This article has been written by Kashish Goel, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Joint venture
The ultimate goal of any business is to grow their bottom line (net profits) and keep on expanding to new market areas, which would get them a larger customer base and better resources. Commonwealth alliance program (CAP) Advisor-focused business solutions, powered by people wrote in a report that strategic alliance accounted for a total of 20% of the revenue in all of 2005, which amounts to a total of $40 trillion. This figure is steadily growing in the years as more and more businesses are growing uniting in order to survive the global competitive environment.
Introduction
It is no secret that one of the most powerful tools to grow a business is Joint Ventures (JVs). JVs can be said when specifically, one person teams up with another person or an agreement between a group of people or between business entities so that they can expand their business and have a larger market presence.
The origins of JV can be traced back to the 1920s. This concept was first used by the American Companies in particular and people in other export nations followed suit. This concept of doing business spread around the world at the end of the II World War. In the 1909s the term “joint venture” gained popularity as the markets of Europe and China opened up.
Purpose of the joint venture
Parties in a joint venture come together in order to attain their business goals which would be harder or costly to attain independently. When a joint venture is established with an ideal partner this helps the party to leverage the resources of the other partner to gain access to new markets, sharing each other’s capabilities or strengthen their position in the current market to diversify into new businesses.
Types of joint ventures
There are 4 most important types of joint venture that are practised by the companies:
- Project-based joint venture- This is a type of JV, where the parties come together with a motive to accomplish a particular task.
- Vertical Joint Venture– This is a type of JV, where the parties are at different level of the same product and decided to come together in a JV
- Horizontal Joint Venture– This is a type of JV, where the parties are competitors and decide to come together.
- Functional-based Joint Venture– This is a type of JV, where the parties come together in order of getting a mutual benefit by the synergy of the two parties.
Now, let’s get into each of them in detail:
Project-Based Joint Venture
This type of joint venture where the corporation enter into agreement to accomplish a particular task that can be anything such as, execution of any particular project or for a specific service that is to be offered together. These collaborations are usually taken by companies for specific and exclusive purpose only and they cease to exist when the specific project is accomplished. In simple terms these are the type of joint ventures that are bound by a particular objective or for a specific project or by time
Example:
Axon Limited, it is the company that launched the development of residential projects, lately they entered into a joint venture with the Trump industries who are the pioneers for sales and marketing of residential projects for “Living Rise”, a new project for Axon Limited. This can be termed as an example project based venture that is done on a particular task and will be terminated after the accomplishment of the said task.
Another example of Cipla and Biocon
‘Cipla’ being a traditional pharma company wanted to enter into the booming industry of biotechnology on the other hand ‘Biocon’ is a biotech company. Cipla. by utilising the resources and development infra of Biocon, Cipla intends to do research and development on a drug for an ailment. Should it be done by Cipla buying out the whole firm of Biocon and could get all the research capabilities but that would have been a very expensive affair for such a project.
In order to make this a successful project between the two companies they came forward together by using their advantages that is, Cipla, which has a widespread marketing Network and Biocon which has some research capabilities, came together and entered into a project-based Joint Venture. Being in a project-based JV doesn’t necessarily mean that they wouldn’t come together for a project in future together. Both of the companies can build from each other resources.
Function-based joint venture
This is a type of joint venture where is the business entities common together in an agreement to mutually benefit, that is, mutual on the account of synergy which is in terms of functional expertise in certain areas, which together can enable them to work in an effective and efficient manner. Before a company enters into a joint venture agreement, the rationale of the companies is to focus on whether they will be able to perform the same task together efficiently or not.
Example:
Suppose there is a company ‘P’ that specialises in the formulation business and it has various intellectual Property Rights under its name but because of lack of money, they are unable to put such intellectual property rights to Commercial usage. On the other hand, there is a company ‘Q’ which is a cash rich company and it doesn’t have any in-house intellectual property rights but they have enough money to fund the other company. Now, both of these companies can come together and mutually benefit from each other by entering into a functional-based joint venture.
Vertical joint venture
This is the type of joint venture where the transaction between the buyers and the suppliers takes place. It is not an economically viable option available and is usually referred to as bilateral trading. In such joint ventures normally the maximum gain captured by the supplier side parties while buyer side parties only get limited games. Here in this joint venture there are different stages of making a single product in industry which are integrated to create economies of scale that is reducing the cost per unit of the product by streamlining the whole process. It is seen usually that this type of joint venture has a higher success rate and also the relationships between the buyer and supplier are good which is ultimately helping the businesses by which they offer quality products and services at a reasonable price to the consumer.
Example:
Lincoln Corp is a business entity invested in certain capital instruments and machinery so as to produce products that are buyer specific. These investments are made by Lincoln solely for the purpose of fulfilling the requirements of the buyer. With a joint venture in place Lincoln corp can avoid uncertainty associated with contracts are usually for a limited time, and leads to the termination of business.
Horizontal joint venture
This type of joint venture where the companies are the direct competitors of each other and are selling similar products. They come together in a joint venture to create an output that can be sold to their customers as well as to the competitor’s customers at the same time. This in this type of joint venture, where the management is very cumbersome and it often leads to disputes because partnerships between the parties who are into the similar line of business have come together. Furthermore, in this type of joint venture the parties suffer from opportunistic behaviour between the partners due to the similar line of business. Gains that are made by this Alliance in the joint venture is shared according to agreement or equally by the parties.
Example:
A company which specialises in steel extrusion business, Base International is an Indian company and has their customers in various industrial units. Whereas, Frank LLC is a company that specialises in the moulding of Steel frames it is a US based LLC, has also applications in the industrial units. These two forms can be said to be in a horizontal line as both of them work in very similar industries and cater to the similar customers.
Both of these companies agreed to enter into a joint venture agreement in which the Indian counterpart will make available to them their site their product parts their local machinery on the other hand the US-based company will offer their collaboration and foreign exchange components on the technical tasks.
By becoming one in a joint venture agreement they will cater to the two companies existing clientele. Now, by doing this both of the companies will sell their products in the markets of their partner’s thereby putting the resources of the parties to a better use and profiting from each other.
Types of a joint venture in India
JVs in India can be of two types:
Contractual Joint Venture
This is the type of joint venture that can be used when the company is not in need of a detached legal entity or it is not feasible for the company to create one.
When the JV is needed to be established for a temporary term or there is a limited activity or, that involves a temporary task this is it type of agreement that is preferred by the company.\
Equity-Based Joint Venture
Here the legal entity address independent is created when there is an agreement of two or more parties.
For this entity that is created independently, the associated parties agree to provide resources or money as their contribution towards the assets or capital to the corporate identity
Examples- Hindustan Aeronautics Ltd, Vistara, Mahindra Renault Ltd., ICIC Lombard, ICIC prudential life insurance company Ltd.
Advantages of joint venture agreement
- You can use your resources more efficiently.
- The parties can get access to a new market to offer their products and scale the distribution network.
- The costs and the risk associated to the business will be shared.
- The parties will gain each other’s knowledge, expertise and specialised staff.
- You can sell your other products in the newly expanded markets.
- Using the partner’s resources to provide services to your customers.
- Having a better R&D department due larger resources.
Disadvantages of joint venture agreement
- The two or more companies may have a different style of management and different cultures that can pose a barrier in the working of the JV.
- In the early stages, there is a lack of support and leadership.
- The distribution of resources and work is not equal.
- Sometimes, the objectives of the JV are not clear.
- All the communication that should happen between the partners might not be good, as they have different styles of management.
- In a JV, one party may have an upper hand due to which the other party may not provide the same level of expertise in R&D.
- Due to the signed contract of a JV, partners’ core business might get affected due to the obligations to fulfil of a contract.
Conclusion
Joint ventures and mergers are said to be an excellent way for business entities to enlarge their market position and increase their profits in the Marketplace. The companies which are similar can use horizontal or vertical Merger. The purpose for both of these are different as in Vertical Merger companies that are joined are in the different stages of the product whereas in a Horizontal merger the companies that are joined are and competition with each other in my opinion the companies can come by temporary to complete a specific project in a given time and the joint venture agreement take and have a started a one goal is achieved.
The particular type of joint venture to be entered is considered upon analysing the circumstances of each of the companies and what type of synergies these companies are aiming toward. It will act as a stepping stone no matter what type of joint venture the business come chooses they can always analyse and how they would work together and what their future collaborations could be.
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