Tying the knot can be tricky for joint ventures

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Technology businesses are making huge commitments to joint ventures, but important planning is being overlooked.

More than 40% of tech businesses will be using joint ventures to boost revenues over the coming year. The corporate assets they are committing are significant, and expected to nearly double within the next 24 to 36 months. Yet despite these high stakes, those involved in joint ventures may be under-planning – both when screening prospective partners and when planning an exit. These are highlights from the latest PricewaterhouseCoopers ‘Technology Barometer’.

Joint ventures involve the sharing of risks and rewards in an enterprise or project co-owned and operated for mutual benefit by two or more business partners. One third of technology businesses are current joint venture participants, involved in an average of 3.3 ventures over the past three years. Another nine per cent are planning an average of 1.6 new joint ventures over the next year.

At the moment, technology businesses are committing 9.34% of their assets to these efforts – people, materials, and dollars. And this allocation is expected to rise to 17.34% over the next two to three years. Large businesses plan to spend 13.49% of corporate assets, an increase of 69%; and smaller businesses anticipate a surge to 22.01%, an increase of 99%.

“The ‘two big I’s,’ International and Internet,” are playing an important role in joint venture activities” said Paul Weaver, global technology industry leader for PWC. “Forty-three percent of j.v. participants are involved in international joint ventures. And leaders of technology businesses tell us 37% of all joint ventures are in large measure driven by e-business.”

Most joint ventures involving technology businesses are structured between corporate partners (82%); few involve purely financial investors (8%), suppliers (6%) or others (4%). Most leaders of the partnering businesses cite accelerated revenue growth (50%) and new product development (45%) as very important benefits.

The three criteria cited most when screening prospective partners are strategic fit (52%), synergistic products and markets (43%) and technical expertise (42%). Of lesser concern are management compatibility (31%); competitive position in the industry (25%); similar operating philosophy (22%); and e-business savvy (15%).

“Strategic fit is of primary importance because long term relationships and significant commitments of resources are involved,” said Weaver. “Each partner needs to feel it is gaining equally from its participation. But I would suggest that when screening, greater emphasis could be placed upon management compatibility, particularly in the beginning when designing the joint venture. Later, when the inevitable bumps in the road occur, the partners will need to share a deep sense of mutual trust.”

In early negotiating with partners, most technology business leaders take three critical issues into consideration from a tax perspective: choice of legal entity (61%); compensating partners that contribute services (59%); and shifting liabilities among the joint venture owners (51%). Other issues considered are possible recognition of gain upon contribution of assets (39%); contributions of appreciated property (25%); and special allocations (17%).

“Joint venture partners should devote adequate time for up-front planning, to determine business and tax objectives, allocation of profits and losses, distributions, and sharing of risk,” said Weaver. “Probably the most important initial consideration should be the type of entity to use for a joint venture. According to the survey, the choice of legal entity most often used for US tax purposes is a corporation (43%), followed by a limited liability company (25%) or a partnership (12%), with 20 percent not reporting. Today, limited liability companies (LLCs) are growing in popularity, however, those adopting this regime must make sure their LLC is taxed as a partnership, not an association.

“From a tax perspective, we see more problems from contributions of appreciated property than from any other area,” added Weaver. “As our survey reveals, partners often don’t understand the importance of contributing appreciated property to the joint venture from a tax standpoint. By underestimating this significance, companies can fundamentally weaken the economics of the deal for themselves and their partners.”

Only half of joint venture participants (49%) report having a formal exit strategy. Among these, 31% use an ‘unwinding mechanism’, a cross-buyout agreement or planned external sale of the entity; 23% cite a ‘viable exit’, such as an initial public offering, a private recap or sale; and 46% said theirs was a hybrid of the other two.

“Leaders of technology businesses need to be alert to the importance of setting up an exit strategy for their joint ventures,” noted Weaver. “Their commitment of assets is way too significant to overlook. Even the best of business relationships can be enhanced through use of a prenuptial agreement.”

Businesses involved in joint ventures are bigger, growing significantly faster, more productive and profitable than their peers on the sidelines. They have more employees at their main location (an average of 1791 versus 1005 for non-participants), and their revenues average $568 million versus $214 million. Yet, despite this significantly larger size, their leaders are expecting a higher rate of revenue growth over the next 12 months: 29.4%, versus 21.4%. Overall, 78% of those involved in or planning joint ventures say these initiatives are important to the present and near-future growth of their business. They report that 9.8% of business growth is attributable to joint ventures, and this is expected to rise to 22.4% over the next two to three years.

Joint venture participants also hold a notable advantage in productivity, averaging $317,000 in revenue per employee versus $214,000 for non-participants, a 48% edge.

Moreover, more joint venture participants have a profitable track record over the past 12 months: 45% had an increase in gross profits, while only 13% had a decrease.

“It’s clear that joint ventures can provide a significant business edge,” noted Weaver. “All the more reason to plan them well.”

PWC’s quarterly ‘Technology Barometer’ focuses on rapidly growing technology businesses of all sizes. It incorporates the views of 391 top industry executives: 150 CFOs and managing directors of large, publicly-held businesses, including high tech subsidiaries and divisions, and 241 CEOs from smaller, privately held companies.

Technology Barometer is compiled with assistance from the economic research firm of Business Science International.

PWC

Technology Barometer

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