Joint Ventures – Getting them Right!
Joint ventures can be useful for foreign companies entering Latin America. A local partner can help you have access to established distribution channels, local expertise, existing infrastructure, workforce, etc. Everything that is needed to quickly hit the ground running. In addition, joint ventures can be useful for companies who are already present in a country but may want to work with another company to ensure they have the required expertise or the financial backing to execute a specific project.
Over the years, we have seen many companies work through joint ventures. Some work out with absolutely no problems but the majority at some point have issues that need to be addressed between the partners. In the worst case scenarios, they end abruptly leaving everyone with a bad taste in their mouth. This is particularly true for companies in Latin America who must navigate not only the business and commercial aspects of operating in a foreign jurisdiction but also those that arise from cultural differences.
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.
How to start the process of forming a joint venture?
Once a suitable partner is found, most companies will start by establishing the basis of their relationship through an MOU (Memo of Understanding). The MOU may cover confidentiality issues, intentions of the parties, decisions on how the business will operate, who will manage it, how will decisions be made, the governing jurisdiction, investment obligations, reporting, and taxation, etc.
This is by far the most important step, particularly when there is two companies that come from different cultures and have never worked together. Unfortunately, this is also the step that we see most companies mishandling. This mainly due to companies rushing the process or not covering all the relevant topics.
From our perspective, the MOU is a critical step which will help both partners decide if there is enough common ground for the joint venture to even work. These early stage discussions also outline how potential problems in the future will be solved which is important considering there are almost always issues at some stage.
If there is a clear understanding between both parties on all the major issues, then there is less chance of having problems in later stages. Even if there are problems, companies that have properly worked through the process will know how to overcome them. We highly recommend that companies take extra time at this stage to ensure there are proper discussions.
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.
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 in the bylaws and shareholder agreements.
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.
The disadvantage is that it often involves greater costs due to governance, bookkeeping, and tax compliance obligations for the newly formed entity.
The contractual agreement is the less common approach. It has its challenges which needs to be managed. From a practical stand point, a contractual agreement for large complex projects can be difficult to manage due to the accounting and taxation aspects.
Other challenges can include – Contractual joint venture do not shield the parties from liability that may arise out of the business operations. In addition, the contract used needs to be very detailed so that no relevant matters are left out. This is particularly important since there is no legal framework to work with such as the case when you incorporate a new company.
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.
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.
- 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.
- The tax burden in a contractual agreement is much harder to define for each partner making tax filings much more complex.
- 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 since each situation can be different.
The most important aspect that companies need to manage is the relationship factor. This starts by putting the time and effort into those beginning stages. A successful joint venture starts with being upfront with expectations and then working through all details for how the partnership will function.
Joint ventures are evolving relationships. 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 the relationship part but they can assist helping companies structure the joint venture, knowing which topics to discuss, and prepare for the off-chance that things do not work out.
Ax Legal is an 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