Partnering relationships involve two or more companies working together to achieve a specific purpose or toward the attainment of common business objectives. Joint ventures, strategic partnering, cross-licensing, co-branding, and technology transfer agreements are all examples of partnering strategies designed to obtain one or more of the following: direct capital infusion in exchange for equity and/or intellectual property or distribution rights; a “capital substitute” where the resources which would otherwise be obtained with the capital are obtained through joint venturing; or a shift of the burden and cost of development (through licensing) in exchange for a potentially more limited upside.
These various types of partnering arrangements have been used for a wide variety of business purposes, including: joint research and co-promotion; distribution and commercialization (particularly between defense and government contractors looking for new applications and markets for products initially developed for the military and governmental sectors); and cross-licensing and sub-licensing of new technologies.
The participants to these agreements could be at various points in the value chain or distribution channel - from agreements by and among direct or potential competitors (e.g. those that cooperate rather than compete as a precursor to a merger and/or to join forces to fend off an even larger competitor) to agreements by and among parallel producers (e.g. to widen or integrate product lines) to parties linked at different points in the vertical distribution channel (e.g. to achieve distribution efficiencies).
Understanding the Differences Between Joint Ventures and Strategic Alliances
The two primary types of partnering relationships are joint ventures and strategic alliances. It is critical to understand the major differences between these two strategies.
Joint Ventures are typically structured as a partnership or as a newly formed and co-owned corporation in which two or more parties are brought together to achieve a series of strategic and financial objectives on a short-term or long-term basis. Companies considering a joint venture as a growth strategy should give careful thought to the type of partner they are looking for and what resources each party will be contributing to the newly formed entity. Like the raising of a child, each parent will be making a respective contribution of skills, abilities and resources.
Strategic Alliances refers to any number of collaborative working relationships in which no formal joint venture entity is formed but two independent companies become interdependent by entering into a formal or informal agreement built on a platform of mutual objectives, mutual strategy, mutual risk, and mutual reward. These relationships are commonly referred to as teaming, strategic partnering, alliances, cross-licensing, and co-branding.
Regardless of the partnering strategy an entrepreneur selects, the underlying industry, or even the actual purpose of the strategic relationship, all successful joint venture and strategic alliance relationships share a common set of essential success factors. These include:
- A complementary unified force or purpose that bonds the two or more companies together.
- A management team committed at levels to the success of the venture, free from politics or personal agendas.
- A genuine strategy synergy where the “sum of the whole truly exceeds its individual parts.”
- A cooperative culture and spirit among the strategic partners that lends to trust, resource sharing, and a friendly chemistry among the parties.
- A degree of flexibility in the objectives of the joint venture to allow for changes in the marketplace and an evolution of technology.
- An actual alignment of management styles and operational methods at least to the extent that it affects the underlying project (as in the case of a strategic alliance) or the management of the new company created (as in the case of a formal joint venture).
- A general level of focus and leadership from all key parties that is necessary to the success of any new venture or business enterprise.
Likewise, the strategic benefits of partnering include the ability to develop a new market (domestic/international), a new product (research and development), or a new technology, to share technology or combine complementary technology, or to create a production/distribution facility. In addition, partnering enables companies to acquire capital, execute a government contract, or gain access to a new distribution channel, network, or sales/marketing capability.
Due Diligence Before Selecting Joint Venture or Strategic Alliance Partners
Care should be taken to conduct a thorough review of prospective candidates, and extensive due diligence should be done on the final candidates being considered. Develop a list of major objectives and goals to be achieved by the joint venture or licensing relationship and compare this list with those of your final candidates. Take the time to understand the corporate culture and decision-making process within each company. Consider the following issues: How does this fit with your own processes? What about each prospective partner’s previous experiences and track record with other joint venture relationships? Why did these previous relationships succeed or fail?
In many cases, smaller companies looking for joint venture partners wind up selecting a much larger Goliath which offers a wide range of financial and non-financial resources that will allow the smaller company to achieve its growth plans. The motivating factor under these circumstances for the larger company is to get access and distribution rights to new technologies, products, and services. In turn, the larger company offers access to pools of capital, research and development, personnel, distribution channels, and general contacts that the small company desperately needs.
But proceed carefully. Be sensitive to the politics, red tape, and different management practices that may be in place at a larger company that will be foreign to many smaller firms. Try to distinguish between that which is being promised and that which will actually be delivered. If the primary motivating force for the small firm is really only capital, then consider whether alternative (and perhaps less costly) sources of money have been thoroughly explored. Ideally, the larger joint venture partner will offer a lot more money. If the primary motivating force is access to technical personnel, consider whether it might be a better decision to purchase these resources separately rather than entering into a partnership in which you give up a certain measure of control. Also, consider whether strategic relationships or extended payments terms with vendors and consultants can be arranged in lieu of the joint venture.
Drafting a Memorandum of Understanding Prior to Structuring Partnering Agreements
Prior to drafting the definitive joint venture or alliance agreements, it is beneficial to hammer out a Memorandum of Understanding to reflect a business handshake on all critical points of the relationship and for the lawyers to use a starting point in the preparation of the formal agreements. The Memorandum of Understanding should address the following topics:
- Spirit and Purpose of the Agreement. Outline why the partnering arrangement is being considered and what are its perceived mission and objectives. Describe “operating principles” that will engender communication and trust. What are the strategic and financial desires of the participants?
- Scope of Activity. Address what products, services, buildings, or other specific projects will be included and excluded from the venture. Identify target markets, such as. Regions and user groups, for the venture and any markets excluded from the venture that will remain the domain of the partners. If the venture has purchase and supply provisions, state that the newly formed entity or arrangement will purchase or supply specific products, services, or resources from or to the owners.
- Key Objectives and Responsibilities. Clarify and specify objectives and targets to be achieved by the relationship, when to expect achieving these objectives, any major obstacles anticipated, and the point at which the alliance will be self-supporting, be brought out, or be terminated. Participants should designate a project manager who will be responsible for each company’s day-to-day involvement in the alliance. If a separate detached organization will be created, the key people assigned to the venture should be designated if practical. Responsibilities should be outlined to make it clear to other partners who will be doing what.
- Method for Decision-making. Each partnering relationship will have its own unique decision-making process. Describe who is expected to have the authority to make what types of decisions in what circumstances and who reports to whom. If one company will have operating control, that entity should be designated at this point.
- Resource Commitments. Most partnering relationships involve the commitment of specific financial resources, such as cash, equity, staged payments, and loan guarantees, to achievement of the ultimate goals. Other ”soft” resources may be in the form of licenses, knowledge, research and development, a sales force, contracts, production, facilities, inventory, raw materials, engineering drawings, management staff, access to capital, and the devotion of specific personnel for a certain percentage of their time. If possible, these “soft” resources should be quantified with a financial figure so that a monetary value can be affixed and valued along with the cash commitments to this internal commitment. In some circumstances, the purchase of buildings, materials, consultants, and advertising will require capital. These external costs should be itemized and allocated between the partners in whatever formula is agreed. If any borrowing, entry into equity markets, such as public offerings or private placements, or purchase of stock in one of the partners is anticipated, these should be noted. In anticipation of additional equity infusions, the partners should agree about their own ability to fund the overruns or enable the venture to seek other outside sources. The manner of handling cost overruns should be addressed. Pricing and costing procedures should be mentioned if applicable.
- Assumption of Risks and Division of Rewards. What are the perceived risks? How will they be handled, and who will be responsible for problem-solving and risk assumption? What are the expected rewards: new product, new market, cash flow, and technology? How will the profits be divided?
- Rights and Exclusions. Who has rights to products and inventions? Who has rights to distribute the products, services, and technologies? Who gets the licensing rights? If the confidentiality and non-competition agreement have not yet been drafted in final form at this point, they should be addressed in basic form here. Otherwise, if the other agreements have been signed, simply make reference to these other agreements.
- Anticipated Structure. This section of the Memorandum of Understanding should describe the intended structure (written contract, corporation, partnership, or equity investment). Regardless of the legal form, the terms, percentages, formulas for exchange of stock, if possible at this stage, should be spelled out. Default provisions and procedures should be addressed at least at the preliminary level.
For entrepreneurial companies and their established counterparts, joint ventures and strategic alliances bring mutual benefits that each would otherwise be unable to achieve independently. Making them work involves understanding what they are all about, conducting effective due diligence, and putting terms in writing prior to structuring agreements.
Andrew J. Sherman Partner Dickstein Shapiro Morin and Oshinsky LLP