The Webinar Review

Joint Venture Structures

Webinar – 4 August 2022 @ 1 pm IST
M&A Academy 2022

Background
A joint venture (“JV”) is a highly fluid concept and executing a successful JV needs a great deal of careful
planning and hard work. You need the right partners, you must have an achievable funding plan, there must
be realistic synergies, but most importantly, there needs to be an effective structure that is in harmony with
the game plan for the JV.

The objective of the webinar was to discuss at a high-level the key features of a JV, common structures for
forming a JV, various considerations impacting the structuring exercise and the critical issues underlying each
JV structure.

Definition
A JV can be described as a strategic alliance between two or more parties for producing synergies through
pooling of complementary yet individual resources and capabilities of the parties to yield a mutually beneficial
result.

When compared to an equity, business or an asset acquisition, the key distinguishing feature of a JV is the
synergies - that is the real USP of this format and the reason why parties collaborate because it is otherwise
challenging or uneconomical for either party to produce such synergies or results individually. Synergies can
defined as the combined effect of the individual resources that the parties bring to the JV which should be
greater and commercially more valuable than the sum of their separate effects so as to justify the strategic
combination.

Common Structures
While there are many variations that can be adopted for structuring a JV from a commercial, regulatory, or tax
perspective, common JV structures are:

 contractual JVs; and

 equity JVs.

An equity JV entails the formation of a separate legal entity to conduct the JV. This is the most common form
in India for long-term broad-based JVs. Contractual JVs (on the other hand) are more ideal for short-term
projects where the creation of a separate legal entity is not considered feasible or desirable , for example, for
tax efficiency.

Structuring considerations

There are several factors at play (both at a micro and macro level) which ultimately impact the choice of the
structure. At the micro level, structuring is driven by the strategic and commercial objectives of the parties like
the scope or the JV or long term goals.

Macro level factors, on the other hand, are the ones that are outside the control of the JV partners and include
regulatory restrictions, applicable tax implications, sunk costs etc. Interestingly, in our experience, macro
factors often end up overriding the micro factors when concretising a JV structure.

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Contractual JVs
These are the most basic form of strategic collaboration and there is no corporate veil that separates the parties
from the JV activity, although each JV partner may establish a special purpose company to hold its JV interest.
Parties engage directly as independent contractors (rather than shareholders) in furtherance of a common
purpose for profit and the joint venture is structured purely though a contract.

From a governance perspective, contractual JVs are typically supported and supervised by a JV committee
consisting of representatives of the parties and all material decisions impacting the JV are be taken by the
committee. Here again, the JV contract is paramount and an effective governance and operational regime
needs to be clearly documented so as to avoid any gaps/disputes.

Some of the advantages and disadvantages of this structure are set out below:

Advantages Disadvanatges

Simplicity and flexibility
Unrestricted decision-making
Ownership remains intact as parties can utilise their
respective assets and IP for achieving a common
purpose without diluting their ownership interest.
Ease of termination through termination of the
underlying contract
Lack of a clear structure and identity which may
affect both internal operations as well as the
interface or contracting with third parties
Risk of potential uncapped liability exposure as a
contractual JV runs the risk of being construed as a
partnership and consequently can subject the JV
partners to joint and several liability for the debts
and losses of the JV activity
Third party financing is typically challenging as there
is no separate legal entity or assets representing
the JV, and therefore, any financing needs to be at
the partner level
Can have significant tax issues if not structured
properly as the tax authorities may qualify such
arrangements as an “association of persons”, and
consequently impose the maximum tax rate, which
could be as high as 40% if any member of the JV is
a non-resident.

Equity JVs
An equity JV structure is undertaken through a distinct legal entity (either a limited liability company or a
limited liability partnership) (“JV Entity”) . The JV partners provide funding or other resources (such as capital
assets, technology or IP) as their contribution to the JV Entity. There are two common ways to form an equity
JV:

 Greenfield venture: JV partners incorporate a new entity in which to undertake the JV activity. An
important consideration here is of course the choice of the legal entity – a company or an LLP. This again
is driven by several factors including tax considerations, operational flexibility, compliance costs and
regulatory restrictions. In our experience, unless there are clear tax advantages for choosing an LLP
structure over a private limited company, a private limited company offers more operational flexibility
(particularly for foreign investors) from a regulatory perspective. For instance, an LLP cannot take a loan
from a non-resident partner. Similarly, the flexibility of doing a non-cash contribution in the form of IP or
technology from a non-resident JV partner does not work in case of an LLP owing to restrictions under
exchange control law.

 Brownfield venture: Here the incoming JV partner acquires shares in an existing company to reach the
agreed shareholding pattern and the company becomes the JV Entity. Interestingly, from a regulatory or
foreign exchange perspective, this model may trigger additional regulatory consent requirements if the
proposed investment results in a change in ownership or control at the investee company level or triggers
the thresholds for regulatory approvals – for instance, a pharma manufacturing company will need prior
approval from the Department of Pharmaceutical if the proposed FDI is more than 74%.

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Some of the key advnatages and disadvanatges of the equity JV structure are as follows:

Advantages Disadvanatges

The chief advantage is that an equity JV format offers
universally recognised distinct legal identity to the JV with
perpetual succession along with a right to sue and be sued.
Since there is a clear identity ascribed to the JV, it is easier
for the partiers to have a well-defined governance and
management structure that separates the JV from the
partners.
JV partners enjoy the benefit of limited liability (shielded by
the corporate veil), and the flexibility to raise external
finance without exposing their own individual assets.
There is improved liquidity and more exit options for the
parties as instead of selling individual assets or business
verticals separately, parties can exit by selling the JV entity
entirely.
This structure adds greater stability to the business of the
JV company and the continuity of the business is not
impacted in case of a change of control event at the JV
level.
Compliances and related costs are higher –
there is a sunk cost for incorporating the legal
entity and running it as a going concern.
There is a higher risk of decision gridlock
(particularly in a 50:50 JV) that can lead to
trapped investment, if the JV partners fail to
reconcile competing strategies.
Similarly, there is a potential risk for conflict of
interest as JV management can emerge as a
de facto third partner with their own agenda.
Lastly, winding up is not challenging and
requires NCLT’s approval.

Governance & control

A key factor pertaining to governance of a JV Entity is the degree of control that the JV partners can (or want
to) exercise over the direction and management of the JV entity (“JVC”). In case of a company, control can be
exercised at two levels – the board and at the shareholders’ level; and is effectively linked to the ownership
pattern and/or affirmative rights that entitle the JV partners to affirmatively manage the day-to-day operations
of the JVC.

Regarding the common governance models, from an ownership standpoint, parties can either opt for an
arrangement where both the parties hold equal ownership of the JVC and exercise joint control over the
management and affairs of the JVC; or there is asymmetric ownership such that one partner holds more than
50% of the share capital and thus exercises majority control over the JVC (typically subject to certain
negotiated veto rights in favour of the minority JV partner).

Key Issues underlying Equity JVs

 Identifying a suitable JV partner and ensuring cultural fit: these issues are paramount for ensuring a
successful JV, and (from our experience) the takeaway here is that effective diligence is key. Each partner
should do a diligence on the credibility, reputation and sector specific experience of the other JV partner
(and its founders/promoters).

 Robust governance: for a successful JV, operational control should be balanced with good governance
policies. A lack of good mechanisms and ethical standards to internally regulate the governance of the
JVC can have severe consequences, especially for foreign investors. Therefore, it is crucial to adopt a
variety of checks and balances such as professional management, specialised committees consisting of
representatives of the partners and the need for independent personnel to be involved in operations and
financial control.

 Deadlock: it may not always be feasible to have consensus over all operational matters of the JVC, and
therefore, disputes are inevitable. JV partners should have a defined framework to resolve any deadlock.
Here again, the ownership pattern of the JVC plays an important role in the structuring of deadlock
mechanism. For instance, a put or call option regime (whereby one party gets to acquire the other subject
to certain agreed parameters and exit price) may not work in case of a 50:50 setup where the business
continuity of the JVC is equally dependent on both the partners, and in such a case, the only practical
solution (if a 100% strategic sale is not possible) could be dissolution of the JVC.

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 Transfer restrictions and exit options: it is equally important for the JV partners to discuss and chart out
an exit path (with or without cause) and have a well-defined regime on share transfers. This is particularly
critical for a foreign investor given the restrictions from an exchange control perspective. For instance, a
minimum 1-year lock-in period applies before a foreign investor can exit pursuant to a call/put option and
the exit cannot be at an assured return owing to the pricing restrictions prescribed under Indian exchange
control law.

 Intellectual Property (IP) Protection: IP is undoubtedly one of the most fundamental aspects of any JV
and even if there is no technology or IP transfer, at a bare minimum a JV would entail co-branding or use
of the partners trademarks etc. Indian law offers protection for IP through registration with various IP
agencies. It is critical for a JV partner (especially a non-resident partner) to conduct a due diligence to see
if its IP is not exposed to Indian markets and should timely seek protection by registering its IP.

 Getting the JV agreement right: from a documentation perspective, the terms relating to the
incorporation, management, governance, operation and capitalisation of the JV entity including the rights
and obligations of the JV partners should be captured in a definitive binding agreement. Further, from an
enforceability perspective, the contractual terms which are meant to bind the JVC should be restated in
the articles of association of the JVC.

Contact Partners

Sameer Sah Sarthak Sarin

Khaitan & Co Khaitan & Co
T: +91 33 2248 7000 T: +91 120 479 1000
E: sameer.sah@khaitanco.com E: sarthak.sarin@khaitanco.com