Using a shareholders' agreement in a joint venture
"Joint venture" is a very loose expression. The term has no special meaning in law.
The words just mean two or more parties doing something together, usually for a limited time or purpose. The parties could be individuals, companies or limited liability partnerships.
You could use the term for an expedition to the South Pole or for children working together on a project as validly as in a business context.
We use it here to mean a co-operation between two businesses with a view to making a profit. Your JV could be to develop a property, to farm land, or to produce goods.
Choosing a structure and why a jointly owned subsidiary company is often used
How a JV is best structured largely depends on what the venture aims to do.
The agreement might simply to be to work together in close co-operation, for example, where one party designs and manufactures a product and the other sells it.
Often JV partners set up the business within a structure such as a partnership, limited liability partnership or company. This allows them greater control. Of the structures used, a company is the most common.
It is likely to be used in circumstances such as:
- when the size and value of the venture justifies the administrative burden of running a company
- where one party faces considerably greater risks from the JV than the other (for example, where one party invests upfront, and the other invests over time)
- where the venture is likely to continue for several years
- where the purpose of the JV is to create a legal 'person' that can perform actions that one or both owners cannot (for example, foreign ownership of certain types of assets)
- new product development, where each side must be certain that they own part of the project, like a collaboration between a pharmaceutical company and a university
- a property development, possibly where one party contributes most of the money and the other most of the management
- where one party is reliant on the other in order to undertake a project, such as in an oil exploration where a UK company with the equipment and expertise partners with a foreign local company who has the rights to explore
Why structure a JV as a company
The advantages of a joint venture structured through a company include:
- shares can be sold easily - to bring in additional partners, or to exit when beneficial. It is far more difficult to sell out of a contractual arrangement, particularly if you only want to sell out partially
- a corporate structure has statutory rules well known to everyone
- it can be controlled much more easily - by way of a shareholders’ agreement which will contain detailed management provisions
- it places the JV at arm’s length from the owners. If it fails, there will be less publicity about the demise of an unfamiliar name
- there will be no financial recourse against either partner because the JV vehicle is a company with limited liability
- the JV company can arrange its own funding, obtain licences, and so on, without the involvement of a parent
- tax arrangements may benefit the venturers
- it may be possible to disclose less information to shareholders and third parties
While such an arrangement is most commonly used for larger projects, there is nothing to prevent a jointly owned company being used for a small venture. Some of the advantages may not apply, but particularly if you have a long term venture, it is a structure to consider.
Regulating the company using a shareholders' agreement
How the JV will work is usually set out in a shareholders' agreement.
Whatever the subject of the venture, the shareholders' agreement should address:
- the purpose of the JV
- the expected duration, with plans for what happens if time is cut short or extended
- the working relationship and roles of the venturers - who is in charge of what, and who has ultimate control?
- management decisions that require unanimous agreement
- how conflict and disagreement will be resolved
- what money and other assets will be contributed, and under what terms - equity or loan?
- how profit and loss will be shared, and how value generated will be distributed
- if new intellectual property is created in the course of the venture, who will own it and what steps will be taken by either party to patent it or otherwise protect it
- what happens if a party dies or becomes bankrupt (careful wording can help to avoid the benefit passing to a receiver or trustee in bankruptcy)
- whether one party can assign (transfer) the benefit of the venture and if so, how?
- who the directors of the company will be, how they will be controlled, appointed and removed
- what the targets and responsibilities of the directors are, and how success and failure will be judged
- who will employ the directors for the purpose of employment law
- exit strategies and how will the agreement terminate. This is probably the most important area to consider - how can you limit your losses in bad circumstances, and lock in gains if the venture succeeds.
In addition, there may be industry-specific provisions such as those relating to materials, equipment, quality control, and service provision.
Recording the agreement
Detail is important. Because parties to a venture are likely to have been discussing the finer point together for some time, writing down that detail is often overlooked - with disastrous consequences.
Another common mistake when drafting a JV agreement is to consider only the positive outcomes. No party will want to suggest that the venture might not be successful, but it is in times of distress that the agreement is challenged.
You might want to read about other important points to consider.
In our experience, the only way to cover even the main alternative outcomes is to consider a multitude of possibilities. We advise that you write down a list of assumptions, winnowed from your business plan, then for each, start asking "what if" questions, always with a view to how the different results will affect each of the shareholder-venturers. The key question to answer should always be: "who has the power in this circumstance".
Real property deals deserve a separate mention because joint ventures in property are by far the most common use for company structures. Property ventures are usually concerned with the “basics” of obtaining planning consent, development, investment management and property management. They are a pooling of expertise and cash for a clearly identifiable purpose with a target outcome, probable measure of success and probable time frame. That is a far cry from the uncertainty of sinking an oil well 1,000 miles of the coast of Western Australia.
When it comes to writing the shareholders’ agreement for a property JV agreement, matters of money and control remain the most important. Details about land registration, planning matters and so on are likely also to feature, but should play a secondary part in protecting your interests.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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