Structural Components of Equity Joint Ventures

October 9, 2014

4541So-called “equity joint ventures” are collaborations between two or more business partners that involve the formation of a separate legal entity, such as a corporation or LLC, within which the joint activities will occur. An equity joint venture should be contrasted with “contractual” joint ventures, which have become a popular topic among lawyers and managers. The distinction between an equity joint venture and a contractual joint venture can be illustrated by comparing the manner in which a United States manufacturer might enter a new foreign market. If the equity joint venture strategy is used, the manufacturer might form a new corporation jointly owned with a foreign partner. The United States party would contribute a license which would allow the joint venture to manufacture the products. The local party might contribute manufacturing facilities and any needed capital and personnel and agree to act as the local distributor for the joint venture. In that case, the parties will share the profits of the joint venture. Alternatively, instead of forming a new corporation, the United States party might use one or more “contractual” relationships, such as license and distribution agreements with the local party, to achieve the desired result of sales in the new foreign market without using a separate joint venture entity.

The formation and use of an equity joint venture, referred to hereafter simply as a “joint venture,” must take into account all of the same issues which are generally encountered with any new business enterprise. For example, each of the joint venture partners will contribute various resources and skills to the new enterprise, including products; financing; personnel; facilities; raw materials; and marketing, managerial and operational expertise.  These contributions may take the form of direct investment in the joint venture or may be provided under the terms of one or more ancillary agreements between the joint venture entity and the partners. The partners must also agree on a number of issues regarding the management and operation of the enterprise.

Assuming that the corporate form is elected for the joint venture, the basic structural components would be as follows: articles of incorporation and bylaws; a shareholders’ agreement that would cover essential issues such as formation procedures, capital contributions, governance and termination of the joint venture; and ancillary agreements covering any services to be provided to the entity by the parties, as well as any agreements with respect to the purchase of products developed or manufactured by the joint venture or the use of the assets of the joint venture by the parties in activities that may, or may not, be related to the specific purpose of the joint venture. Among the various agreements are an administrative services agreement (§ 103:17) (see Master Form at § 103:241); a supply agreement (§ 103:15); an equipment purchase agreement (§ 103:16); one or more licenses with respect to technology or manufacturing rights (§ 103:13); one or more distribution agreements (§ 103:18); and an agreement with respect to the lease, acquisition or construction of facilities (§ 103:14).

The procedures to be followed regarding the formation of the entity are typically specified by relevant laws in the jurisdiction in which the entity is to be organized. For example, formation of a new general partnership in the United States to conduct the joint venture activities will be governed by the applicable state partnership statutes (§§ 21:48 et seq.), formation of a new LLC to conduct the joint venture activities will be governed by the applicable state LLC statutes (§§ 23:45 et seq.), and formation of a new corporation for the joint venture requires compliance with applicable corporations law statutes (§§ 6:38 et seq.). For larger transactions, the parties may enter into a master formation of joint venture transaction agreement which sets out in detail the steps that will be taken to form and organize the new entity and accept the contributions that each of the parties has committed to the joint venture. This approach may be appropriate when the parties are both public companies contributing a substantial amount of their assets to the joint venture since such a transaction may require regulatory and shareholders’ approvals that will take a substantial amount of time. See Specialty Form at § 103:312.10.

If the corporate form is used for the joint venture activities charter documents (i.e., articles of incorporation and bylaws) must be drafted and approved by the parties. These basic charter documents describe the capital structure of the entity as well as any specific rights granted to the shareholders with respect to voting, distributions and liquidation of the entity. See Specialty Form at § 103:316. Articles are filed with the appropriate regulatory body at the time the entity is formed, while the bylaws are approved by the board of directors of the entity and ratified by the parties in their capacity as shareholders.

The parties to a joint venture will agree to make various contributions of cash, tangible assets and other intangible rights to the joint venture. They are the sole owners of the joint venture and receive shares, if the corporate form is used, partnership interests, if the partnership form is used, or membership interests, if the limited liability company form is used, which evidence their interests in the venture. The cash and other assets to be contributed, as well as the terms associated with the contributions (i.e., the value of non-cash assets) can be included in the joint venture agreement or in a separate contribution agreement, which can become quite lengthy in situations where a party is contributing essentially all of the assets of an operating business or division. See Specialty Form at § 103:312.30.

The parties will generally enter a shareholders’ agreement which will govern their respective rights and obligations with respect to the operation of the joint venture. See Master Form at § 103:125. This agreement is the key operational document for the joint venture and sets forth the understanding of the parties with respect to capitalizing, managing, and terminating the relationship.

While a corporation is often used for formation and operation of a joint venture, the parties may opt for a partnership, in which case the joint venture agreement will follow the structure of a commercial partnership agreement. See Specialty Form at § 103:317. If a limited liability company is used for the joint venture the joint venture agreement will follow the structure of an operating agreement. The content of the operating agreement will depend on the activities of the joint venture and, in particular, the management structure that the parties have chosen. In some instances the parties will effectively share control by retaining the right to appoint an equal number of members of the joint venture LLC’s board of directors. See Specialty Form at § 103:315.30. However, it is also possible to use an “operator-managed” model under which one of the parties assumes primary responsibility for operating the joint venture business on a day-to-day basis. See Specialty Form at § 103:304.70.  If the parties wish to create a governance structure that is similar to a corporation, they can opt for a manager-managed LLC with professional managers selected and overseen by a board of directors consisting of members from each of the parties. See Specialty Form at § 103:304.90.  When the LLC joint venture is owned by two public companies provisions should normally be included to set out the procedures that will be followed in the event that there is a “change in control” of one of the parties. See Specialty Form at § 103:312.20.