A joint venture is a business entity created by two or more parties, generally characterized by shared ownership, shared returns and risks, and shared governance. Companies typically pursue joint ventures for one of four reasons: to access a new market, particularly emerging markets; to gain scale efficiencies by combining assets and operations; to share risk for major investments or projects; or to access skills and capabilities. There are two types of joint venture:-
· Contractual joint venture
· Equity based joint venture
Contractual Joint Venture (CJV)-
In a contractual joint venture, a new jointly-owned entity is not created. There is an agreement to work together but there is no agreement to give birth to an entity owned by the parties who are working together. The two parties do not share ownership of the business entity but each of the two parties exercises some elements of control in the joint venture. A typical example of a contractual joint venture is a franchisee relationship. In such a relationship the key elements are:
a. Two or more parties have a common intention – of running a business venture
b. Each party brings some inputs
c. Both parties exercise some controls on the business venture
d. The relationship is not a transaction to transaction relationship but has a character of relatively longer duration.
Generally speaking, the above four can be called as the distinguishing characteristics of a Contractual Joint Venture as opposed to a Contractual Transaction-based relationship.
Foreign companies often resort to contractual joint ventures when they do not wish to invest in the equity capital of a business in India even though they wish to exercise controls and want to decide the shape that the venture takes. For example, a foreign company may have a Technology Collaboration agreement with an Indian company whereby the foreign company controls all key aspects of running the business. In such a case the foreign company may like to retain the option of taking equity at a future date in the Indian company run by its technology. This will mean that though to begin with the venture is a contractual joint venture, the parties may convert it into an equity based joint venture at a later date.
Equity Based Joint Venture (EJV)
An equity joint venture agreement is one in which a separate business entity, jointly owned by two or more parties, is formed in accordance with the agreement of the parties. The key operative factor in such case is joint ownership by two or more parties. The form of business entity may vary – company, partnership firm, trusts, limited liability partnership firms, venture capital funds etc. From the point of a foreign company, the most preferable form of business entity is either a company or a limited liability partnership firm. We shall discuss this aspect in detail in the next section.
In an equity based joint venture, the profits and losses of the jointly owned entity are distributed among the parties according to the ratio of the capital contributions made by them. However, the division of profits and losses is not the only characteristic of an equity-based joint venture. The key characteristics of equity-based joint ventures are as following:
a. There is an agreement to either create a new entity or for one of the parties to join into ownership of an existing entity
b. Shared Ownership by the parties involved
c. Shared management of the jointly owned entity
d. Shared responsibilities regarding capital investment and other financing arrangements.
e. Shared profits and losses according to the Agreement.
It is not necessary that all the above five characteristics are fulfilled in every equitybased joint venture. For example, there are often agreements where one of the parties is investing but has no say in the management of the joint venture (JV) company.
There are also situations where a foreign company may want to exercise management control even though it is not investing in the JV company. Typically, if a foreign company is providing technology and other knowledge-based inputs, it may want to ensure that the JV company is managed as per its directions. In such cases the foreign company may retain an option to invest in the JV company at a future date. Such a structure may also be used by a foreign company to create a foothold for itself in a sector where Foreign Direct Investment (FDI) is not allowed.
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