SUSTAINABLE ENTREPRENEURSHIP PROJECT

Transcription

1 A Guide for Sustainable Entrepreneurs SUSTAINABLE ENTREPRENEURSHIP PROJECT Dr. Alan S. Gutterman

2 : A Guide for Sustainable Entrepreneurs Published by the Sustainable Entrepreneurship Project ( and copyrighted 2017 by Alan S. Gutterman. All the rights of a copyright owner in this Work are reserved and retained by Alan S. Gutterman; however, the copyright owner grants the public the non-exclusive right to copy, distribute, or display the Work under a Creative Commons Attribution- NonCommercial-ShareAlike (CC BY-NC-SA) 4.0 License, as more fully described at About the Project The Sustainable Entrepreneurship Project ( engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business. In furtherance of its mission the Project is involved in the preparation and distribution of Libraries of Resources for Sustainable Entrepreneurs covering Entrepreneurship, Leadership, Management, Organizational Design, Organizational Culture, Strategic Planning, Governance, Corporate Social Responsibility, Compliance and Risk Management, Finance, Human Resources, Product Development and Commercialization, Technology Management, Globalization, and Managing Growth and Change. Each of the Libraries include various Project publications such as handbooks, guides, briefings, articles, checklists, forms, forms, videos and audio works and other resources; management tools such as checklists and questionnaires, forms and training materials; books; chapters or articles in books; articles in journals, newspapers and magazines; theses and dissertations; papers; government and other public domain publications; online articles and databases; blogs; websites; and webinars and podcasts. About the Author Dr. Alan S. Gutterman is the Founding Director of the Sustainable Entrepreneurship Project and the Founding Director of the Business Counselor Institute ( which distributes Dr. Gutterman s widelyrecognized portfolio of timely and practical legal and business information for attorneys, other professionals and executives in the form of books, online content, webinars, videos, podcasts, newsletters and training programs. Dr. Gutterman has over three decades of experience as a partner and senior counsel with internationally recognized law firms counseling small and large business enterprises in the areas of general corporate and securities matters, venture capital, mergers and acquisitions, international law and transactions, strategic business alliances, technology transfers and intellectual property, and has also held senior management positions with several technology-based businesses including service as the chief legal officer of a leading international distributor of IT

3 products headquartered in Silicon Valley and as the chief operating officer of an emerging broadband media company. He received his A.B., M.B.A., and J.D. from the University of California at Berkeley, a D.B.A. from Golden Gate University, and a Ph. D. from the University of Cambridge. For more information about Dr. Gutterman, his publications, the Sustainable Entrepreneurship Project or the Business Counselor Institute, please contact him directly at alangutterman@gmail.com.

4 Joint Ventures 1 Setting the Stage Businesspeople often use the term joint venture to describe a wide range of collaborative relationships and, in fact, business partners often base their relationship on specific contractual obligations, such as a fairly short and loosely worded agreement to work together in a specific area perhaps accompanied by a common form of commercial contract such as a license or distribution agreement. The focus of this chapter, however, is on joint ventures that use a separate business entity (e.g., a corporation, partnership or limited liability company ( LLC )) to conduct the specified business activities. Use of a separate entity allows the parties to limit the liability associated with the relationship while remaining actively involved in the management of the project. Both parties would have the right to designate members to serve on the board of directors (or other managing board or committee) of the joint venture entity and would make other contributions of cash, assets and other resources. Among other things, joint ventures may be used to share risks, achieve and maintain economies of scale, efficiently and successfully gain access to new markets and tap into financial resources that may not be available internally or through other outside sources. A joint venture can also be used as a prelude to an acquisition once the parties have gathered experience about whether they are good fit for full integration by working together in a joint venture. Key Topics Covered Key topics covered in this Guide include the following: General legal characteristics and structural components of joint ventures Motivations for joint venture relationships Regulation of joint venture relationships Evaluation and selection of joint venture partners Developing a joint venture business plan Contributions to the joint venture and joint venture capital structures Steps for forming a joint venture Management and operation of joint ventures Pre-termination withdrawals of joint venture partners Termination of joint ventures Learning Objectives After reading this Guide, you should be able to: 1. Describe the general legal characteristics of joint ventures. 2. Identify and describe the functional types of joint venture relationships. 3. Understand how joint venture relationships are regulated. 4. Describe the process for forming a new joint venture. 5. Describe the factors to be considered in evaluating and selecting joint venture partners. 6. Identify and discuss the key elements of a memorandum of understanding. 7. Describe the key elements of an effective and useful joint venture business plan. 8. Describe the key issues for managing the joint venture. 9. Describe the key issues for operating the joint venture. 10. Understand the reasons for early termination of joint ventures. 11. Understand the procedures for pre-termination withdrawal and termination of the joint venture.

5 1 Introduction 2 Businesspeople often use the term joint venture to describe a wide range of collaborative relationships and, in fact, business partners often base their relationship on specific contractual obligations, such as a fairly short and loosely worded agreement to work together in a specific area perhaps accompanied by a common form of commercial contract such as a license or distribution agreement. The focus of this chapter, however, is on joint ventures that use a separate business entity (e.g., a corporation, partnership or limited liability company ( LLC )) to conduct the specified business activities. Use of a separate entity allows the parties to limit the liability associated with the relationship and may even be required for alliances with local partners in various foreign countries formed to engage in specific activities in a mutually defined customer or geographic market. The participants are generally business units of the respective parties, perhaps a division or a wholly-owned subsidiary. A US company entering into an international joint venture may elect to have its ownership interest in the joint venture acquired by its international division or a continental or national affiliate. Both parties would have the right to designate members to serve on the board of directors (or other managing board or committee) of the joint venture entity and would make other contributions of cash, assets and other resources. However, if the entity is organized under the laws of the local party s country the US company must take precautions to understand the default rules applicable to such entities and the degree of flexibility the owners of such an entity have to deviate from those rules by agreement or through provisions in the charter documents. Parties to a joint venture are motivated by a variety of factors and the goals and objectives identified by the party certain influence the form of the joint venture and the activities that will be conducted in the name of, and using the resources contributed to, the joint venture. Among other things, joint ventures may be used to share risks, achieve and maintain economies of scale, efficiently and successfully gain access to new markets, tap into financial resources that may not be available internally or through other outside sources, overcome barriers to acquisition or as a prelude to an acquisition once the parties have gathered experience about whether they are good fit for full integration by working together in a joint venture. The advantages and disadvantages of a joint venture structure are similar to those applicable to any type of strategic alliance. In addition, however, parties may select an equity joint venture, rather than using a network of contractual agreements, in situations where both parties want to be directly involved in the management of various key functions. Moreover, a joint venture can be used to achieve a commonality of interests, and reduce the risks of opportunistic behavior by the parties, when valuing intangible assets that require further development. The use of an independent entity is also believed to accelerate the transfer of knowledge required for a successful collaboration. Finally, a joint venture is a common strategy for establishing business activities in a new foreign country in reliance on the resources of a local party.

6 2 General legal characteristics of joint ventures While there are a wide variety of cooperative business relationships that might be characterized as joint ventures, some of the essential elements of a joint venture as a matter of law are as follows: 3 Joint ventures are established by contract, expressed or implied, and consist of one or more agreements involving two or more persons or organizations which are entered into for a specific business purpose. Joint ventures are formed for a specific and definable business objective and are established for a limited duration, primarily because the complementary production activities involve only a limited subset of the assets of the participants, the complementary assets have only a limited service life, and/or the complementary production activities will be of limited efficacy. Each of the participants to a joint venture contribute property, cash, or other assets and organizational capital held by them for the pursuit of a common and specific business purpose. As opposed to a contractual relationship, the contributions in the context of a joint venture are made to a newly formed business enterprise, which usually takes the form of either a corporation or a partnership, created to pursue the business goals and objectives of the venture. As such, the participants acquire a joint property interest in the assets and subject matter of the joint venture. The participants share a common expectation regarding the nature and amount of the expected financial and intangible goals and objectives of the joint venture. The goals and objectives of a joint venture tend to be narrowly focused, recognizing that the assets deployed by each of the participants represent only a portion of the overall resource base. The participants share in the specific and identifiable financial and intangible profits and losses of the joint venture, as well as certain elements of the management and control of the joint venture. While the aforementioned elements are of greatest importance in identifying a legal joint venture, they also illustrate many of the key characteristics of any independent joint venture, such as a new joint venture corporation, partnership or LLC. 3 Functional types of joint venture relationships Joint ventures can be classified by the various functions which may be performed by the enterprise. For example, a research and development joint venture can be a useful structure for combining the creative resources and assets of two or more entities in order to facilitate technical exchange and, hopefully, reduce the amount of time that might otherwise have been required in order to complete the development work. An R&D joint venture arrangement can be quite general; however, in light of the substantial costs and risks associated with development work, it is common for the agreement to include comprehensive provisions relating to the scope and duration of the research plan, covenants from each of the parties regarding protection of technology developed in the course of the joint venture, and, in most cases, agreements regarding use of the new technology. In some cases the formation of the joint venture occurs pursuant to a prior

7 agreement between the owners of the joint venture who may have entered into a separate agreement to carry out specific activities, such as basic research, that need to be completed before the more elaborate joint venture structure is implement. For example, a joint venture and partnership purchase option agreement has been used in the context of an R & D investment partnership structure to set out the terms of a joint venture that might be formed after the sponsor of the project accepts and uses funds from investors to complete preliminary research projects that will hopefully lead to the creation of products that can be commercially exploited in a joint venture owned by the sponsor and the investors. Complex R&D joint ventures include a number of the ancillary agreements, including assignment and license agreements covering technology which the parties contribute to the joint venture's activities and development and supply agreements pursuant to which the parties undertake to provide materials to the joint venture. 4 Manufacturing and production joint ventures are primarily dedicated to combining the resources of the parties in order to produce goods that would be available for use or sale by one or both of the parties. For example, one of the parties may wish to contribute the right to use one or more of its patents, as well as any related production technology and trade secrets, to a new joint venture enterprise, while the other party would contribute facilities, equipment, and personnel to manufacture the products covered by the patent. The finished products could then be delivered to the technology licensor for sale or sold by the joint venture, perhaps under a distribution arrangement with the manufacturing party. A joint venture between a domestic manufacturer and a foreign enterprise selling products into the United States might be formed to provide the foreign enterprise with a local source of materials and replacement parts for servicing customers in the United States. It is important to note that the activities of a production joint venture need not be limited to goods, and joint ventures are a popular vehicle for completion of building construction contracts. Marketing and distribution joint ventures are used for the purpose of distributing the goods and services of one or more of the parties in a given geographic area. For example, if a company is seeking to enter a new geographic market in another part of the United States with the assistance of a local partner with substantial expertise in that market, a new joint venture company might be created and the company would contribute the products, as well as any trade secrets or trademarks, and the local partner would provide the capital, facilities and human resources required to fully exploit the products in the market. In addition, the local partner may be able to provide the joint venture with access to various marketing channels and scarce supplies and utilities. A joint venture format might also be used to combine the professional know-how and services of a physician and the facilities and equipment owned by another to launch and operate a clinical laboratory. Still another example is when a joint venture is formed for the import and sale of specified products in a defined geographic territory and it is contemplated that the local party will initially provide logistics support and access to its preexisting distribution network in the territory with the long-term goal of having the joint venture mature to the point where it becomes an independent profit center.

8 Hybrid joint venture relationships combine two or more of the basic product development and distribution functions referred to above. A joint venture of this type is usually intended to serve as an integrated business enterprise, owning or controlling all of the assets and resources which might be required in order to develop and manufacture new products and market and distribute such products in specified markets. Each of the parties will contribute, either directly or through licensing or similar contractual arrangements, all the capital, technology, facilities and human resources required to fulfill the objectives of the joint venture's original business plan. 5 4 Motivations for joint venture relationships A joint venture carries with it a number of advantages and disadvantages. On the one hand, a joint venture can provide a party with access to resources and skills that are unavailable to it at any reasonable cost. However, on the other hand, use of a joint venture can be quite risky given the reliance that must be placed upon the ability and willingness of the other party to perform its obligations during the term of the arrangement. In considering whether or not to enter into a joint venture, notice should be taken of some of the following motivations that might drive a party toward such a relationship: The party may not have sufficient financial resources to take on a particular project by itself and may seek a partner to assist in sharing the financial burden and other risks of the project. Projects which require a substantial amount of investment in development work and product testing may be good candidates for the joint venture structure. In some cases, a partner may even be willing to provide most, if not all, of the funding in exchange for gaining access to the intangible assets of the party. The party may want to gain access to the technical resources and skills of another party. A joint venture which brings together managers and scientists from each party will facilitate the rapid exchange of information regarding existing and new technologies. The party may seek a joint venture with a local party in a new foreign market as a means of accelerating the pace of market penetration. The local party should be able to provide the requisite knowledge of local tastes and customs, and providing for equity involvement by the local partner will ensure that it will provide the best services to the joint venture. A joint venture may also be required in order to satisfy host country rules which require local participation. The party may use a joint venture to decrease the costs associated with the manufacture of its products while retaining some control over the quality of the process and the technology used in the course of completing the manufacturing activities. A party may choose a joint venture structure, rather than a network of contractual relationships, in order to ensure that it is in a position to directly manage the specific functional process, be it research work, manufacturing, or distribution. Also, a joint venture may be appropriate when the party believes that it will need to provide personnel to facilitate rapid transfer of trade secrets and other information for use in the collaborative venture.

9 In general, companies typically consider a new joint venture for several different reasons and no single factor will be governing. In fact, the rationale for a particular joint venture may change over time and ultimately the parties may determine that a relationship is no longer practical or feasible. Certainly, risk sharing is one of the key factors for both parties in a joint venture, particularly in situations where the parties are engaged in a project that requires a substantial amount of capital, the costs of product development are high and it is quite likely that the development effort will fail. Opportunities for economies of scale also entice joint venture participants and an effort should be made, subject to antitrust and competition law restraints, to construct and execute a business model that efficiently pools the resources of the parties and allows the joint venture to achieve the critical mass necessary for it to be competitive. A joint venture is also a viable path to gaining access to market segments and/or geographic areas that would not otherwise be available to a participant. 6 For younger companies, a joint venture is a good way to get access to the funding necessary to complete development of new products while also gaining credibility in the marketplace if its joint venture partner is well-known and well-regarded. For their part, established companies may enter into a joint venture with a prospective acquisition target as a means for determining whether an acquisition is feasible and desirable. The initial joint venture arrangement, which would include an option in favor of the established company to purchase the target, would be less costly than a full-scale acquisition and would allow the established company to cut its losses in the event that it becomes clear that a full combination of the businesses would not be profitable or deliver the desired result for the established company. Established companies in certain industries, such as pharmaceuticals, have often relied on joint ventures with younger companies as a way to develop new products without incurring substantial research and development ( R&D ) costs: younger companies are cash poor and need the support of larger established companies to fund expensive R&D to develop new drugs while experienced companies with the resources to move a new drug through the product approval and commercialization process would prefer to rely on the specialized technical and scientific capabilities of a younger company for the initial R&D rather than creating their own inhouse R&D infrastructure. 5 Regulation of joint venture relationships The formation and operation of a joint venture generally raises many of the same legal issues as confront any other new business entity. For example, the parties must be mindful of the requirements imposed by the law governing the specific form of business entity chosen for the joint venture. Also, in spite of the benefits of combining the resources of the parties, antitrust and competition law regulators will scrutinize the competitive impact of the joint venture. Joint ventures often involve an exchange of sensitive business information between the parties and raise concerns with respect to the protection of intellectual property and related rights. In the case of transnational joint ventures which, by definition, are expected to engage in the transfer and sale of technology and goods across national boundaries, the parties must consider the possible

10 effect of foreign investment and technology transfer laws, export controls and customs laws, laws pertaining to the sale of goods and anti-bribery laws. In addition, depending on the joint venture, the parties may also need to be concerned with employment, environmental and securities laws. Finally, the formation and operation of a joint venture will certainly raise challenging tax questions. 7 While courts and commentators have offered definitions of a joint venture, there is no joint venture statute to be found in federal or state law and this means that joint ventures must either be operated under common law principles or explicitly formed, organized and operated under the one of the recognized forms of business organizations such as corporations, partnerships and limited liability companies. Each of these business organizations have their own unique set of rules relating to the commercial activities in which they can engage, the rights and obligations of the organization, the governance process for the organization, and the rights and duties of the managers and owners of the organization. Also, statutory rules for each of these organizations set out the specific procedures that need to be followed for formation and termination. Antitrust laws will always be important in structuring joint ventures since there will almost always be licenses, distribution agreements, supply or marketing arrangements, research and development work, or other ancillary arrangements that will have both procompetitive and anticompetitive aspects or at least potential anticompetitive effects. As noted elsewhere in this chapter, joint ventures can be classified by the various functions which may be performed by the enterprise and the nature of the functional activities is an important predictor of the level of scrutiny that will be focused on the collaboration for antitrust law purposes. Based on recent cases, as well as the adoption of the National Cooperative Research Act of 1984, the type of joint venture that is least likely to pose antitrust problems is a research and development joint venture, since its activities are typically at least a step or two removed from the level where the most significant amounts of competition might be expected to occur. Production joint ventures have also been the beneficiaries of relaxed treatment, as well as the changes in the National Cooperative Research and Production Act of Marketing joint ventures are the most likely to raise antitrust problems, whether or not the joint venture is involved in research and production activities, because they can often fail to add productive capacity to the market and present horizontal competitors with an attractive vehicle to coordinate pricing and marketing decisions. The analysis may also turn on the scope of the joint venture's activities, with one-shot joint ventures with a limited focus (e.g., a joint venture to build a particular, multibillion-dollar hydroelectric plant) much less likely to be a cause for concern than a joint venture in which the participants would integrate all of their activities in a particular field. 6 Basic structural components of an equity joint venture The formation and organization of an equity joint venture is a complex process that should be carefully planned in advance (see Table 1). In general, the activities to be conducted while forming an equity joint venture must take into account all of the same issues which are generally encountered with any new business enterprise. For example,

11 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 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; additional capital contributions; disputes and deadlock, including alternative dispute resolution; buyout and option to purchase; and termination or breakup of the venture. 8 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 to conduct the joint venture activities will be governed by the applicable state partnership statutes, formation of a new LLC to conduct the joint venture activities will be governed by the applicable state LLC statutes, and formation of a new corporation for the joint venture requires compliance with applicable corporation law statutes. Assuming that the corporate form is elected for the joint venture, the basic structural components would be the so-called charter documents (i.e., articles of incorporation and bylaws), which are filed with the appropriate regulatory authority and describe the capital structure of the corporation as well as any specific rights granted to the shareholders with respect to voting, distributions and liquidation; and a shareholders' agreement that would cover essential issues such as the business objectives of the venture; initial capitalization of the venture, especially the contributions to be made by each of the parties; additional financing for the venture; management and control of the venture; the operational activities of the venture (e.g., administration, research, manufacturing, distribution, sales, etc.); transfers of shares and procedures for early withdrawal of one of the parties prior to the end of the designated term for the venture; accounting matters, including allocations and distributions of income and other assets; and the term and termination of the venture. In addition, the shareholders agreement will often include various representations and warranties by each of the parties, agreements with respect to confidentiality of information exchanged in the course of the venture, procedures for the resolution of disputes, a description of any internal controls required to monitor the progress of the venture. Use of a partnership or LLC would require preparation of the customary charter documents for those entities such as a certificate of limited partnership, articles of organization, a partnership agreement or an operating agreement. In addition to the documents and agreements discussed above, the parties may also enter into one or more contractual agreements directly with the joint venture to provide necessary support in various areas that may be required in order for the newly-formed entity to operate and be successful: A party may be engaged to conduct a specified program of research for the joint venture. The party may receive cash payments to defer the costs of the work and the joint venture would either own the results of the development program or have the right to use the results as the exclusive licensee.

12 Although it is usually the intent of the parties to build the joint venture into a selfsustaining business enterprise, one or both of the parties may contract with the venture to provide basic administrative and management services for a portion of the contemplated term of the venture. A joint venture is an appropriate business form when one of the parties is in a unique position with respect to its ability to supply one or more essential components to the venture. As such, the venture will often enter into a supply agreement with the party designed to ensure the ready availability of needed components for the products that are to be manufactured and distributed by the venture. While tangible and intangible property may be contributed outright to the joint venture, it is also possible to loan or rent such properties, in the form of a lease or license, to the venture in return for a specified rate of return. A party may enter into an agreement to manufacture products to be distributed by the joint venture. This is quite common in joint ventures in developing or emerging countries with relatively lower labor and manufacturing costs; however, the nonmanufacturing party must be sure that the manufacturer will be able to satisfy all the requirements of the joint venture. Developing an independent distribution and marketing capability is generally perceived to be far too expensive for the joint venture form. Accordingly, one or both of the parties may take responsibility for distributing the joint venture s products through their existing distribution channels. 9 Although the joint venture is established as a separate legal entity, the enterprise will only survive for that period which is required in order for each of the parties to achieve the specific goals and objectives of the relationship. Upon termination of the joint venture, the entity will either be liquidated with the parties each receiving their agreed allocation of the remaining assets and resources of the venture, or one of the parties will buy the interest of the other party and continue to operate the business of the venture outside of the original joint venture relationship. Most of the termination provisions will be described in great detail in the master agreement between the parties (e.g., the shareholders agreement in the case of a corporate joint venture) and the charter documents for the joint venture entity (e.g., the articles of incorporation in the case of a corporate joint venture). But, even though the master agreement may include termination provisions, the parties may elect to enter into a separate form of agreement to dissolve the joint venture when the time to wind up the business actually arrives. Table 1 Checklist of Activities for Formation of New Joint Venture 1. Conduct an internal assessment to identify the goals and objectives for the proposed joint venture and engage counsel to assist in the formation of the joint venture and the negotiation of documentation required in connection with the formation and organizational activities. 2. Consider the need to engage a finder, broker, or investment banker to assist in the transaction (e.g., locating prospective joint venture partners) and, if so, prepare necessary documentation. 3. Identify prospective joint venture partners and collect preliminary information from publicly-available sources. 4. Draft confidentiality agreement for execution by parties prior to commencement of definitive negotiations and exchange of information during due diligence investigation.

13 5. Concurrently with the execution of confidentiality agreement, establish procedures for conduct of due diligence investigation by both parties. 6. Make a preliminary determination of appropriate joint venture structure and commence analysis of relevant legal (e.g., tax, corporate, securities, antitrust, environmental, and employment/labor) and accounting issues. 7. Prepare timetable and list of required documents for proposed transaction and consider the need for a meeting of all parties to allocate responsibilities. 8. Negotiate, draft and execute a letter of intent or memorandum of understanding. 9. Draft a preliminary business plan for the joint venture or be sure that it is a priority item to be completed within a short time after formation of the joint venture. 10. Prepare initial drafts of all required agreement, including shareholders', partnership or operating agreement, all required ancillary agreements and documents (e.g., documents required for formation of the new joint venture entity) and any necessary schedules or exhibits (e.g., schedule of capital contributions), and circulate drafts of all such agreements to all parties. 11. Prepare and complete all required pre-transaction filings with regulatory authorities (e.g., Hart-Scott- Rodino Act, foreign regulators, etc.). 12. Determine all required entity actions (e.g., director and shareholder approvals in the case of a corporate joint venture) for parties to enter into transaction and for new entity to be formed and enter into agreements relating to formation and operation of joint venture. 13. Consider need for third party consents to the transaction (e.g., lenders) and, if necessary, obtain such consents. 14. Consider need for formal opinions from accountants regarding tax and/or accounting treatment of the formation and operation of the joint venture and from investment bankers regarding the value of contributions to be made by each of the parties. 15. Prepare all necessary documentation for transfer of assets to joint venture at the time of closing, including bill of sales, assignments, licenses, leases, etc. 16. Collect comments on all documents and prepare final form of agreements for execution. 17. Prepare all documents to be delivered at closing, including legal opinions, officers' certificates, etc., and arrange for copies of good standing certificates and similar documents from regulators to be available for delivery to the parties at the closing. 18. Verify that all regulatory approvals for the transaction have been obtained. 19. Check to be sure that all representations and warranties in the shareholders', partnership or operating agreement are correct, and that all covenants and closing conditions have been satisfied. 20. Obtain all required signatures to documents. 21. Prepare a closing memorandum and conduct a pre-closing to insure that all documents are in order and that arrangements have been made for timely delivery of the consideration (e.g., wire transfers to appropriate accounts opened in advance of closing) and all other required filings. 22. Close the transaction and verify that all documents have been properly dated and delivered. 23. Complete organization of new entity (e.g., initial meeting or actions by incorporators and board of directors in the case of a corporate joint venture). 24. Give all required notices to regulatory authorities and other parties regarding consummation of transaction. 25. Calendar periodic review of compliance with covenants included in the documents (e.g., completion and approval of initial business plan), as well as dates of meetings required for the governance and operation of the entity (e.g., annual meetings of directors and shareholders in the case of a joint venture corporation). 26. Circulate copies of documents to all parties. 10 Public Joint Ventures While most of the discussion in this publication focuses on the formation, organization and management of joint ventures using a new business entity, such as a corporation or limited liability company, notice should be taken of joint ventures that are formed by an investment by a new party into an existing business entity that results in a collaboration between the new party and the executive team of the existing business entity. In that scenario, there are typically far more than just two equity owners of the joint venture business: the

14 new party and the previous shareholders or members of the existing business entity. In fact, a so-called public joint venture has often been created in certain industries, such as in the biotechnology sector, when an established company purchases an equity stake in an existing public company that provides capital for the public company to take on projects of interest to the purchaser. A representative list of such transactions compiled based on deal occurring during the 1990s revealed that public joint ventures had been used in a wide range of industries beyond pharmaceutical and biotechnology such as ice cream and frozen desserts, regional banks, brewing, consumer products, clinical laboratory testing, exploration and production, utilities, agriculture and cellular communications. 11 While very deal is different, the initial investments were made with the consent and support of the board of directors of the company, ranged from 29.5% to 60% of the outstanding equity after the deal was done, and often included options to increase the ownership stake short of an outright acquisition; however, any option to purchase additional equity was carefully structured in advance to ensure the public minority shareholders of the company were adequately protected. Structures varied significantly and included the following: A tender offer by the purchaser to the existing public shareholders of the company, endorsed and supported by the directors of the company, that resulted in the purchaser s acquisition of a significantly minority interest in the company. A tender offer by the purchaser as above coupled with an additional investment of cash and/or other assets by the purchaser directly into the company to provide the company with new resources and increase the purchaser s ownership stake in the company. A direct investment of cash and/or other assets into the company by the purchaser in exchange for an equity stake and, in some cases, subordinated debt securities or other unlisted low voting securities. A merger of a subsidiary of the purchaser and the company that resulted in the issuance of an equity interest in the surviving entity to the purchaser. A contribution of the stock of one of the purchaser s operating subsidiaries to the company in exchange for cash and an equity interest in the company, a transaction that provides the company with the opportunity to use the resources from the purchaser s former subsidiary to pursue projects of joint interest. Not surprisingly, such large investments triggered changes in corporate governance procedures given that the purchaser had substantial influence over the company by virtue of its equity stake, but generally the purchaser was willing to go without complete control over the company and leave the existing management team in place in order to ensure continuity over day-to-day operations and maintain the company s corporate culture. For example, purchasers usually agreed to limitations on the number of directors they could designate for the board of the company and requirements that certain corporate actions could not be completed without the approval of directors unaffiliated with the purchaser. In addition, the purchaser frequently agreed to employment agreements with key personnel of the pre-transaction company. In turn, the purchaser was almost always granted the right to approve significant actions relating to the company at the board and/or shareholder level. While, as discussed above, the purchaser typically made cash investments in the company, it also contributed resources from its own businesses, including business units that had been operated as subsidiaries, and entered into other commercial agreements with the company covering activities such as research and development, manufacturing, distribution and/or marketing. By contributing business units that included sales and marketing activities for their existing products, purchasers were able to have an immediate impact on the breadth of the company s product line and increase the size of the company s sales force. Options to make additional investments were generally tied to specific product development activities and purchasers sometimes carved out additional flexibility for the company by creating revolving lines of credit that the companies could tap into to meet short- and medium-term capital requirements. Source: Portions of the discussion above are adapted from C. O Brien and S. Gummaregula, International Public Company Joint Ventures, an article originally published in 2004 that appeared in Transnational Joint Ventures (Eagan, MN: Thomson Reuters, 2015).

15 7 Evaluation and selection of joint venture partners A good deal of time and effort must be spent in locating appropriate candidates for a joint venture. It may be possible to build on an existing relationship with a current supplier, distributor or customer. In other cases, information about potential candidates should be solicited from a variety of experts in the area of interest, such as trade associations; chambers of commerce; investment and commercial bankers; lawyers; accountants; and independent consultants. Firms with complementary strengths and needs can also be identified by reviewing information in published reports, such as the periodic reports that may be filed with the United States Securities and Exchange Commission and with similar regulatory agencies in other countries. Government organizations in many countries (e.g., Ministry of Commerce, Ministry of Trade and Industry) often serve as catalysts for foreign investment and joint venture transactions. 12 Clearly, a joint venture presents special problems since, by its very nature, a joint venture requires partial integration of the skills, attitudes, bias and experiences of the organizations of each of the partners, as well as many of the persons within them. Fortunately, there are few subjects that have been more extensively analyzed then the selection of potential joint venture partners and there is broad agreement that the following factors should be considered during the search process: The potential partner should be compatible with the firm in a number of areas, such as the level of commitment to the joint venture, the size and structure of the organization and the underlying national and corporate cultures. Under the best of circumstances, the parties will have had some sort of prior relationship with one another. The functional skills and resources of the potential partner must complement those of the firm. For example, in an international joint venture formed in order to take advantage of the local partner's ability to rapidly access the market, the firm should be more concerned about the skills of the prospective partner in the distribution area than about the partner's ability to assist in developing any new products. The potential partner should have the managerial resources required to provide all needed assistance to the joint venture, particularly in those areas in which the partner is to have primary functional responsibility. Although the joint venture often is operated as a wholly separate entity, it is sometimes useful to have a partner that is willing and able to provide facilities and administrative support for a portion of the joint venture's activities. There are cases, such as in international joint ventures and in ventures which involve products which are subject to government testing and approval, when the skill and experience of a prospective partner in dealing with the government can be extremely important. For example, in a number of foreign countries, the government exercises actual or de facto authority over local distribution. The potential partner must have sufficient financial resources to support the joint venture, as well as any functional activities that it will be called upon to undertake for the joint venture. A joint venture is perhaps the most visible form of business relationship. If possible, an effort should be made to find a partner with a solid reputation in the

16 market, as well as in the functional skills and resources that the partner is being asked to provide to the joint venture. 13 Information on all of the factors above, as well as the specific skills and resources to be contributed by the prospective partner to the joint venture, should be gathered during a formal due diligence investigation, which involves a general review of each party s business and affairs as a condition to consummation of the final form of agreement. The due diligence investigation, which may occur in stages before and after execution of a memorandum of understanding, which is discussed below, but before the signing of the joint venture documents, and which allows the parties and their counsel to independently verify the information about the other party's business that has been provided to them. The exchange of information also allows each party to evaluate its prospective partner to determine, at least preliminarily, potential compatibility, the relative stages of technological development, the respective financial strengths (or weaknesses) of both parties, their respective management structures and ideologies, and whether all of these various factors are or can be made complementary. In many cases, satisfactory completion of the due diligence investigation is made an explicit condition to the closing of the transaction. No information regarding the proposed joint venture or the current operations of either of the parties should be exchanged before the parties enter into an appropriate agreement to preserve the confidentiality of sensitive technical or business information and to restrict the disclosure of the information to unnecessary parties. These confidentiality and nondisclosure agreements can take a variety of forms, ranging from simple one-page letters to long and elaborate documents that require a good deal of negotiation. The amount of effort that goes into preparing a confidentiality and nondisclosure agreement will depend on the scope of information to be disclosed and its importance to each of the parties, as well as relevant common and statutory law protections for trade secrets and confidential information. The type of information exchanged will depend on the circumstances and the amount of preparation done by each of the parties in advance of the exchange. In many cases, one of the parties may have already conducted a substantial feasibility study of the proposed joint venture project, and may have developed some form of preliminary business plan to demonstrate the economic feasibility and attractiveness of the proposed joint venture. While such a plan may be extremely useful, it is important to remember that there may be substantial differences between the accounting practices of the parties, as well as the relevant tax rules in cases where the parties are from different countries. Also, the preliminary model of the proposed project will uncover potential differences with respect to assumptions relating to the timing of contributions, distributions to the partners, and the level of retained earnings and required outside financing. There is no standard set of procedures that can be referred to for conducting a due diligence investigation in the context of a proposed joint venture. The amount of effort will depend on the particular company, the type of transaction, the style of the company conducting the investigation and, to some extent, the size and importance of the proposed