What is in this article?:
A joint venture may make sense for lots of reasons, but how it is established is critical to its success. Partnership is a big step. Look before you leap!
- Defining governance, control
- Defining partners’ obligations
- Documenting the exit strategies
Getting Out Safely
Perhaps the most difficult issue in documenting a JV is the exit strategy. The average joint venture lasts only about five years. A good JV agreement includes mechanisms by which the partnership can be terminated, sold, and/or by which one party can “buy out” the other.
Commonly, default in fulfilling obligations under the agreement by one party can result in termination of that party’s interests at a stated price or formula. In a non-default situation, the parties may wish to provide “put” or “call” rights.
Frequently, JV agreements will have a “right of first offer” or “right of first refusal,” by which the selling party must give the other party the opportunity to buy its interest before selling to a third party. The problem is agreeing upon a fair way to determine the buyout price. Some JV agreements rely on appraisal, and some on a formula price. Either of these may prove to be inaccurate over time.
Due to this uncertainty, a “Russian roulette” or “Texas shoot out” provision might be used, giving either party the right to offer to sell its interests to the other party for a price determined by the offering party. Then, the party receiving the offer has the right to accept it or turn the tables and buy the offering party’s shares at the offered price. This is intended to cause the offering price to be reasonable -- but if the non-offering party is in financial distress, unfairness can result.
A JV agreement also may contain “drag-along” or “tag-along” rights, the former giving the majority owner the right to require the other party to sell its interests to a third party upon request, and the latter giving the minority owner the right to “tag along” in when the majority shareholder sells out its interest. The parties also might include as part of any exit strategy the continuation of confidentiality and non-compete obligations of the selling partner.
In sum, the most critical aspect of a successful JV is choosing a trustworthy partner whose interests are aligned, and talking through all the what-if’s before signing the agreement. The parties must recognize their fiduciary obligations to each other, and negotiate a JV agreement that comprehensively and clearly provides for how the JV is to be governed and terminated.
Susan Apel is a partner at K&L Gates LLP in Pittsburgh, and the former general counsel of Ellwood Group Inc. Contact her at Susan.Apel@klgates.com.