A joint venture agreement allows two or more businesses to merge their entities—or a portion of their products or services—in order to start a new business activity. Furthermore, each business contributes assets to the joint venture and the parties agree on how to divide the income and expenses that come from this partnership.
If you are considering creating or entering into a joint venture agreement, it is important to understand what a joint venture agreement actually does, the requirements to enter into this agreement, the benefits for entering into a joint venture, and other issues that may occur from this partnership.
What is a Joint Venture Agreement
In a joint venture agreement, the entities that agree to this contract can be individuals, a group of individuals, companies, or corporations. Furthermore, this agreement can involve two business entities that sell products or services in the same sector. However, companies in two completely opposite sectors can also use this agreement to create a new product or service. Additionally, a joint venture agreement allows each of the parties that agree to this partnership to work together, while keeping separate legal status.
To form a joint venture, you do not technically need to sign a contract. However, to ensure that both parties follow the original agreement, businesses should use a contract when entering into this agreement. Furthermore, by creating a contract that outlines both parties’ responsibilities, the likelihood that litigation occurs relating to the partnership significantly decreases. Below are some of the important features that every joint venture agreement contract should include.
Joint Venture Agreement Contractual Provisions
- A description of the contributions provided by both companies whether in the form of cash or assets. Furthermore, the contract should document the value of those contributions.
- Each of the parties’ individual functions in the project. This could include responsibilities such as technical contributions, supply chains, or commercial commitments.
- Instructions on how the parties will meet to stay updated on the progress of the project.
- The length of the partnership and a project timeline if necessary.
- Instructions for how the agreement can be terminated if no longer feasible or profitable.
- A description of who will be responsible to manage the day-to-day options of the project.
- Whether profits will be based on the level of contribution of each party or by a specific formulation.
- Finally, if working with company secrets, a section detailing non-disclosure agreements.
While there are many things that both parties need to review before signing the joint venture agreement contract, the above contractual provisions are the most important.
Requirements for Joint Ventures
When starting a joint venture, it is important to understand exactly why you are entering into the agreement and state the duties each party will have. The key elements to review or state before entering into a joint venture will typically include:
- The number of parties involved
- The scope in which the joint venture will operate. This includes the geography, product, and technology that the agreement will utilize.
- What and how much each party will contribute to the joint venture
- The structure of the joint venture itself
- Initial contributions and ownership split of each party
- The kind of arrangements to be made once the deal is complete
- How the joint venture is controlled and managed
- How the joint venture will be staffed
Why You Should Implement a Joint Venture Agreement
Understanding what a joint venture does, how to create a proper joint venture contract, and the requirements for a joint venture is important. However, understanding the benefits that this business entity offers is even more important. The reason for this is that if you are going to share information with another entity or spend time and money on a project, you should ensure that the benefits you will receive from this transfer of information are worth the risk required. Below are some of the largest benefits that a joint venture offers.
Leverage Resources
Aside from creating a new product or service, a joint venture agreement allows two or more entities to take advantage of both company’s resources. For example, one partner may have a fully functioning and extremely productive manufacturing process. Furthermore, the other partner may have industry-leading distribution channels. By combining the best of what both companies have to offer, they can bypass their individual weaknesses to create a superior product or service.
Cost Savings
Similar to leveraging resources, companies that partner can increase their cost savings. One common way to do this is by increasing the number of products they sell. This is particularly true when the companies need to implement advanced technology to reach the product or services’ full potential. Finally, aside from the economies of scale savings that companies can receive from a joint venture agreement, companies can also save money or improve their chances of success by sharing or increasing advertising and labor costs.
Combined Expertise
Every company has a workforce with a set of skills, unique backgrounds, and certain expertise that allows the company to succeed. Thus, companies that enter joint venture agreements can greatly benefit from combining the two companies’ proprietary skills and talent. This is true whether the partnership utilizes one companies packaging systems or the creative team of the other company.
Using a Joint venture to Enter Foreign Markets
A common—and extremely useful way—that companies use a joint venture agreement is to partner with a local business so that they can enter a foreign market. For example, a company that wants to expand its distribution network into a new market can partner with a local business to either use their current distribution network or advise them on how to set up their own distribution network. Additionally, certain countries have restrictions on foreign businesses that are trying to enter their market. In this case, a joint venture agreement will allow a foreign business to partner with a local company. Thus, a joint venture agreement can help companies enter otherwise unattainable areas.
Final Thoughts
A joint venture agreement can offer many benefits to any parties that enter into this agreement. Though extremely beneficial, it is important to understand how the companies in the joint venture agreement are taxed.
Commonly, companies entering into a joint venture agreement will set up a new entity under which they will do business. However, the Internal Revenue Service does not acknowledge joint ventures. Thus, how the company will be taxed depends on the business structure that the two companies agree to create. For example, if the company operates as an LLC, then the profits and losses would pass through to the owners’ personal tax returns just like any other LLC. Additionally, the joint venture agreement will spell out how the profits and losses of the new entity are taxed. Finally, if the agreement is strictly contractual and the companies do not set up a new entity, the agreement can still determine how the tax is divided up between the entity.
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