This article is written by Visha Shah who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
A joint venture in common parlance means a business arrangement wherein two or more entities come together to pool their resources and efforts to accomplish a task and thus have a strategic edge in the market. Ideally, a joint venture (JV) may be a new initiative with similar services, or it may be a newly incorporated company with distinct business operations.
A JV is usually initiated through an agreement between the concerned companies and the profits or losses are shared by all the partners as agreed in the JV Agreement. There are various advantages why companies may enter into a JV such as shared investments and expenses, technical expertise and know-how, government tenders, etc. In India, JV is quite common in various sectors like infrastructure, insurance, technology-based companies.
Forms of JV
Normally, the structure for a JV is chosen based on what the venture intends to do. In India, a JV may either be equity-based/incorporated or contractual/unincorporated.
Equity/Incorporated JV:
An equity JV structure is most feasible for long-term JVs. An equity/incorporated JV is a structure wherein a new separate legal entity is incorporated with two or more parties to the agreement either as a new company under the Companies Act, 2013 or as an LLP under the Limited Liability Partnership Act, 2008. In an equity JV, the parties have joint ownership and management of the newly created entity, and the profits and losses are generally divided as per the ratio of capital invested by the parties respectively or as agreed mutually by the parties.
Company JV:
Under this form of JV, since companies have an independent legal structure, there is flexibility to raise finance and the company survives even if there is a change in ownership. A specific minimum amount of capital is not prescribed either in a public or a private company. A private limited must have at least 2 share-holders whereas at least 7 share-holders are required in a public limited and the share-holders may either be foreign citizens or foreign companies. However, it is mandatory as per the Companies Act, 2013 that 1 director is an Indian resident.
LLP JV:
Under LLP form, the parties form a new legal entity under the Limited Liabilities Partnership Act, 2008. Forming an LLP is beneficial as it provides the JV a separate legal status as well as limits the liabilities of the partners. Under an LLP, 2 designated partners are required wherein 1 of the partners is an Indian Resident. The government of India has recently permitted FDI in LLPs which operate in sectors that have 100% FDI through an automatic approval route and there are no sector-specific conditions with respect to FDI-linked performances.
In case the JV is going to have foreign investment, then separate LLP is preferred and it must comply with FEMA Regulations.
Contractual Agreement/Un-incorporated:
A contractual agreement JV does not require a newly incorporated separate legal entity since this kind of structure is more feasible for project-based or limited activity tasks.
Partnership JV:
Forming a partnership firm under the Indian Partnership Act, 1932, is a simpler process than forming a company under the Companies Act, 2013. This is an unincorporated JV structure where the main motive is earning profits.
Strategizing Shareholding Pattern in a JV
Shareholding Pattern:
When two entities prepare to enter into a JV, the most crucial step is to decide the level of ownership and control. Some companies adopt a 50-50 split of equity pattern for flexibility in carrying out the business operations. So, if the companies entering into a JV want to have equal ownership and control over the operations and management of newly created JV, then the JV has to be structured in a 50-50 equity split so that both the entities have an equal number of shares and also equal representation in the Board of Directors and equal managerial and operational responsibilities. In this structure, contribution by both parties is roughly equal as no party wants to leave off control and ownership of JV. Another reason why companies choose a 50-50 structure is that they wish to build a long-term partnership that is independent and also sustainable as it involves balanced risks, contributions, and rewards.
Strategic factors also determine the share-holding pattern of a JV business which depends on what the parties have to offer to the business —- cash, land, business, technology, or intellectual property. For instance, one of the partners is contributing only land, then in such case, the partner may be interested only in part profits and a smaller shareholding. A minority shareholding is also sometimes interesting in certain cases because it limits the capital expenditures, and also reduces the risks that shareholder is exposed to along with reducing the operating responsibilities.
However, if a partner is heavily investing in a JV, then such a partner may prefer to have control over the company’s management and operations along with a large stake.
Not always do the shareholdings depend on only these factors. Even though the shareholding pattern may have a wide impact on the control of operations and management of a company, they are also subject to individual sectoral regulatory restrictions. For example, in the insurance sector, the ownership and control of an insurance company is supposed to be with Indian parties as per the provisions of the Insurance Regulatory Authority of India since the government of India has not allowed 100% FDI. So, if a foreign company wants to invest in the insurance sector in India, it has to form a JV with an Indian insurance company, wherein the shareholding of the foreign partner shall be limited as per the sectoral regulatory norms.
Under a JV, what usually happens is that the party that contributes the maximum assets/cash holds the most equity and will also receive voting rights as per the holding. When a JV is structured as a 50-50 equity split entity, the majority of decisions like an admission of a new partner to the JV, amendment to the original JV agreement, material investments, etc. require both partners’ approvals. A shareholder who holds a 25% stake, can exercise certain control which includes the right to block certain resolutions in special matters. A minority shareholder having a 10% stake in issued and paid-up capital also holds certain exercisable rights like with-holding consent for carrying an annual general meeting at a short notice or take action against oppression and mismanagement.
To protect the rights of the partners, it is better that the shareholding partners either hold at least 76% stake and thus, gain special control of the JV. However, holding a 90% stake gives complete control over the JV. It is pertinent to note that if a JV is a private limited company, the transfer of shares is restricted to maintain the pattern of shareholding of minority and majority shareholders.
Everything regarding the shareholding pattern has to be drafted into the shareholders’ agreements with clear terms and conditions and all necessary clauses like for instance the drag/tag along clause, exit clause, etc. that can affect the shareholding and rights of other partners/promoters/shareholders.
The following are a few ways of structuring shareholding in a JV under a company and a contractual agreement:
Company:
The Memorandum of Association (MOA) as well as Articles of Association (AoA) while incorporation, need to be well-drafted so that it reflects all the rights and obligations of all parties. It is important that for a JV agreement and a shareholders’ agreement to be binding on the JV company, the terms and conditions of these agreements are mentioned in the MoA and AoA. And if at any time during the span of JV, there are changes in the shareholding pattern or change in ownership of JV, then there should be a clause in the JV agreement and shareholders’ agreement to amend MoA and AoA as and when need be.
In a JV, the following are how shareholding could be structured:
Subscribe to shares of JV:
All the parties to a newly incorporated JV subscribe to the shares of the company in a mutually agreed ratio along with all terms and conditions of sharing profits and losses as well. This setup allows structural flexibility and ease of management to all the parties of the JV.
Transfer of Technology and share subscription:
Another way of structuring shareholding in a JV is that the parties to the JV incorporate a new separate company, and then one party transfers its business technology instead of cash consideration to this newly formed JV company in lieu of shares issued by the new JV. However, if assets/business technology is transferred in lieu of shares in an LLP, then this may be subject to provisions of “consideration other than cash” under the Companies Act, 2013.
Collaborating with the existing company:
When another entity wants to acquire the shares of an existing JV company, this proposed partner (entity) can either acquire the shares of the existing shareholder(s) or can subscribe to new shares. And the MoA and AoA will have to be amended accordingly.
Unincorporated/Strategic Alliances:
When a JV is a contractual agreement, then irrespective of the investment by the parties in the JV, the shareholding will be as per the terms and conditions of the shareholders’ agreement which shall be in a mutually agreed ratio by them. It is pertinent to note here that even if the parties are not partners in legal parlance, they still are participants in that contract and that makes them equally exposed to all claims and liabilities for the activities they carry out following the contractual agreement.
CCI Rule
As per the Competition Act, any change in control of ownership or assets which crosses a specific threshold as prescribed by the CCI shall be notified to the Competition Commission of India. If in case a new JV is formed, then the partners need to check whether the new JV is within the purview of the term ‘enterprise’ under the Competition Act. A Greenfield JV generally does not need to be notified nor does it require prior clearance of the CCI since it does not own assets or generate revenue. In case of a JV which is by way of filing a fresh share subscription or by acquiring shares in an existing JV, if crosses the prescribed CCI limits, has to be notified to the CCI.
Exit Route
Ideally, a JV’s structure is framed in a manner wherein it is easy to change in the future. Even today, there are JVs that have been operating strongly for decades. It is easy to exit a JV as compared to a merger or acquisition once the strategic milestone is achieved or a particular tender/project is complete for instance, once the objective of forming JV is completed, the partner can sell their stake or opt to dissolve the JV completely as well. However, to make the exit smooth and flexible the JV partners should have a detailed exit strategy in place in the transaction agreement.
There are a few components for exit which can be looked at from the point of view of a JV:
Exit triggers: These are the factors that focus on the milestone achievement or completion of a JV project. It also focuses on if the JV is unable to achieve the target due to heavy competition in the market or another reason, the partners might consider taking an exit from the setup.
Exit Scenario:
Ideally in an exit scenario, partners may consider selling shares, winding up the company, or transfer of interest.
Following are a few options of an exit scenario for a JV:
Options to exit from a JV company –
Either the exiting JV partner may offer to sell his shares to other partners/shareholders/promoters and then one of them buys those shares (here the offer to sell happens through a right of first refusal or right of first offer, which helps the other shareholders/promoters to control the process of adding a new shareholder); and if the partners/shareholders/promoters do not buy the shares, then those shares may be offered to a third party, subject to transfer restrictions as per AoA and Shareholders’ agreement and approval from the other shareholders and the board of directors as per the specified conditions in the AOA and shareholders agreement; or
The partners in the JV company may mutually decide to exit the JV, wherein the company is still completely operative, by selling their shares to a third party and thus liquidating the original partners’ shareholding, subject to terms and conditions of the AOA, JV agreement and the Shareholders; agreement; or
In case the project for which JV was formed is completed and the company is not required to operate anymore, it is also possible that parties wind up the company and go for striking off the name of the company.
Exiting a JV by issuing an IPO:
Exit through an IPO is ideally opted for in 2 cases — one when the company’s early shareholders are looking to cash out their ownership shares to a certain percentage or completely and second when a particular shareholder wants to exit the JV while the company continues to be operative. Due procedures as listed by SEBI have to be followed to offer an IPO such as eligibility of a JV company to offer IPO, minimum offer, prospectus for offer, etc.
LLP:
Under an LLP, the partnership or company as the case may be wound up by the option of the parties and situations as mentioned in the LLP Agreement.
Un-incorporated/Contractual Agreements/Strategic Alliances:
Exit route under this form is subject to the terms of the contract entered into by the Parties to the JV. However, sometimes it is not possible to exit a JV without prior approvals of appropriate authority especially when the JV is formed for a government tender.
Conclusion
Ownership and control in a JV is important for a successful JV. And when it comes to shareholding of these companies, picking a right structure of shareholding as well as detailed and crisply drafted shareholders agreements and AoA play an important role. Proper shareholding pattern makes sure that there is an alignment in the partners of the company and it also helps to mitigate the potential risks of deadlock.
References
- https://www.nortonrosefulbright.com/en/knowledge/publications/dbff2f61/joint-ventures-an-overview
- https://www.netlawman.co.uk/ia/shareholders-agreement-in-joint-venture
- https://corpgov.law.harvard.edu/2020/11/13/decision-making-in-5050-joint-ventures/
- http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Joint_Ventures_in_India.pdf
- https://www.waterstreetpartners.net/blog/structuring-joint-venture-and-partnership-transactions-the-top-10-jv-ownership-and-control-models
- https://www.lexology.com/library/detail.aspx?g=52a164b0-ef5c-441f-821c-ebc42c7c2c78
- https://www.onhandcounsel.co.uk/business-structuring/business-models-part-3-joint-venture-companies-and-shareholders-agreements/
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