a planned exit strategy so that all parties are protected once the partnership reaches its goal.

Key Takeaways

  • A joint venture (JV) is when two or more businesses come together to create a new legal entity to achieve a certain business goal.
  • JV's can be created to offer a new product or service, reach new customers, and access new markets.
  • The profits and losses of a JV are separate from that of the existing businesses of the partner companies.
  • When creating a JV, it is critical to decide upon many topics before getting started, such as management control, profit and loss percentages, business objectives, and an exit strategy.
  • An exit strategy is important to have as it provides a clear path on how to dissolve a business, avoiding any drawn-out discussions, costly legal battles, unfair practices, negative impacts on customers, and any possible financial loss.
  • The partnership agreement is an important document to create before beginning a JV listing all critical aspects of the JV, including the exit strategy.

What Is a Joint Venture?

A joint venture is when two or more businesses come together to form a new business in order to pursue a new business goal. The businesses combine their resources, leverage the skills of each specific entity, and share in the profits and losses that are separate from their individual businesses.

A joint venture can be created to launch a new product or service, reach new customers, or tap into new geographical markets. A JV can be structured in almost any way, such as a corporation, a partnership, or a limited liability company (LLC).

When a JV is created, it is important to outline how each separate company will contribute to the new venture. Determining ownership stake, responsibilities, management, profit and loss sharing, and an exit strategy when the business is completed are all important areas to agree upon before starting.

Why Implement an Exit Strategy?

There are a number of benefits to creating and maintaining a joint venture, but none of the parties reap the full rewards once the venture dissolves unless a sound exit strategy is in place from the beginning. A joint venture is intended to meet a particular project with specific goals, so the venture ends when the project is complete.

However, companies' business needs, product portfolios, and served audiences change over time while working through the project, and these shifts can create tension among partners in a joint venture once it comes to an end. If a participating company is left to its own devices to structure the division of new assets or market reach, joint ventures have the potential to end in disaster and possible court intervention.

Termination Conditions in the Partnership Agreement

Within the partnership agreement that establishes a joint venture, partners can protect themselves from conflict with other participating companies by including termination conditions in the contract. These conditions can include requiring a partner to give three or six month's notice prior to ending the business relationship, and the allowance of the remaining partner to buy out the departing partner.

Each of the termination conditions should be discussed when the joint venture is formed and agreed upon by each participating company or individual. Most joint ventures are dissolved through a partner buyout, but the addition of clear termination conditions in the joint venture agreement can dictate how the transaction plays out for each partner.

The taxes that a joint venture will be responsible for are based on the legal structure it was created as, e.g. an LLC or a partnership.

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.

A sale can be a quick way out for partners, but finding the right buyer can present challenges. A spinoff can become a taxable event when not done correctly, but it can allow operations to continue well into the future under a new company structure. An employee ownership buyout transitions the business into the hands of current employees, increasing productivity and the potential for profits. However, this is typically an option only for large joint ventures.

No matter the exit strategy that is chosen, partners in a joint venture can reduce the potential for conflict by having clear termination or dissolution terms in the joint venture agreement from the start.

The Bottom Line

Joint ventures can be extremely beneficial to the companies involved, leveraging the skills and assets of each company to create a new product or service, access a new area of the industry, reach new customers, and reduce competition. As joint ventures are created typically for a specific reason, they most often have a finite life cycle.

Just as important as deciding on the business goals, such as what products to sell, what markets to reach, and at what price to sell, so is deciding how the joint venture will be terminated when the business reaches its goals or if the JV proves unsuccessful.

Having a clear exit strategy will save time for everyone involved, reduce costs, avoid any expensive legal battles, and leave each partner on good terms for possible future collaborations.

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