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Companies – even competitors – often work closely together. They use synergies or create them themselves in order to achieve common goals. This is not only done locally, on a small scale, but worldwide, across national borders. The joint venture is one of the most established forms of corporate cooperation.
The history of the joint venture can be traced back to the 1920s. At first, American companies in particular made use of it, but business people in other export nations soon followed suit. This type of venture spread worldwide after the end of the Second World War. The term “joint venture” then gained considerable popularity in the 1990s as the Eastern European and Chinese markets opened up.
- What is a joint venture?
- Prominent examples
- What types of joint ventures exist?
- Special case: contractual joint venture
- What are the motives for a joint venture?
- Requirement for market access
- What are the advantages of a joint venture?
- What are the disadvantages and risks of a joint venture?
- How can a joint venture be established? What are the requirements?
- Schematic process of setting up an equity joint venture
- How does a joint venture pay taxes?
What is a joint venture?
In practice, a joint venture means that two or more companies, which are legally and financially independent of each other, cooperate with one another. The partners will remain independent, but will pool forces and resources to a certain extent in order to jointly implement specific projects and achieve business goals.
The partners both bear the management responsibility and the financial risk and, if the business is successful, they will share the profit. If unsuccessful, they share the resulting losses among themselves. The size of each company’s voice and the profit share usually depends on how much each company has financially contributed to the joint project.
In a joint venture, at least two independent companies work closely together strategically to achieve specific goals. To do this, they either set up a subsidiary or establish contractual arrangements for cooperation without setting up a joint venture.
BMW's long-standing cooperation with the Chinese car manufacturer, Brilliance, is one of the best-known examples of joint ventures. The partners operate two Chinese plants in which several BMW models are manufactured, as well as an engine factory. Europe's largest aircraft manufacturer, Airbus, and the Canadian train and aircraft manufacturer, Bombardier, also work together in a joint venture. Their core business is the production and sale of the medium-haul C-Series jet.
What types of joint ventures exist?
In an equity joint venture (EJV), the partners establish a joint subsidiary, i.e. a legally independent third-party company, usually in the form of a corporation. This excludes unlimited financial liability of individual partners. As described above, the partners each contribute capital to the joint venture. They share the management functions and bear the financial risk of the investment or project in question.
If the capital shares are equally distributed, this is known as a joint venture on an equal basis. If this is not the case and one of the partners dominates, it is referred to as a majority joint venture. This option is sometimes chosen in order to simplify decision-making processes or to curb (too) one-sided knowledge-sharing at the expense of the majority shareholder. So, it is important to establish adequate co-decision rights – up to the corresponding veto rights of minority shareholders.
The above-mentioned Airbus-Bombardier collaboration is an example of a majority joint venture: Airbus owned 50.01% of the joint company when it was founded, whereas Bombardier owned 31%.
Special case: contractual joint venture
In contrast to an equity joint venture, the partners in a so-called contractual joint venture (CJV) do not establish a joint subsidiary and therefore do not create an independent legal entity. Contracts regulate the distribution of costs, risks, and profits between the companies involved. Advantages of the contractual joint venture: the formation costs are lower, the contractual basis can be made more flexible, and profits and losses can be distributed freely, as can the voting rights. When it comes to the construction, the partner companies are also not necessarily liable with their capital contribution, but can be held directly liable.
What are the motives for a joint venture?
A joint venture is particularly suitable for implementing major projects that are difficult or impossible for a company to implement on its own. Cooperations like these can also be helpful to give the business a better position against the competition or to open up new markets – e.g. with the help of a local partner. It could also simply be a matter of asserting common interests over third parties.
Companies entering into joint ventures often pursue long-term goals, including new product developments or fundamental research. Medium-sized companies hoping to establish themselves internationally often choose this path. Together, supply chains can be designed more efficiently and market risks can be mitigated or even avoided.
The partners ideally complement each other in terms of skills, infrastructure, and resources, and contribute a wide variety of assets, such as operating facilities at different locations, land, qualified employees, relevant specialist knowledge, proven market knowledge, important contacts, and specific management skills.
Requirement for market access
Many companies are entering into joint ventures not only in the western industrial nations, but also in numerous developing and emerging countries. In some strictly regulated markets, cooperation between foreign investors and one or more domestic companies is even a state-imposed prerequisite for market access (see BMW and Brilliance in China). Sometimes this only applies to certain industries.
This means that what was originally voluntary now becomes state-imposed. The more tempting the respective sales market appears, the greater the incentive to enter into a "marriage of convenience" like this.
What are the advantages of a joint venture?
To improve the chances of a joint venture being successful, all partners should clearly communicate their goals and expectations and carefully coordinate them. Last, but not least, the "chemistry" between the partners should also be right for long-term, sustainable cooperation.
As outlined above, the main advantages of cooperating are to strengthen the business’ competitive position and to reduce or distribute risks across several shoulders. Not every partner needs to be an expert in every area; instead, finances, expertise, and other resources are pooled so that every party benefits. The partners combine their strengths and compensate for individual weaknesses. They use common supply, production, and distribution structures to avoid unnecessary and expensive parallel structures where they would have to invest alone.
What are the disadvantages and risks of a joint venture?
When companies merge and share resources, there is of course the danger that internal company information and critical know-how will “leak” to a competitor. Benefits and risks should therefore be carefully weighed up in advance. In the best case, an equal exchange of resources takes place, which are used together and ultimately benefit all parties involved.
However, the more partners that are involved, the more complex the management and control of joint projects can become. The general coordination effort is often underestimated. Cultural differences can also lead to complications when partners from different backgrounds work together. If there’s no harmony, instability and failure can end up being a real threat. In any case, all partners should always attach the same importance to the joint project in order to avoid imbalances.
How can a joint venture be established? What are the requirements?
A joint venture is usually established under the corporate law of the country in which its headquarters are located. It is therefore crucial to first define the company concept, the location, and the target market(s) and, if applicable, the product range and production capacities. It is just as important, of course, for the cooperation partners to be chosen carefully – after all, the goals must be the same. Furthermore, any conflicts between a possible joint venture and the parent companies regarding target markets, marketing channels, and competition issues must be ruled out.
Once these issues have been resolved, companies need to reach an agreement on financing and the level of investment. The partners must also agree on how to deal with the acquired knowledge and, if necessary, licenses, and patents. Factors such as staff allocation, management bodies, and allocating managerial tasks should also be discussed at an early stage so that the set-up and production phases can start in an orderly fashion.
Furthermore, the conditions at the desired location must be carefully checked in advance. In addition to the specific investment conditions, these conditions include tax law, civil law, commercial law, administrative law, and political issues. Factors such as wages and access to the required sales channels also need to be considered. The type of legal structure the joint venture has is largely dependent on the location.
Joint ventures are governed entirely on the legal agreement that got them started in the first place. The most common structure is a separate business entity, where each party owns a specific percentage of the entity. It functions through the legal status of the participants (co-venturers or venture partners). If the joint venture is a corporation, and both businesses have equal shares in the business, then the company will be structured so each partner entity has an equal number of shares of company stock and equal management.
Schematic process of setting up an equity joint venture
The process can vary depending on the country in which it was founded, so here is only an overview of typical stages. In any case, the prescribed registration deadlines must be met.
The potential partners first explore the objectives and tasks, capital shares, and location issues in preliminary negotiations before coming to a conclusion on the joint venture agreement itself and the articles of association. A subsequent feasibility study roughly defines the chances of success and, depending on the founding country, also allows authorities to assess the project’s approvability. This is followed by the request for approval as well as one for the name. Once a business permit has been granted, further registry entries (e.g. with the tax authorities) may be required for the joint venture to acquire legal capacity.
How does a joint venture pay taxes?
The answer to this question is also closely linked to the form of the joint venture and the choice of location – i.e. to the locally applicable tax and duty law, according to which the level of taxation income, consumption, and substance is determined. The respective rules of corporate taxation apply to an equity joint venture as an independent, legally binding acting company. In a contractual joint venture, however, the parent companies themselves remain responsible.
The IRS doesn’t recognize the joint venture as a taxing entity so it is the business structure that determines how taxes are paid. If it’s a separate business entity, then taxes will be paid according to this business form e.g. if it’s an LLC, it will pay taxes like one.
If the joint venture is a contractual relationship with an agreement between two independent companies, the terms of the agreement will determine how tax is paid and which company pays what amount.