Practical Tips for entering into Joint Ventures
Foreign companies entering Latin America may chose to do so through a joint venture with a local company to help with their entry into a new market. A local partner can provide a foreign company quick access to distribution channels, local expertise, in country infrastructure and workforce, shared business costs, etc. Companies already present in the country may form a joint venture in order to have the required expertise for a specific project. On the other hand, partnering with another business, let alone a company from a different culture and country, can be complex to say the least. It takes time and effort to build the right relationship and structure the joint venture properly.
What is a joint venture?
A joint venture is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity that has a short, medium, or long term horizon.
A joint venture can be formed in different ways and will often depend on what both companies are looking to achieve. It is important to understand the overall goals of the partnership so that a proper structure can be put in place that helps accomplish both companies objectives.
How to start the process of forming a joint venture?
Most companies will start by establishing the basis of their relationship through an MOU (Memo of Understanding). This is an important step since you can cover basic issues before involving lawyers and accountants ensuring both partners are on the same page. We highly recommend that companies take the proper time needed at this stage to cover the relevant topics so that there is a clear understanding between both parties on all the major issues.
The MOU may cover confidentiality issues, intentions of the parties, basic obligations on how to carry on the business operations, the governing jurisdiction, investment obligations, etc. Once you have come to an agreement on all of the relevant topics, you should now involve your legal counsels who may bring some additional issues to the table. It is important to remember that an MOU carries very little legal weight in the event that one party does not wish to proceed.
From our perspective, the MOU is more about taking the time to discuss all of the logistics and considerations upfront so that there is less chance of having problems in later stages,
How can joint ventures be structured?
In Chile, this legal-commercial structure of a joint venture may be carried out in two ways:
- Through a legal entity that is incorporated with both parties as shareholders.
- Through a contractual agreement between two parties where all relevant matters are included.
The actual structure that is chosen really depends on the objective at hand. A short term project that is relatively simple may be best through a contractual agreement. A long term project that is more complex in nature may be better structured through a new legal entity.
1. Incorporating a Legal Entity
Incorporation of a new entity with the partners as shareholders is usually the recommendable way to form a joint venture. This solves many of the common issues that arise since it creates a legal structure and there are basic norms that protect the partners involved. Matters such as administration, disputes, equity and capital contributions are already covered in shareholder agreements or the bylaws and may be changed to accommodate the parties’ intentions.
From a practical stand point, it also creates a much simpler accounting structure since both companies put in their agreed capital and the accounting of the new entity is clearly defined with profits or losses covered by the partners in accordance to their participation percentages.
2. Contractual Agreement
The contractual agreement is the less common approach but it includes a few challenges which must be dealt with. A positive aspect is that is quite flexible since both parties are free to negotiate and agree on any and all of the issues that are required. The challenge is that the contract needs to be comprehensive so that no relevant matters are left out. The contract needs to be drafted and carefully reviewed as it is the main legal instrument that will be used in case of a disagreement in the future.
From a practical stand point, a contractual agreement for large complex projects can be difficult to manage due to the accounting and taxation aspects.
Taxation of a Joint Ventures
The taxation will depend on whether the joint venture has been structured purely as a contractual agreement or through a legal entity.
With this in mind, there are still a few key principles regarding taxation of a joint venture:
- A joint venture is taxed depending on the kind of income they produce and the legal structure employed.
- A joint venture that is not structured as a legal entity may be considered a Permanent Establishment (PE) with basically the same tax burdens as a formal company.
- It is important to note that PE’s lack some of the benefits that legal entities possess. PE’s are no longer a desirable business platform as they have been in past years.
- The tax burden in a contractual agreement is much harder to define for each partner making Tax filings much more difficult.
- The tax structure must ensure the recovery of VAT (GST). Once again, in a contractual agreement this is a matter that must be carefully considered.
- The tax structure must look out for any tax leakages. A complex contractual agreement may make it harder to be tax efficient.
- Any agreement should consider fair market value for contributions from the partners. Capital and labour must be clearly defined by the parties.
Joint ventures are often better formed through new legal entities which can be easier to structure and manage than through a contractual agreement. With that being said, it really depends on the project or the goals of the parties as to which way they choose to go since each situation will be different.
The more important aspects that companies need to manage is the relationship factors. A successful joint venture starts with being upfront with expectations, working out the details for how the partnership will function, and generally having a trusting relationship where both parties are willing to be flexible with each other.
Joint ventures are evolving relationships. Positive interactions and dialogue between both parties is critical since problems will inevitably arise. For a joint venture to be successful, it must be able to weather bad moments and adapt to new circumstances as they emerge. Lawyers and accountants cannot help with this part but they can assist helping companies structure the joint venture and prepare for the off-chance that things do not work out.
Ax Legal is a legal and business advisory firm that works with foreign companies in Latin America. Our team of legal and commercial advisors have a distinguished track record of helping foreign technology and services companies to grow and operate in Latin America. Over the years, we have worked with starts up, mid-size businesses, and publicly listed companies. The one common factor that connects are clients is that they are leaders in their field, providing innovative technologies and services to the industrial sectors.
To better understand how we can support you in the Region, please contact Cody Mcfarlane at firstname.lastname@example.org