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.
Each of the participants in a JV is responsible for profits, losses, and costs associated with it. However, the venture is its own entity, separate from the participants’ other business interests.
- In a joint venture (JV), two or more businesses decide to combine their resources in order to fulfill an enumerated goal.
- 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 a JV
Although a JV is a partnership in the colloquial sense of the word, it can be formed using any legal structure: Corporations, partnerships, limited liability companies (LLCs), and other business entities can all be employed.
Despite the fact that the purpose of a JV is typically for production or research, one can also be formed for a continuing purpose. JVs can combine large and small companies to take on one or several projects and deals.
Here are the four main reasons why companies form JVs.
1. To Leverage Resources
A JV 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.
2. To Reduce Costs
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.
3. To Combine Expertise
Two companies or parties forming a JV might each have different backgrounds, skill sets, or expertise. When these are combined through a JV, each company can benefit from the other’s talent.
4. To Enter Foreign Markets
Another common use of JVs is to partner with a local business to enter a foreign market. A company that wants to expand its distribution network to new countries can enter into a JV agreement to supply products to a local business, thus benefiting from an already existing distribution network. Some countries have restrictions on foreigners entering their market, making a JV with a local entity almost the only way to do business in the country.
How to Set up a JV
Regardless of the JV structure, the most important document will be the agreement that sets out all of the rights and obligations of each party to the venture. The objectives, the initial contributions of the parties, the day-to-day operations, the right to the profits, and the responsibility for losses are all set out in the JV agreement. It is important to draft it with care to avoid risking litigation down the road.
Pros and Cons of a JV
A joint venture gives each party the opportunity to exploit a new business opportunity without bearing all of the cost and risk. Joint ventures by nature are riskier than "business as usual" and sharing the risk is a wise move.
If the right participants are involved, the joint venture also starts out with a broader base of knowledge and pool of talent than any one party possesses on its own. For example, a joint entertainment venture set up by an animation studio and a streaming content provider can get off the ground more quickly—and probably with a better chance of success—than either participant could alone.
Cons of a Joint Venture
Embarking on a joint venture requires relinquishing a degree of control. The vital decisions are being made by two or more parties.
The companies involved must go into the project with the same goals and an equal degree of commitment.
Extreme differences between the participants' company cultures and management styles can be a barrier to success. Will the executives of an animation studio be able to communicate in the same language as the executives of a digital streaming giant? They might, or they might line up in opposing camps.
Setting up a joint venture multiplies the number of management teams involved. If one party undergoes a significant change in its business structure or executive team, the joint venture can get lost in the shuffle.
Paying Taxes on a JV
When forming a JV, the most common thing the two parties can do is to set up a new entity. As 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. As the JV is a separate entity, it will pay taxes as any other business or corporation does. However, if it chooses to operate as an LLC, its profits and losses would pass through to the owners’ personal tax returns, as with any other LLC.
The JV agreement will spell out how profits or losses are taxed. If the agreement is merely a contractual relationship between the two parties, then it will determine how the tax is divided up between them.
JVs vs. Partnerships and Consortiums
A JV is not a partnership. That term is reserved for a single business entity that is formed by two or more people. JVs join two or more different entities into a new one, which may or may not be a partnership.
The term “consortium” is sometimes used to describe a JV, and there are similarities. However, a consortium is a more informal agreement than a JV. For example, 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. The agencies still pursue their own businesses independently. In a JV they would share ownership of the created entity, jointly responsible for its risks, profits, losses, and governance.
Examples of JVs
Once the JV has reached its goal, it can be liquidated like any other business or sold. For example, in 2016 Microsoft Corporation sold its 50% stake in Caradigm, a JV it had created in 2011 with General Electric Company.
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 has become 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 Would a Firm Enter Into a Joint Venture (JV)?
There are many reasons to join forces with another company on a temporary basis, including for purposes of expansion, development of new products, and entering new markets (particularly overseas).
JVs are a common method of combining 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 JV?
A JV 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 JV is complete. JVs also provide the benefit of shared risk.
What Are Some Disadvantages of Forming a JV?
JV contracts commonly limit the outside activities of participant companies while the project is in progress. Each company involved in a JV 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 a JV is created may also expose each company to liability inherent to a partnership unless a separate business entity is established for the JV. Furthermore, while companies participating in a JV share control, work activities and use of resources are not always divided equally.
Does a JV Need an Exit Strategy?
A JV is intended to meet a particular project with specific goals, so it 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 drawn-out discussions, costly legal battles, unfair practices, negative impacts on customers; and controlling for any possible financial loss. In most JVs 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 JV, as well as the potential for conflict.
The Bottom Line
A joint venture between companies can open the way for expansion into a new line of business by each participant at a relatively modest cost. In fact, it sounds ideal: Each company contributes its own expertise but the cost of the venture is split among them.
It's only ideal, though, if the companies have a shared vision and an equal commitment to the success of the joint venture.