Thursday, September 28, 2023

3 pitfalls in a joint venture that founders should avoid

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Startup founders should be aware of the legal pitfalls that joint ventures and strategic alliances can pose as they try to save money as technology valuations plummet.

Every deal is an opportunity for both parties to pursue their strategic goals without any takeover risk. But the relationship needs the right structures so that both parties benefit, which also means flexibility to deal with changing circumstances.

Falling growth forecasts have hit the valuation of startups hard and reduced the amount of capital expected to flow into the technology sector in the near future.

Layoffs common in the US have reached Australia’s shores. Neobank Volt has decided to close the store (Daily startup) after failing to secure new capital. More of this is likely to come.

The message from VCs to Australian and US startups was clear: save as much money as possible to get you through this recession.

As a result, we expect an increase in joint ventures and strategic alliances (JVs) among the Australian startup community as companies look for ways to save money, retain talent and maintain strategic roadmaps in an environment of tighter wallets for investors.

To quickly set the tone, a JV is a transaction where two companies agree to combine certain resources and leverage their respective tactical and strategic strengths for a specific project. This could be a product or service similar to what one or both of them offer, or it could even be the creation of a brand new business with a different core business or market.

JVs are common in certain industries such as commodity industry, rain or shine. The Harvard Business Review reports that companies, including Rio Tinto and Shell, rely on joint ventures for 25% or more of their revenues. HBR also names Amazon, GlaxoSmithKline, Lockheed Martin, Siemens and Volkswagen as frequent users.

JVs can take various forms. In a joint venture with legal personality, a new company is registered, where the parties involved are shareholders in the new company. A shareholders’ agreement sets out the rights and obligations of the parties and the manner in which the joint venture will be conducted. This is really akin to a startup situation with two founders.

Strategic alliances have a similar principle behind them, but the parties do not create a separate entity to hold the combined business. These arrangements may include distribution partnerships and referral arrangements, or sometimes even joint research and development agreements. We’ve already seen a rise in companies looking to forge new distribution deals as they quickly seek new revenue streams.

The major appeal of JVs is access to expertise, a pool of capital or other resources owned by a JV partner without the risks associated with a buyout or merger. This can be especially helpful during a recession.

But there are three main reasons why joint ventures and strategic alliances don’t work; failure to correctly define the inputs and outputs for each joint venture partner; an inability to match the incentives of the JV and each of her partners; and failure to anticipate external changes.

The probability of success of a joint venture is determined in the negotiation phase. Successful joint ventures will have defined and aligned a range of high-level issues, including their contributions to the JV, their rights to the benefits generated by the JV, and the extent to which each partner can continue to operate freely outside or even in competition with the JV. JV.

3 things to consider

First, companies that view JVs as a strategic option need to find the right partner(s). The selection criteria should be based on actual need. For example, a startup might have a lot of talent and ideas, but a lack of capital and infrastructure, meaning their best JV partner is likely to be a BigCo that likely has both. However, companies must also ensure that the partner is also a cultural fit. While by no means a deal breaker, the parties should recognize that a cultural mismatch may exist and strive to align with governance rules and structures to avoid or minimize friction down the line.

Second, the parties must clearly define the types and values ​​of their contributions. The success of the JV will depend on access to sufficient human capital, financial capital and other assets (including intellectual property) to sustain the JV given the anticipated business plan. While some contributions will be readily valued in current dollar terms, others, such as IP licenses and non-compete obligations, will also need to be valued to ensure that the parties each contribute their agreed-upon proportionate share.

Third, the partners must determine the structure and business model of the joint venture. It is critical for a joint venture to have a detailed management structure, operating model and performance metrics and for the partners to ensure that all parties have respective incentives well aligned with the overall success of the business. This includes mechanisms to ensure the resilience of the JV in the face of changing operating conditions.

Finally, the parties should adequately consider how to exit the joint venture in a way that everyone can agree to beforehand. Sometimes this means buy-out rights. In other cases, this means that the parties can divest the business.

Joint ventures fail if the parties are not aligned. While joint ventures can be a critical and timely tool to reduce cash burn while maintaining momentum during a downturn, they require a degree of care and foresight to ensure the project starts and lasts.

Founders who take the time to properly conceptualize and negotiate the legal structures of a joint venture with the right partner may find that the economic slowdown is more likely to become a speck in the rearview mirror than their peers.

  • Anthony Bekker is founder and MD, APAC, of ​​Australian-American technology legal consultancy BizTech Lawyersb & Chris Spillman is MD, Americas, at BizTech Lawyers

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