What Is a Joint Venture and How Do You Form One?

Like many shrewd business owners, you might've recognized that your business has some weaknesses or limitations—maybe you lack finances, market reach, or name recognition. But if you have a new business project or idea, you don't want to be limited to only what your business can provide.

You might have another company in mind that can fill in what your company lacks and take your business idea to the next level. And if the other company likes your idea, then you both might decide to enter into a mutually beneficial arrangement: a joint venture (JV).

Although JVs are often associated with large companies or international deals, if used under the right circumstances, they can be effective for small business owners as well.

Table of Contents

• What Are the Elements of a Joint Venture?
• Should You Form a Joint Venture?
• Questions To Ask Before Entering Into a Joint Venture Agreement
• How Do You Form a Joint Venture?
• What Are Some Tips for a Successful Joint Venture?

What Are the Elements of a Joint Venture?

A JV is created when two or more established businesses agree to pool their resources and respective talents to achieve a particular goal. Typically, JVs are formed for a limited time to accomplish a specific business goal.

Types of Joint Ventures

Under a JV arrangement, each party contributes cash, property, assets, or other resources to the business venture. Then the parties agree on how profits, losses, management, and control of the venture will be divided.

You can formalize a JV either by entering into a contract—usually called a "joint venture agreement"—or by forming a separate business entity. Though if you form a separate business entity, you usually also have a JV agreement or some other contract or document that governs the business venture.

Forming a contractual relationship. If two businesses agree to join forces and cooperate with each other in a limited and specific way, then they might create a contract. The JV contract would set out the terms and conditions for how the business arrangement would work, such as what resources each company would contribute and how profits will be divided and taxed. For example, if you want to sell your product through another company's distribution network, you and the other business could enter into a contract that details each party's responsibilities and rights in the product and profits.

Establishing a new, separate business entity. Two businesses might decide to set up a separate and independent company to handle the JV work or project. For example, you and another business owner might decide to form a corporation, limited liability company (LLC), or partnership to produce and sell a new product through a joint arrangement. The business entity you choose will inform how you own and manage the business as well as how you're taxed. (For more, read how to choose the best ownership structure for your business.)

However you decide to set up your JV, you should have a written legal agreement setting out how the venture will work. (For tips on how to negotiate your business agreement, read our article on 11 strategies in contract negotiation.)

Joint Ventures vs. Partnerships

Although a JV shares many of the same characteristics as a partnership, there are two key differences: the scope and duration of the business. A JV is usually based on a single project that lasts for a limited period whereas a partnership usually involves an ongoing business relationship that lasts for an indefinite period.

To learn more about the differences between the two business structures, read our article on partnerships vs. JVs.

Joint Ventures vs. Mergers

JVs are often confused with mergers. While JVs can lead to mergers (or acquisitions), the concepts and legal relationships are distinct.

A merger involves two separate businesses combining to form one new business. In a merger, the old businesses no longer exist—only the new consolidated company is left. Where there were once two companies, now there's just one.

In a JV, the two companies can combine to form a new company, but the two original companies still exist. So, where there were once two companies, now there are three companies.

Should You Form a Joint Venture?

If you want to achieve a particular goal but you only have some of the resources to reach that goal, then a JV could be a good option—especially if your goal is just one part of your business plan. Forming a limited arrangement with someone else can help you advance your business ambitions without significantly altering what you've already built for your company.

Advantages of Forming a Joint Venture

By entering into a JV and combining resources with another business, you can potentially experience better growth and profitability than you or the other business could achieve on your own.

Some of the benefits that businesses can provide to each other in a JV arrangement include:

• access to new markets and distribution channels
• introduction of new business contacts
• added specialized expertise and resources, including research and development, and
• additional financing and purchasing power.

JVs are also useful where there are licenses and regulatory requirements to do business—a standard hurdle for companies trying to access foreign markets. If you're trying to access a regulated market, a JV can help you leverage another company's established presence. By using another business's license, you can avoid having to go through the licensing and regulatory paperwork that would otherwise be required, a potentially enormous benefit.

Joint Ventures Should Be Mutually Beneficial

A JV should be beneficial to both parties. You can take advantage of another business's strength in an area where your business is weak and offer a complementary benefit to the other party.

For example, suppose you have a product you want to sell but no presence in that market. So, you decide to establish a JV with a business that has an existing distribution channel capable of reaching customers for your product. Through the JV arrangement, you immediately gain access to customers and expand your market presence without having to hire a sales force, take on debt, seek outside investors, or otherwise commit your own resources. In turn, having a new product to market to an existing customer base is a complementary benefit that you provide to the other company.

What Questions Should You Ask Before Entering Into a Joint Venture Agreement?

While you and the other company might share the same goals, you might have different ideas on how to reach those goals. It's important to iron out the details of your JV arrangement now to avoid any confusion or dispute later on. You should answer five important questions before you put your agreement into writing.

How Will the Costs be Split?

When you form a JV, the first thing you need to talk about is money—and the initial monetary issue you need to resolve is costs. It might be the case that the creation of a JV doesn't incur any additional, material costs for either company. For example, the parties might simply agree to allow each other to use mutual resources and services either free of charge or at a discount.

However, in instances where costs must be incurred (for example, if the parties need to lease commercial property for their JV operations), then your JV agreement should specify:

• how any upfront costs will be divided
• how the parties will share expected costs going forward, and
• each party's responsibility for unforeseeable future expenses.

You should draft these provisions to be as detailed and comprehensive as possible, while also contemplating any potential future expenditures.

How Will the Profits Be Allocated?

The second monetary issue that the parties need to address is how profits will be split. As with the cost provisions, the terms and conditions of the agreement dealing with profit sharing should be as detailed and forward-thinking as possible.

Your profit-sharing arrangement can be based on any criteria that you and the other party agree on. But a general rule of thumb is that your relative entitlement to profits should be proportional to your contribution to the JV.

For instance, suppose Brooks Advancements, a regional company, creates the initial designs for a motorcycle. Limited by its current trade channels and financial resources, Brooks Advancements decides to create a JV with Mason Mechanics, a national manufacturer. Mason Mechanics takes Brooks Advancements' initial designs, improves upon them, and finances the marketing and production of the motorcycles. Because Brooks Advancements didn't finance the project and only provided the initial designs, it wouldn't make sense for the company to take home most of the profits.

Further, to minimize potential disputes over profit calculations and disbursements, your agreement should include specific terms regarding each party's responsibilities in maintaining and sharing financial records related to the JV. For example, your agreement might say that if you request the other party's financial records, then the other party has 10 business days to provide these records to you.

How Will Management and Operational Decisions Be Made?

The management and operations of a JV can be tricky when executive decisions must be made. If your JV has only two companies involved, then the simplest solution would be to require that decisions outside of the ordinary course of business be approved by the mutual written consent of both companies' principals. If there are three companies involved in the JV, then the solution could be that such decisions require the approval of at least two of the principals.

In any case, JVs naturally involve owners who are accustomed to running their businesses with a certain degree of independence. The purpose of the JV agreement is to define how major decisions are to be made in the interest of minimizing clashes of autonomous personalities.

How Will the Parties Deal With Disputes and Termination?

You and your co-venturer will also have to plan for disputes in case one side fails to perform their end of the contract (or "breaches" the agreement). Typically, people decide between three main termination provisions.

Allow the breaching party to fix (or "cure") their breach. If you want a more friendly solution to a contract breach, you can provide a cure period. Under this approach, once you've notified the other company in writing about their breach, they'll then have a time period within which to fix the problem, or else you'll have the right to terminate the agreement. For example, suppose a JV agreement requires Elm Street Packaging to ship 100 pounds of gravel every two weeks. But Elm Street has a mix-up at the plant and misses their shipping deadline. Fortunately for Elm Street, their agreement gives them a 15-day cure period. So, Elm Street has 15 days to make up for their missed gravel shipment.

Allow the non-breaching party to end the agreement when there's a breach. If you want a stricter approach to a breach, you can allow either party to end the contract when the other party violates the agreement. In this case, you don't allow the other party to fix the issue. Instead, as soon as you're aware of the breach, you can end the agreement. You should still require that any notice to end the agreement be delivered in writing.

Allow either party to end the agreement at any time for any reason. Instead of waiting for or requiring one party to prove a breach, you can permit either party to terminate the agreement at any time for any reason. But you should require that the terminating party give at least a minimum number of days advanced written notice to the other party. For instance, your agreement could allow either party to terminate the agreement as long as they give the other party 10 days' advanced written notice.

What Happens After Termination?

The terms of your JV agreement should address the procedures you and your co-venturer will follow if the agreement is terminated by either party (or both parties). The termination provisions should address:

• how any remaining costs, assets, and cash will be split among the parties
• how any outstanding third-party contracts specifically relating to the JV will be handled
• whether any confidential or proprietary information—such as intellectual property, work product, and trade secrets—will be destroyed, shared, or returned to the other party, and
• how the JV will be dissolved or winded up.

These provisions should utilize as much language as possible involving good faith, cooperation, and reasonableness. If the JV ends on bad terms, you'll want to still have both parties cooperating to tie up any loose ends. Ending the business arrangement properly is in the best interests of both parties.

How Do You Form a Joint Venture?

Forming a JV might only require a few steps, but the thought and effort you put behind each step are crucial. Follow these steps to set up your JV.

1. Choose Your Joint Venture Partner

To create a JV, the first thing you'll need to do is choose a partner. Having a well-defined business objective in mind will allow you to look for and identify a co-venturer that complements your business and can help you achieve your goals.

For example, suppose you've developed an exciting new sound speaker but lack adequate resources to access the right market for your product. In that case, you might look for a company with a good market presence in the electronics industry that you can join forces with to sell, promote, and distribute your product.

Performing a SWOT (strengths, weaknesses, opportunities, and threats) analysis can help identify potential areas where you might want to align your resources with another company.

You'll also want to see whether you and the other business—and the key players in each company—will be able to work well together. Spend time getting to know the people you'll be working with and the company's core values. Ask the following questions about the other business:

• What's their attitude toward collaboration?
• Do the business leaders share your level of commitment?
• Will the corporate cultures of your two companies mesh?
• How financially secure is your potential partner?
• What kind of management team do they have in place?
• How's the company performing in terms of production, marketing, and personnel?
• Are the people in charge people you can trust?

2. Decide on the Type of Venture You Want

You and your co-venturer should decide whether you want to form a contractual relationship or set up a separate entity for your venture.

The main considerations for choosing one form over the other are:

• the complexity of your proposed business venture
• how much liability protection you want for your JV business, and
• the amount of money you want to spend establishing the JV.

If the venture is relatively small, the costs associated with creating a separate legal entity might not be justified. On the other hand, if liability is a concern, you might want to invest in forming a corporation or LLC to protect yourself from business debts and obligations.

3. Draft Your Joint Venture Agreement

Once you've identified your co-venturer and thought about what type of JV arrangement you want, you should put your terms in writing. If you're still figuring out the finer details of your arrangement but you want to reflect each party's commitment, you can sign a letter of intent (LOI). The LOI can document what the parties already agree on and provide a roadmap for the more complicated agreement ahead.

Some people skip LOIs and proceed directly to drafting their JV agreement. JV agreements can be lengthy and complicated depending on the proposed business venture and the relationship between the parties. The key provisions in a JV agreement should include:

• the business objectives of the JV
• the structure of the venture (whether it'll be a separately formed enterprise or operated through the existing businesses)
• each party's contributions to the venture, including cash, property, and assets
• management and control of the JV
• how profits, losses, and liabilities will be shared
• the role of employees in the JV
• how intellectual property created by the JV will be treated (for example, will the businesses jointly own the property rights?)
• a dispute mechanism between the parties
• the JV's duration or procedures to terminate the arrangement, and
• a confidentiality clause to protect any commercial trade secrets.

A formal contract is necessary for all parties' protection and to make sure everyone understands the terms and conditions of the venture.

4. Create a Separate Legal Entity, If Necessary

If your JV calls for you to create a separate legal entity, you'll need to take steps to form one. If you've chosen a corporation to run your JV, learn the steps to start a corporation. If you've chosen an LLC, read about how to start an LLC.

What Are Some Tips for a Successful Joint Venture?

To form and run a successful JV, you'll need to thoroughly research and analyze the venture's aims and objectives as well as the parties involved in the transaction. Ultimately, to succeed, the JV must be beneficial for both parties.

Here are some tips for success:

• Ensure the goals and expectations of the venture are clear and agreed to by all parties.
• Balance each company's levels of expertise and investment.
• Identify and integrate the cultures and management styles of the partnering firms.
• Provide sufficient leadership and support, particularly in the early stages.
• Make sure the staff and everyone involved understand the purpose of the venture.

Speaking With a Business Attorney

If you have experience working with other businesses and understand what makes a successful relationship, you can probably form and run a JV on your own. But if you're not sure whether a JV is the right choice for your business or you're having trouble reaching an agreement with the other side, consider talking to an attorney who has experience with JVs.

A lawyer can help you decide which type of JV makes the most sense for your business's goals. They can also help you negotiate and draft your JV agreement and reevaluate your employment contracts to make sure your JV is ready to launch.