JOINT VENTURES – When and How to Use This Corporate Framework

Synopsis

A joint venture (JV) is a legal framework in which two business parties contribute content and joint business activity. The joint venture can be established as a partnership (regular or limited) or a limited liability company, and the type of structure depends on the various circumstances and considerations of each venture.

The main characteristic of joint ventures is that the two partners hold equal ownership and/or control in the JV (or close to it), equality that affects the way the joint venture is built and the way its business is managed, as shall be further elaborated in this article.

Background – Economics of comparative/complementary advantages

Often, two parties wish to collaborate in the building of a joint activity. The background of joint ventures is diverse and is rooted in the relative advantages that each of the two partners brings to the transaction: whether it is a relative advantage in financial capital, human capital, professionalism, experience or reputation, the ability of both parties to leverage these advantages for joint activity is significant to the success of the venture.

On the face of it, the advantages of establishing a joint venture are very similar to mergers and acquisitions: the ability of two business entities to combine forces, as well as to benefit from relative advantages that each entity brings to the transaction, such as: better financing, synergy between the businesses, reduction of marginal expenses, entry into new markets, etc.

In Israel, there are no legal provisions that refer specifically to a legal framework in the form of a “joint venture”. Around the world, there are some countries that have enacted specific legislation regarding joint ventures, establishing diverse provisions and mechanisms, while other countries, like Israel, have not established a concrete regime for this concept.

This matter came up in several court judgments[1], in which it was determined that the Israeli judicial system can refer to joint ventures in several alternatives: a partnership agreement, an agency relationship or an entrepreneurial relationship. In any case, the discussion is largely moot in light of the nature and form of the structure of the joint venture and the contractual system between the parties.

The Joint Venture Structure

The joint venture can be structured in the form of two types of corporations: a company or a partnership. Partnership can be in two alternative types, a regular partnership or a limited partnership.

In brief, we shall note that the considerations for examining the type of corporation are diverse, starting with considerations of taxation, redundancy of the corporation (requiring statutory dissolution, or not), the ability to add additional partners, regulation, etc.

In this context, it is important to note another issue, being corporate finance: if the joint venture wishes to raise external financing, and perhaps in the future even make a public offering, in most cases a limited company rather than a partnership would be the preferred structure, due to the relative ease a company has in raising capital and issuing varied securities, certainly in private companies (ordinary or preferred shares of various types, issuing convertible or straight debt, etc.).

Central provisions in a joint venture agreement

The most significant indication of a joint venture is the joint control of the parties in the venture. This fact has an impact on the relationship between the parties and on significant provisions in the relationship between the parties, including provisions relating to decision-making, resolution of future disputes, and in extreme cases also in relation to separation mechanisms, as will be elaborated below.

The joint venture agreement includes several trivial instructions between the partners in the venture, including the following issues:

– Financing and the providing of guarantees;

– Future dilutions;

– Decision-making mechanisms (organs, quorums, veto rights, etc.);

– Standard mechanisms relating to holdings in the joint venture, such as pre-emptive rights, rights of first refusal, bring along and tag along obligations;

– Instructions regarding the provision of services by each partner to the joint venture;

– Profit sharing mechanism;

– Mutual call options and put options;

– Provisions regarding non-competition with the partnership’s businesses;

– Solutions in the case of reaching an impasse: an independent professional director, an agreed arbiter, and a pricing mechanism (below).

Pricing mechanism – BMBY

A pricing mechanism between parties would appear to nullify the basic purpose for which the joint venture was established, which is harnessing the relative advantages that each party brings to the joint venture for the purpose of maximizing the benefits for all parties.

At the same time, in some cases, usually after the joint venture has already been active for significant period of time and it has accumulated assets, experience and goodwill, there is business logic for the continued existence of the joint venture even in the event that one of the parties buys out the share of the other party and becomes the sole owner of the activity.

There are various types of pricing mechanisms (Buy Me Buy You), and in the situation of a joint venture it is very important to define the outgoing partner’s obligations to the joint venture, for example the continuation of non-competition clauses, continuing to provide assets and/or knowledge to the joint venture as well as continuing to provide services to the joint venture, since if these obligations did not continue to bind the outgoing partner, there would be no value in buying out its share.

Before we finish, we would like to point out that over the past few years, the courts have issued instructions for pricing mechanisms even in cases where the parties did not initially agree among themselves on a pricing mechanism. The reasons that formed the basis of the courts’ decision are varied. For example, the importance that the courts see in the continuation of business activity that generates profits for the parties[2]. Another example concerned the mechanism that the court applied to the relationship between the parties in order to resolve claims of oppression of the minority by the majority[3]. In any case, it is important to note that the pricing mechanism produces an effective solution even for situations where two equal parties in a joint venture (incorporated as a partnership or a company) reach a situation where they decide to go their separate ways.

In conclusion

A joint venture is an effective framework for promoting joint activity between parties that have equal influence and who are able to join forces with the aim of maximizing the benefits of both parties involved.

There is substantial importance in the way the mechanism is structured, by which both parties establish the joint venture, and of course additional mechanisms in relation to the joint management of the project.

[1] The main judgment was handed down by the Supreme Court in Civil Appeal 262/86 Walter Roth vs. Deak & Co. Inc.

[2] Civil Appeal Leave 5596/00 Shulamit Stavi v. Shauli Nachusi

[3] Civil Appeal 4588/19 Rajda Asad Kardosh-Salem v. Kardosh & Co. Ltd.

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